<PAGE>
 
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION

                            Washington, D.C.  20549
                                _______________

                                  FORM 10-Q/A

(Mark One)

[X]     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                 THE SECURITIES EXCHANGE ACT OF 1934
        FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998

                                       OR


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

                         Commission file number 0-24936


                                7TH LEVEL, INC.
             (Exact name of registrant as specified in its charter)

            Delaware                                  75-2480669
(State or other jurisdiction of         (I.R.S. Employer Identification No.)
incorporation or organization)


        1201 Richardson Drive
             Suite 277
          Richardson, Texas                                75080
(Address of principal executive offices)                 (Zip Code)

       Registrant's telephone number, including area code: (972) 498-8100
                                        
     Registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and
(2) has been subject to such filing requirements for the past 90 days.

                           Yes     X         No 
                                 ----            ----

     Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.

        Common Stock, $0.01 Par Value                   17,586,192
            (Title of Each Class)            Number of Shares Outstanding at
                                                      November 6, 1998
<PAGE>
 
                                7TH LEVEL, INC.

                                  Form 10-Q/A
               For the Quarterly Period Ended September 30, 1998

                                     Index

PART I     FINANCIAL INFORMATION                                       Page No.
                                                                      ----------

Item 1     Condensed Consolidated Balance Sheets at September 30, 1998      3
           (Restated) and December 31, 1997     
 
           Condensed Consolidated Statements of Operations for the Three    4
           and Nine Months Ended September 30, 1998 (Restated)   and 1997

           Condensed Consolidated Statements of Changes in Stockholders     5
           Equity for the Nine Months Ended September 30, 1998 (Restated)
           and  the Year Ended December 31, 1997
 
           Condensed Consolidated Statements of Cash Flows for the Nine     6
           Months Ended September 30, 1998 (Restated) and 1997
 
           Notes to Condensed Consolidated Financial Statements (Restated)  7
 
Item 2     Management's Discussion and Analysis of Financial Condition      10
           and Results of Operations
 
PART II    OTHER INFORMATION
 
Item 1     Legal Proceedings                                                17
 
Item 2     Changes in Securities                                            17
 
Item 6     Exhibits and Reports on Form 8-K                                 18
 
           SIGNATURE                                                        19
<PAGE>
 
Part I - FINANCIAL INFORMATION
Item 1.  Condensed Consolidated Financial Statements

                                7TH LEVEL, INC.
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                  (Unaudited)

<TABLE> 
<CAPTION> 
                                                                   September 30, 1998        December 31, 1997
                                                               -------------------------    ------------------
                                                               (As restated - See Note 2)
<S>                                                                 <C>                       <C> 
                                     ASSETS
Cash and cash equivalents                                                $ 7,292,750              $ 2,465,079
Accounts receivable, net                                                      49,876                1,112,026
Inventories                                                                        -                   18,477
Other current assets                                                         122,686                  752,847
                                                                    -----------------          ---------------
               Total current assets                                        7,465,312                4,348,429
Fixed assets, net                                                          3,249,156                4,960,560
Intangible assets, net                                                         8,577                   13,132
Other assets                                                                 114,674                  532,605
                                                                    =================          ===============
               Total assets                                             $ 10,837,719              $ 9,854,726
                                                                    =================          ===============

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Accounts payable                                                           $ 256,896              $ 1,111,732
Accrued expenses and other current liabilities                             3,881,757                5,352,874
Current portion of notes payable                                             485,135                   79,318
                                                                    -----------------          ---------------
               Total current liabilities                                   4,623,788                6,543,924
Notes payable                                                                      -                  377,027
Notes payable to related parties                                                   -                  108,108
Other                                                                        203,395                  366,212
                                                                    -----------------          ---------------
               Total liabilities                                           4,827,183                7,395,271
Commitments and contingencies
Stockholders' equity:
        Series B convertible preferred stock
               ($10,173,151 liquidation value)                             5,479,138                        -
        Common stock                                                         175,862                  137,837
        Additional capital                                                83,990,864               70,642,628
        Accumulated deficit                                              (83,635,328)             (68,333,578)
        Cumulative other comprehensive income                                      -                   12,568
                                                                    -----------------          ---------------
               Total stockholders' equity                                  6,010,536                2,459,455
                                                                    =================          ===============
               Total liabilities and stockholders' equity               $ 10,837,719              $ 9,854,726
                                                                    =================          ===============
</TABLE> 

                            See accompanying notes.

                                       3
<PAGE>
 
                                7TH LEVEL, INC.
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (Unaudited)

<TABLE> 
<CAPTION> 
                                               Three Months Ended    Three Months Ended      Nine Months Ended     Nine Months Ended
                                              September 30, 1998    September 30, 1997      September 30, 1998    September 30, 1997
                                             -------------------   --------------------     ------------------   -------------------
                                         (As restated - See Note 2)                    (As restated - See Note 2)
<S>                                             <C>                     <C> 

Net revenues                                           $ 251,345         $ 3,271,245           $ 785,486             $ 8,432,817
Cost of revenues                                          40,867             558,691             164,210               4,261,839
                                                 ----------------   -----------------    ----------------       -----------------
       Gross profit                                      210,478           2,712,554             621,276               4,170,978
                                                 ----------------   -----------------    ----------------       -----------------
                                                                                                              
Operating expenses:                                                                                           
       Research and product development                1,028,766           4,370,096           3,197,739              12,991,379
       Sales and marketing                               231,317           1,808,237             773,627               5,532,830
       General and administrative                        999,192           1,289,558           4,824,743               4,228,984
       Amortization of intangible assets                   1,518             453,529               4,554                 507,848
                                                 ----------------   -----------------    ----------------       -----------------
             Total operating expenses                  2,260,793           7,921,420           8,800,663              23,261,041
                                                 ----------------   -----------------    ----------------       -----------------
             Operating loss                           (2,050,315)         (5,208,866)         (8,179,387)            (19,090,063)
Interest and other, net                                 (220,198)             30,433          (1,643,225)                311,226
                                                 ----------------   -----------------    ----------------       -----------------
             Net loss                               $ (2,270,513)       $ (5,178,433)       $ (9,822,612)          $ (18,778,837)
                                                                                                              
Dividends on preferred stock                             173,151                   -             173,151                       -
Beneficial conversion feature in association                                                                  
       with preferred stock                            5,479,138                   -           5,479,138                       -
                                                 ================   =================    ================       =================
Net loss available to common stockholders           $ (7,922,802)       $ (5,178,433)      $ (15,474,901)          $ (18,778,837)
                                                 ================   =================    ================       =================
                                                                                                              
Basic and diluted loss per common share                  $ (0.45)            $ (0.38)            $ (1.00)                $ (1.38)
                                                 ================   =================    ================       =================
                                                                                                              
Basic and diluted weighted average                                                                            
       shares outstanding                             17,462,159          13,679,239          15,439,185              13,635,203
                                                 ================   =================    ================       =================
</TABLE> 

                            See accompanying notes.

                                       4
<PAGE>
 
                                7TH LEVEL, INC.
      CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
                                  (Unaudited)

<TABLE> 
<CAPTION> 
                                                                                                                                
                                                Number of Shares  Common       Convertible       Convertible        Additional 
                                                of Common Stock    Stock   Preferred Series A  Preferred Series B    Capital    
                                                -----------------------------------------------------------------------------------
<S>                                             <C>             <C>             <C>             <C>             <C> 
Balance at December 31, 1996                      13,579,522     $ 135,795                                       $ 70,347,110  
                                                                                                                               
Issuance of common stock under                                                                                                 
stock option and stock purchase plan                 198,580         1,986                                            326,634  
                                                                                                                               
Common stock issued upon exercise of                                                                                           
warrants                                               5,634            56                                              1,404  
                                                                                                                               
Common stock issued for consulting services           40,000           400                                             74,600  
                                                                                                                               
Cancellation of unearned common stock issued                                                                                   
as contingent purchase consideration                 (40,000)         (400)                                          (107,120) 
                                                                                                                               
Foreign currency translation adjustment                                                                                        
                                                                                                                               
Unrealized loss on investments                                                                                                 
                                                                                                                               
Net Loss                                                                                                                       
                                                -------------------------------------------------------------------------------
Balance at December 31, 1997                      13,783,736      $137,837              $ -              $ -      $70,642,628  
                                                                                                                               
                                                                                                                               
Issuance of Series A Preferred Stock                                                                                           
   (net of issuance costs of $3,020,862)                                          2,479,138                         2,789,738  
                                                                                                                               
Issuance costs in connection with Notes                                                                             1,467,452  
                                                                                                                               
Beneficial Conversion Feature                                                                                       5,479,138  
                                                                                                                               
Conversion of Series A Preferred Stock                                                                                         
   to Series B Preferred Stock                                                   (2,479,138)       2,479,138                   
                                                                                                                               
Conversion of Notes to Series B Preferred Stock                                                    3,000,000        1,500,000  
                                                                                                                               
Warrants issued to Non-employees                                                                                        7,861  
                                                                                                                               
Common Stock issued upon exercise of warrants      2,813,584        28,136                                               (136) 
                                                                                                                               
Common Stock Granted to Officers                     765,000         7,650                                          1,379,295  
                                                                                                                               
Issuance of Common Stock under Stock and             223,872         2,239                                            672,359  
   Stock Purchase Plan                                                                                                         
                                                                                                                               
Compensation expense on options issued                                                                                         
   to non-employees                                                                                                    52,529  
                                                                                                                               
Cumulative Translation Adjustment                                                                                              
                                                                                                                               
Net Loss                                                                                                                       
                                                                                                                               
                                                -------------------------------------------------------------------------------
 Balance at September 30, 1998                    17,586,192      $175,862              $ -       $5,479,138      $83,990,864  

</TABLE> 

<TABLE> 
<CAPTION> 
                                                   Cumulative             Unrealized
                                              Other Comprehensive         gain (loss)           Accumulated
                                                    Income               on investments           Deficit             Total
                                              -------------------------------------------------------------------------------------
<S>                                             <C>                     <C>                     <C>               <C> 
Balance at December 31, 1996                      $ 51,193                   $  (5,811)         $ (45,875,90)      $ 24,652,387

Issuance of common stock under                      
stock option and stock purchase plan                                                                                    328,620

Common stock issued upon exercise of                
warrants                                                                                                                  1,460

Common stock issued for consulting services                                                                              75,000

Cancellation of unearned common stock issued        
as contingent purchase consideration                                                                                   (107,520)

Foreign currency translation adjustment                                                                                 (38,623)

Unrealized loss on investments                                                   5,811               

Net Loss                                                                                         (22,457,678)       (22,457,678)
                                              -------------------------------------------------------------------------------------
Balance at December 31, 1997                       $12,568                   $       -          (868,333,578)        82,459,455
                                                    
Issuance of Series A Preferred Stock                
   (net of issuance costs of $3,020,862)                                                                              5,268,876

Issuance costs in connection with Notes                                                                               1,467,452

Beneficial Conversion Feature                                                                    (95,479,138)      $          - 

Conversion of Series A Preferred Stock              
   to Series B Preferred Stock                                                                                     $          -

Conversion of Notes to Series B Preferred Stock                                                                       4,500,000  

Warrants issued to Non-employees                                                                                          7,861

Common Stock issued upon exercise of warrants                                                                            28,000

Common Stock Granted to Officers                                                                                      1,386,945

Issuance of Common Stock under Stock and            
   Stock Purchase Plan                                                                                                  674,598
                                                    
Compensation expense on options issued              
   to non-employees                                                                                                      52,529

Cumulative Translation Adjustment                   (12,568)                                                            (12,568)

Net Loss                                                                                          (9,822,612)        (9,822,612)

 Balance at September 30, 1998                -------------------------------------------------------------------------------------
                                                   $     -                   $       -          (883,635,328)        $6,010,536

</TABLE> 

                                       5
<PAGE>
 
                                7TH LEVEL, INC.
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (Unaudited)



<TABLE> 
<CAPTION> 
                                                                                Nine Months Ended       Nine Months Ended
                                                                                September 30, 1998      September 30, 1997
                                                                                ------------------      ------------------
                                                                            (As restated - See Note 2)
<S>                                                                             <C>                     <C> 
Cash flows from operating activities:
      Net loss                                                                       $ (9,822,612)         $ (18,778,837)
      Adjustments to reconcile net loss to net cash used in
           operating activities:
                Non-cash compensation and interest                                      3,096,237                                  -
                Depreciation and amortization                                           1,449,787              3,097,171
                (Gain) loss on sale of assets                                             166,745                (94,802)
                Gain on early retirement of debt                                                -                (10,142)
                Change in operating assets and liabilities                               (213,694)             4,553,338
                                                                                 -----------------       ----------------
                          Net cash used in operating activities                        (5,323,537)           (11,233,272)
                                                                                 -----------------       ----------------

Cash flows from investing activities:
      Capital expenditures                                                                (43,968)              (437,464)
      Proceeds from sale of assets                                                         49,529              5,594,010
      Sale of short-term investments                                                            -              3,791,162
                                                                                 -----------------       ----------------
                          Net cash provided by investing activities                         5,561              8,947,708
                                                                                 -----------------       ----------------

Cash flows from financing activities:
      Issuance of Common Stock under stock option
                and stock purchase plans                                                  674,598                254,288
      Issuance of Common Stock                                                              7,650                    400
      Net proceeds from issuance of preferred stock                                     5,268,876                      -
      Net proceeds from debt issuance                                                   4,310,900                      -
      Proceeds from exercise of warrants                                                   28,000                      -
      Repayment of long-term obligations                                                 (144,377)            (5,750,000)
                                                                                 -----------------       ----------------
                         Net cash provided by (used in ) financing activities          10,145,647             (5,495,312)
                                                                                 -----------------       ----------------

                         Effect of exchange rate changes on cash                                -                (29,013)
                                                                                                         ----------------
                         Net increase (decrease) in cash                                4,827,671             (7,809,889)
Cash and cash equivalents, beginning of period                                          2,465,079             10,798,372
                                                                                 -----------------       ----------------
Cash and cash equivalents, end of period                                               $7,292,750             $2,988,483
                                                                                 =================       ================
</TABLE> 

                            See accompanying notes.

                                       6
<PAGE>
 
                                7TH LEVEL, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

1.  Basis of Presentation

          The condensed consolidated financial statements of 7th Level, Inc.
(the "Company") are unaudited and reflect all adjustments, consisting of normal
recurring adjustments, which are, in the opinion of management, necessary for a
fair presentation of the results for the interim periods.  These condensed
consolidated financial statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended December 31, 1997 and the Company's Quarterly
Reports on Form 10-Q for the quarterly periods ended March 31, 1998 and June 30,
1998.  The results of operations for the three and nine months ended September
30, 1998 are not necessarily indicative of the results for the entire year
ending December 31, 1998.

2.  Restatement

At the November 18, 1998 meeting of the Emerging Issues Task Force, the staff of
the Securities Exchange Commission ("SEC") issued minutes regarding how issuers
should account for convertible securities.  The minutes dealt with, among other
things, the observation, by the Task Force, that in certain circumstances, the
intrinsic value of the beneficial conversion feature may be greater than the
proceeds received from the sale of the convertible instrument.  In those
situations, the Task Force reached a tentative conclusion that the amount of the
discount assigned to the beneficial conversion feature should be limited to the
amount of proceeds received.

As a result of the foregoing, the Company is restating the financial statements
contained in the Quarterly Report of Form 10Q for the three and nine month
periods ended September 30, 1998.  The Company has reduced the beneficial
conversion feature originally recorded in the amount of approximately
$15,000,000 to approximately $5,500,000. The impact of such restatement on the
Company's Condensed Consolidated Statement of Operations and Balance Sheet is as
follows:


<TABLE>
<CAPTION>
                                                        Three Months Ended                      Nine Months Ended
                                                        September 30, 1998                     September 30, 1998
 
                                                  As Restated       As Originally       As Restated         As Originally
                                               -----------------      Reported       ------------------       Reported
                                                                  -----------------                      -------------------
<S>                                            <C>                <C>                <C>                 <C>
Net Loss available to common stockholders           ($7,922,802)      ($17,414,526)       ($15,474,901)        ($24,966,625)
Loss per Common Share                                    ($ .45)            ($1.00)             ($1.00)              ($1.62)
 
 
                                                                            September 30, 1998
                                                 As Restated                                               As Originally
                                               ----------------                                          ------------------
                                                                                                              Reported
                                                                                                         ------------------
Additional Capital                                  $83,990,864                                                  93,482,588 
Accumulated Deficit                                ($83,635,328)                                               ($93,127,052)
</TABLE>

                                       7
<PAGE>
 
3.   Loss per Common Share

          The Company adopted the provisions of Statement of Financial
Accounting Standards No. 128 ("SFAS 128"), Earnings per Share, in the fourth
quarter of 1997, which requires companies to present basic earnings per share
and diluted earnings per share.  Basic loss per share is computed by dividing
loss attributable to common stockholders by the weighted average number of
common shares outstanding during the period.  Diluted loss per share reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock.  There is no
difference between basic and diluted loss per share in the accompanying
financial statements as the potential issuances of common stock had an
antidilutive effect.  Options outstanding to purchase 3,267,807 and 2,589,200
shares of common stock during the three- and nine-month periods ended September
30, 1998 and 1997, respectively, and warrants outstanding to purchase 1,278,195
and 350,000 shares of common stock during the three- and nine-month periods
ended September 30, 1998 and 1997, respectively and 10,000 shares of Series B
Convertible Preferred Stock convertible into 5,000,000 shares of common stock
during the three- and nine-month periods ended September 30, 1998 and notes
payable convertible into 137,562 shares of common stock during the three- and
nine-month periods ended September 30, 1998 and 1997 have not been included in
the computation of dilutive loss per share because to do so would be
antidilutive.

4.   Private Placement

          In May 1998, the Company sold, pursuant to a private placement,
Secured Promissory Notes ("Notes") in the aggregate principal amount of
$4,500,000 and warrants for 675,000 shares of common stock, par value $0.01 per
share ("Common Stock"), of the Company at an exercise price of $0.01 per share.
The Company allocated approximately $1,200,000 of the proceeds from the Notes to
the warrants based on the relative fair values of the Notes and the warrants.
Accordingly, the Company amortized the related debt discount to interest expense
over the period from May 6, 1998 (date of issuance) to July 13, 1998 (date of
exchange  see below).  All of such warrants were exercised in June 1998. On July
9, 1998, the Company obtained stockholder approval for, among other things, an
increase in its authorized Common Stock (the "Certificate of Amendment") at its
1998 Annual Meeting of Stockholders.  The Certificate of Amendment was filed on
July 10, 1998.  On July 13, 1998, the holders of the Notes exchanged the Notes
for 4,500 shares of the Company's Series B Convertible Preferred Stock, $0.01
par value per share ("Series B Convertible Preferred Stock") and warrants to
purchase 1,125,000 shares of Common Stock at an exercise price of $0.01 per
share.  The Company allocated $3,000,000 to Series B Convertible Preferred Stock
and $1,500,000 to warrants in accounting for the exchange.

          In May 1998, the Company also sold, pursuant to a private placement,
shares of Series A Preferred Stock in the aggregate amount of $5,500,000 and
warrants for 1,375,000 shares of Common Stock at an exercise price of $0.01 per
share.  The Company allocated approximately $2,500,000 of the proceeds from the
Series A Preferred Stock to the warrants based on the relative fair values of
the Series A Preferred Stock and the warrants.  All of such warrants were
exercised in June 1998. On July 13, 1998, after the Certificate of Amendment was
approved by the Company's stockholders and was filed with the Secretary of State
of the State of Delaware, the exchange of 5,500 shares of Series A Preferred
Stock for 5,500 shares of Series B Convertible Preferred Stock was effected.

          The Certificate of Designations, Preferences and Rights of Series B
Convertible Preferred Stock (the "Certificate of Designations") provides that on
the original issue date of the Series B Convertible Preferred Stock, the holders
of the Series B Convertible Preferred Stock will have the right to nominate two
members of the Board of Directors of the Company.  The Series B Convertible
Preferred Stock ranks senior and prior to the Common Stock and to all other
classes or series of stock issued by the Company.

                                       8
<PAGE>
 
Dividends accrue on the shares of Series B Convertible Preferred Stock at the
rate of 8% per annum; provided, however, that in the event the Company fails to
redeem the Series B Convertible Preferred Stock on or before April 30, 2005 (the
"Anniversary Redemption Date"), pursuant to the Certificate of Designations, the
dividend rate on the Series B Convertible Preferred Stock shall increase 2% per
annum on each anniversary of the Anniversary Redemption Date. Annual dividends
are cumulative and are payable quarterly in arrears when and as declared by the
Company's Board of Directors. These shares have a liquidation preference of
$1,000 per share. The Series B Convertible Preferred Stock is convertible
immediately into Common Stock, initially at a conversion price of $2.00 per
share, subject to adjustment. The shares of Series B Convertible Preferred Stock
may be redeemed, at the option of the Company, at $1,000 per share on or after
the Anniversary Redemption Date. Upon a change of control, the Company may offer
to redeem such shares at $2,000 per share or the Company may issue to each
holder of Series B Convertible Preferred Stock warrants exercisable for 250,000
shares of Common Stock for each 1,000 shares of Series B Convertible Preferred
Stock owned by such holder at an exercise price of $0.01 per share. The Company
also has optional redemption rights at any time after i) completion of an
underwritten public offering by the Company with gross proceeds to the Company
of at least $20,000,000 and a price per share of Common Stock of at least $4.00
per share, subject to adjustment, or ii) after the Company's Common Stock shall
have traded at an average price in excess of $4.00 per share, subject to
adjustment, for 20 consecutive trading days and the aggregate market value of
the Common Stock held by non-Affiliates of the Company is at least $35,000,000.
The holders of Series B Convertible Preferred Stock also are entitled to certain
preemptive rights, co-sale rights and registration rights.

For the three and nine months ended September 30, 1998, the Company was required
to increase the loss attributable to common stockholders, as a result of the
beneficial conversion feature which arose due to the increase in the market
price of the Company's Common Stock from the date the Company received
commitments with respect to the $10,000,000 financing (April 20, 1998) to the
date of issuance of the Series B Convertible Preferred Stock (July 13, 1998).
The beneficial conversion feature is based upon the difference between the
market price of the 5,000,000 shares of Common Stock into which the Series B
Convertible Preferred Stock is convertible and the carrying value of the Series
B Convertible Preferred Stock on the date of authorized issuance, but is limited
(as discussed above) to the proceeds received with respect to each security
issued.  As the Company allocated $3,000,000 of proceeds to the Series B
Convertible Preferred Stock, and approximately $2,500,000 of proceeds to the
Series A Preferred Stock, the amount of the beneficial conversion feature is
approximately $5,500,000. The one-time occurrence was accounted for similar to a
non-cash dividend and had no effect on the Company's net loss or aggregate
stockholders' equity.

5.   Contingencies

  In connection with the Company's exit from the multimedia CD-ROM content
development and publishing business, including international office closures,
the Company is party to certain controversies.  It is the opinion of management
that adequate provision for losses has been made and the ultimate resolution of
these issues is not expected to have a materially adverse effect on the
Company's financial position, results of operations or cash flows.

                                       9
<PAGE>
 
ITEM 2.     Management's Discussion and Analysis of Financial Condition and
            Results of Operations

     The following information should be read in conjunction with the
financial statements and the notes thereto and in conjunction with Management's
Discussion and Analysis of Financial Condition and Results of Operations in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997 and
the Company's Quarterly Reports on Form 10-Q for the quarterly periods ended
March 31, 1998 and June 30, 1998.  This analysis is provided pursuant to
applicable Securities and Exchange Commission regulations and is not intended to
serve as a basis for projections of future events.


Overview

     The Company continues to leverage its core animation software technology on
the Internet, other narrow and broadband networks and standalone PC's. The
Company has developed a software technology, Agent 7, which can be used to
produce, lip synch and play back animated characters on Web pages and from
within all major PC software packages, such as Microsoft PowerPoint, Word and
Excel. Agent 7 1.0, which was first released for sale on the Company's website
on August 7, 1998, is the first commercial application of 7th Level's core
technology, which has been named Media Control 7, or "Mc7". Mc7 can be used to
control, manipulate and publish multiple sources of media streaming over the
Internet and other networks or multiple sources resident on standalone PCs. 7th
Level plans to release additional applications this year and next, based on Mc7
(1).

     The Company is emerging from the development phase of its new Internet
technology.  The Company released the first application of its new Internet
technology, Agent 7, in August 1998.  Sales of this application are dependent to
a substantial extent on the download of its player, Mc7, which enables Internet
users to view the interactive animation published by Agent 7.  The Company to
date is largely dependent upon its strategic marketing and distribution partners
to proliferate independent downloads of Mc7, and, based upon agreements and
forecasts by such key partners, had anticipated substantial download activity in
the summer of 1998.  For reasons independent of the Company, anticipated
download activity has been delayed, resulting in delay of the Company's proposed
marketing program for Agent 7 and concomitant delay in sales activity.  The
Company has been advised by one of its key marketing partners, RealNetworks,
that it expects to release a final version of its new player accompanied by a
substantial marketing program designed to promote download of its updated player
known as Realplayer G2 in the near future.  G2 will support an auto-install
feature of Mc7 which the Company believes will result in commencement of
substantially more downloads of its player(1).  In addition, with the release
and promotion of G2, RealNetworks will release for sale a special version of
Agent 7 designed for use with RealNetworks' G2 player and has advised the
Company that it intends to support the release of Agent 7 G2 with a substantial
marketing campaign(1).  The Company intends to tailor its own marketing of Agent
7 to the timing and success of the G2 program.  The Company has also been
negotiating licenses of its Agent 7 technology to other companies who would
integrate the technology in their own vertical applications such as web based
training applications.  The Company believes that use of its technology by
others in this fashion will enhance licensees' offerings and therefore represent
an attractive royalty revenue source for the Company in the future(1).

     Realizing that the delay in independent Mc7 downloads could delay a
substantial portion of anticipated sales of Agent 7, the Company accelerated
completion of development of two applications that are not dependent on advance
player download for broad based adoption, namely desktop applications known as
Present 7 and voice activated e-mail known as Mail 7.  The first of these
applications, Present 7, is expected to be completed and ready for marketing
around year end, and Mail 7 is expected to be completed in the first quarter of
1999(1).  The Company has begun discussions with potential marketing and
distribution partners for these applications.   The Company has also completed
an alpha version of its interactive character animation technology for use in
instant messaging such as ICQ and expects to have a beta version ready in the
second quarter of 1999(1).  Instant messaging applications have enjoyed a great

                                       10
<PAGE>
 
deal of growth and attention in the Internet space over the course of the last
year, and in the opinion of management, represents a substantial opportunity for
the Company's technology.

     The Company has begun to realize the benefits of previous actions
reflecting a dramatically lower cost structure primarily due to staff reductions
and associated overhead requirements.  Further, the Company believes actions
taken in the early fourth quarter of 1998, specifically a reduction in the
production personnel in the Glendale, California office and a subleasing of a
portion of the Glendale facility, will reduce expenses by over $1 million on an
annualized basis(1).


Results of Operations

Three Month Periods Ended September 30, 1998 and September 30, 1997

     In the three months ended September 30, 1998, 7th Level net revenues
decreased to $251,345, which is significantly lower than the $3,271,245 achieved
in the three months ended September 30, 1997. Approximately $37,000 of revenues
from custom character work and Agent 7 was recognized in the three months ended
September 30, 1998 which amounted to 15% of total revenues.  The remaining 85%
of revenues were royalties from licenses for the Company's CD-ROM game
technology.  The Company's minimal revenues in the 1998 period represent the
transition from the previous business model and the new strategy as discussed
above.   Included in net revenues for the three months ended September 30, 1997
was $1.8 million for the sale of Dominion, one of the Company's CD ROM game
titles. Excluding the sale of Dominion in the third quarter of 1997,
approximately 51% of remaining net revenues related to product sales and 49% was
from licensing, OEM and development contracts.

     Cost of revenues for the quarter ended September 30, 1998 was $40,867 or
16% of net revenue, including processing of e-commerce sales, royalty payments
and development costs.  For the quarter ended September 30, 1997, cost of
revenues was $558,691 or 17% of net revenues.  The Company expects fluctuations
in gross margin in the future as the Company's new business strategy is
implemented and as changes occur in the composition of the revenues and the
associated cost of revenues.(1)

     Research and product development expenses were $1,028,766 and $4,370,096
for the three months ended September 30, 1998 and 1997, respectively.  Research
and product development costs decreased 76% in the 1998 period due to reductions
in headcount and related expenditures in line with the new business strategy.
Results from the 1997 period included spending for five CD-ROM titles in active
production.

     Sales and marketing expenses were $231,317 and $1,808,237 for the quarter
ended September 30, 1998 and 1997, respectively.  Sales and marketing expenses
included $107,526 and $446,321 of expenses for advertising, marketing and public
relations and $123,791 and $1,361,916 of expenses related to internal staffing
for the three months ended September 30, 1998 and 1997, respectively.  Following
its departure from the CD-ROM games business, the Company has effected various
cost saving measures including staff reductions and lower advertising
expenditures which resulted in the significant decrease in sales and marketing
expenses between the two periods.  The Company expects increases in sales and
marketing expenses in the future as the Company launches the new mc7
applications.(1)

     General and administrative expenses, including amortization of intangible
assets, for the three months ended September 30, 1998 were $1,000,710 compared
with $1,743,087 for the three months ended September 30, 1997.  General and
administrative expenses for the quarter ended September 30, 1997 included
approximately $453,500 amortization for the write off of the goodwill associated
with the San Francisco based Lanpro entities acquired in December 1995.
Excluding the write off, general and administrative expenses decreased
approximately 22% between the two periods.

                                       11
<PAGE>
 
     The Company's interest income was more than offset by interest expense in
the three months ended September 30, 1998.  Net interest expense was $220,198
recognized in the three months ended September 30, 1998 compared to $30,433 net
interest income for the three months ended September 30, 1997.   Included in the
amount for 1998 was approximately $317,000 expense related to amortization of
debt issuance costs and accretion of debt discount following the financing
transaction (see "Liquidity and Capital Resources").

Nine Month Periods Ended September 30, 1998 and September 30, 1997

     For the nine months ended September 30, 1998, net revenues totaled $785,486
compared to $8,432,817 for the nine months ended September 30, 1997. As
previously disclosed and as described above, the Company has transitioned from
the CD-ROM games business and is leveraging the underlying software technologies
in the new business strategy. The 91% decrease in net revenues reflects the
shift in business strategy as the first of the new products on the mc7 platform
was formally released late in the third quarter of 1998 and accordingly, no
significant revenues have been realized.

     Cost of revenues during the nine months ended September 30, 1998 was
$164,210 or 21% of net revenue. For the nine months ended September 30, 1997
cost of revenues was $4,261,839 or 51% of net revenue. The Company expects
fluctuations in gross margin in the future as the Company's new business
strategy is implemented.(1) The gross margin in the first nine months of 1997
was negatively impacted by changes in the revenue mix, through the inclusion of
substantial returns and price protection adjustments and development revenue,
which has a higher cost of revenue than product sales or OEM licensing revenue.

     Research and product development expenses were $3,197,739 for the nine
months ended September 30, 1998 compared to $12,991,379 for the nine months
ended September 30, 1997. Research and product development expenses decreased
75% over the same period of the prior year due to reductions in headcount and
related expenditures in line with the new business strategy.

     Sales and marketing expenses were $773,627 or 98% of revenues, for the nine
months ended September 30, 1998, compared to $5,532,830, or 66% of revenues, for
the nine months ended September 30, 1997. Internal staffing expenses decreased
approximately 84% as a result of personnel reductions and closure of the
Company's international sales and marketing offices. Costs for advertising,
marketing and public relations decreased by 88% in the first nine months of 1998
compared to the first nine months of 1997 as only one product was released
during the 1998 period, the formal launch of which was in early fourth quarter
and therefore marketing activities were negligible in the first nine months of
1998.

     General and administrative expenses were $4,829,297, including amortization
of intangible assets, for the nine months ended September 30, 1998, compared
with $4,736,832 for the nine months ended September 30, 1997. One time charges
were recognized in the first nine months of 1998 totaling $1,824,000 which
included approximately (i)$1,380,000 in non-cash compensation related to stock
granted to the Company's Chairman and Vice Chairman, (ii) $44,000 in charges for
certain stock options and stock warrants granted to consultants and (iii)
$400,000 related to professional fees associated with the terminated merger with
Pulse. Approximately $853,500 of the amount in the 1997 period was for non-
recurring items, including approximately $453,500 for the write off of goodwill
associated with the San Francisco based Lanpro entities acquired in December
1995 and approximately $400,000 was associated with expenses related to employee
resignations in the first quarter of 1997. Excluding these non-recurring
expenses, general and administrative expenses decreased approximately 23%
between the two periods.

     Net interest expense was $1,643,225 for the nine months ended September 30,
1998 compared to $311,226 net interest income for the nine months ended
September 30, 1997.  Included in the amount for 1998 was approximately
$1,657,000 expense related to amortization of debt issuance costs and accretion
of debt discount following the financing transaction (see "Liquidity and Capital
Resources").  The change

                                       12
<PAGE>
 
is also because of lower cash balances available for investment along with
higher average debt outstanding. Included in the amount for 1997 was
approximately $95,000 for the gain recognized from the sale of an office
building, net of the interest capitalized as a cost of financing the acquisition
of land and office building construction.


Liquidity and Capital Resources

          Cash and cash equivalents increased $4,827,671 during the first nine
months of the year to $7,292,750 at September 30, 1998.  The increase is the
result of the $10,000,000 private placement funded in May 1998, offset by
operating activities during the first nine months of 1998.  Net cash used in
operating activities was $5,323,537 which included a net loss of $9,822,612 for
the nine months ended September 30, 1998, offset by non cash items such as
charges for stock grants and amortization of debt issuance costs and accretion
of debt discount described above, as well as the non-cash depreciation and
amortization expenses.  Approximately $710,000 of cash was provided in the nine
months ended September 30, 1998 from the issuance of Common Stock due to
exercises of stock options, stock purchase agreements and stock warrants.  The
Company sold surplus equipment resulting in a loss on disposition of
approximately $167,000, and has significantly curtailed capital expenditures,
with disbursements of approximately $44,000, in the first nine months of 1998
compared to approximately $437,000 in the same period of 1997.  Capital
expenditures for the remainder of 1998 are anticipated to be minimal (1),
however, the Company continues to use cash and operate at a loss.

          In May 1998, the Company sold, pursuant to a private placement, Notes
in the aggregate principal amount of $4,500,000 and warrants for 675,000 shares
of Common Stock at an exercise price of $0.01 per share. The Company allocated
approximately $1,200,000 of the proceeds from the Notes to the warrants based on
the relative fair values of the Notes and the warrants.  Accordingly, the
Company amortized the related debt discount to interest expense over the period
from May 6, 1998 (date of issuance) to July 13, 1998 (date of exchange  see
below).  All of such warrants were exercised in June 1998. On July 9, 1998, the
Company obtained stockholder approval for, among other things, an increase in
its authorized Common Stock and the Certificate of Amendment was filed on July
10, 1998.  On July 13, 1998, the holders of the Notes exchanged the Notes for
4,500 shares of the Company's Series B Convertible Preferred Stock, $0.01 par
value per share ("Series B Convertible Preferred Stock") and warrants to
purchase 1,125,000 shares of Common Stock at an exercise price of $0.01 per
share.

          In May 1998, the Company also sold, pursuant to a private placement,
shares of Series A Preferred Stock in the aggregate amount of $5,500,000 and
warrants for 1,375,000 shares of Common Stock at an exercise price of $0.01 per
share.  The Company allocated approximately $2,500,000 of the proceeds from the
Series A Preferred Stock to the warrants based on the relative fair values of
the Series A Preferred Stock and the warrants.  All of such warrants were
exercised in June 1998. On July 13, 1998, after the Certificate of Amendment was
approved by the Company's stockholders and was filed with the Secretary of State
of the State of Delaware, the exchange of 5,500 shares of Series A Preferred
Stock for 5,500 shares of Series B Convertible Preferred Stock was effected.

          The Certificate of Designations, Preferences and Rights of Series B
Convertible Preferred Stock (the "Certificate of Designations") provides that on
the original issue date of the Series B Convertible Preferred Stock, the holders
of the Series B Convertible Preferred Stock will have the right to nominate two
members of the Board of Directors of the Company.  The Series B Convertible
Preferred Stock ranks senior and prior to the Common Stock and to all other
classes or series of stock issued by the Company.  Dividends accrue on the
shares of Series B Convertible Preferred Stock at the rate of 8% per annum;
provided, however, that in the event the Company fails to redeem the Series B
Convertible Preferred Stock on or before April 30, 2005, (the "Anniversary
Redemption Date") pursuant to the Certificate of Designations, the dividend rate
on the Series B Convertible Preferred Stock shall increase 2% per annum on each
anniversary of the Anniversary Redemption Date.  Annual dividends are cumulative
and are payable quarterly in arrears when and as declared by the Company's Board
of Directors.  These shares

                                       13
<PAGE>
 
have a liquidation preference of $1,000 per share. The Series B Convertible
Preferred Stock is convertible immediately into Common Stock, initially at a
conversion price of $2.00 per share, subject to adjustment. The shares of Series
B Convertible Preferred Stock may be redeemed, at the option of the Company, at
$1,000 per share on or after the Anniversary Redemption Date. Upon a change of
control, the Company may offer to redeem such shares at $2,000 per share or the
Company may issue to each holder of Series B Convertible Preferred Stock
warrants exercisable for 250,000 shares of Common Stock for each 1,000 shares of
Series B Convertible Preferred Stock owned by such holder at an exercise price
of $0.01 per share. The Company also has optional redemption rights at any time
after i) completion of an underwritten public offering by the Company with gross
proceeds to the Company of at least $20,000,000 and a price per share of Common
Stock of at least $4.00 per share, subject to adjustment, or ii) after the
Company's Common Stock shall have traded at an average price in excess of $4.00
per share, subject to adjustment, for 20 consecutive trading days and the
aggregate market value of the Common Stock held by non-Affiliates of the Company
is at least $35,000,000. The holders of Series B Convertible Preferred Stock are
also entitled to certain preemptive rights, co-sale rights and registration
rights.

     For the quarter ended September 30, 1998, the Company was required to
increase the loss attributable to common shareholders, as a result of the
increase in the market price of the Company's Common Stock from the date the
Company received commitments with respect to the $10,000,000 financing (April
20, 1998) to the date of issuance of the Series B Convertible Preferred Stock
(July 13, 1998).  The beneficial conversion feature, which increases the loss
attributable to common shareholders, is based upon the difference between the
market price of the 5,000,000 shares of Common Stock into which the Series B
Convertible Preferred Stock is convertible and the carrying value of the Series
B Convertible Preferred Stock on the date of authorized issuance, or
approximately $5,500,000.  The one-time occurrence was accounted for similar to
a non-cash dividend and had no effect on the Company's net loss or aggregate
stockholders' equity.  In the view of the Company's accountants, based on the
SEC's current position and the recent discussions of the Financial Accounting
Standards Board's Emerging Issues Task Force Topic D-60 (Accounting for the
Issuance of Convertible Preferred Stock and Debt Securities with a Nondetachable
Conversion Feature), the Series B Convertible Preferred Stock conversion feature
is required to be recognized and measured on July 13, 1998, notwithstanding the
fact that the price of the Company's stock was lower than the conversion price
at the time the financing was committed.  The underlying conversion rate was
provided for when the terms of the financing were agreed to and at a price above
the then current market price of the Company's Common Stock, i.e., "out-of-the-
money".  Subsequent to reaching agreement on the financing transaction, the
market price of the Company's Common Stock increased such that the conversion
rate (fixed at the time of the financing commitment) was "in the money" at the
time the securities were issued.  Management does not believe that the required
accounting treatment reflects the favorable impact of the financing on the
Company's financial condition.

     In the normal course of business, the Company evaluates potential
acquisitions, joint ventures and strategic alliances that may complement the
Company's business.  While the Company has no present commitments or agreements
with respect to any material business combinations, the Company may in the
future consummate transactions which may require the Company to issue additional
capital and such issuances may be significant.

     To date, the Company continues to use cash and operate at a loss.  The
Company's ability to achieve positive cash flow depends upon a variety of
factors, including the timely introduction and market success of its products,
the costs of developing, producing and marketing such products, adoption of the
Internet as a medium of commerce and communications and various other factors,
some of which may be beyond the Company's control.  If the Company requires
additional capital, it would seek such funding through additional public or
private financing, although there can be no assurance that the Company will be
able to obtain such financing(1).

                                       14
<PAGE>
 
Year 2000

          In the past, a number of computer software programs were written using
two digits rather than four to determine the applicable year.  As a result,
date-sensitive computer software may recognize a date using "00" as the year
1900 rather than the year 2000.  This could result in major system failures or
miscalculations, and is generally referred to as the "Year 2000" problem.  A
review of the Company's information systems has been completed and a plan is
currently in process to modify or replace those systems that are not Year 2000
compliant.  Management believes that all Company systems are compliant, or will
be compliant by December 31, 1998.  Additional validation of the Company's
systems will be conducted through testing throughout 1999.

          In addition to the assessment of in house systems, the Company  plans
to assess the readiness of its significant vendors for the Year 2000 issue.
Contingency plans will be developed in the event that business-critical vendors
do not provide the Company with satisfactory evidence of their readiness to
handle Year 2000 issues.

          The Company does not believe the costs related to the Year 2000
compliance project will be material to its financial position or results of
operations.  However, the cost of the project and the date on which the Company
plans to complete the Year 2000 modifications are based on management's best
estimates .  Unanticipated failures by critical vendors as well as failure by
the Company to satisfactorily execute its own compliance could have a material
adverse effect on costs and timing of the program.  As a result, there can be no
assurance that these forward-looking estimates will be achieved and the actual
cost and vendor compliance could differ materially from those plans, resulting
in material financial risk.

                                       15
<PAGE>
 
Recently Issued Accounting Principles

          In June 1997, Statement of Financial Accounting Standards No. 131,
Disclosures about Segments of an Enterprise and Related Information ("SFAS No.
131") was issued.  This statement establishes standards for reporting
information about operating segments in annual and interim financial statements,
although this statement need not be applied to interim financial statement in
the initial year of its application.  This statement is effective for fiscal
years beginning after December 15, 1997.  The adoption of SFAS No. 131 is not
expected to have a material impact on the Company's financial statements and
related disclosures.

          In April, 1998, Statement of Position (SOP) 98-5, Reporting on the
Costs of Start-up Activities was issued.  This SOP provides guidance on the
financial reporting of start-up and organization costs and requires that these
costs be expensed as incurred.  The provisions of SOP 98-5 are effective for
financial statements for fiscal years beginning after December 15, 1998.
Adoption of SOP 98-5 is not expected to have a material impact on the Company's
financial statements.  The Company will adopt the provisions of this SOP on
January 1, 1999.

--------------------------------------------------------------------------------
(1)        Certain statements contained herein including those indicated by 
     (1) are forward looking statements that involve risks and uncertainties.
     Accordingly, no assurance can be given that the actual events and results
     will not be materially different than the anticipated results described in
     the forward looking statement. There are a number of important factors that
     could cause actual results to differ materially from those expressed in any
     forward looking statements made by the Company. These factors include among
     others, the Company's ability to complete new products at planned costs and
     on planned schedules, the Company's ability to attract and retain strategic
     partners, the Company's ability to leverage intangible assets in its
     technology, the success of the Company's cost reduction strategy and the
     Company's ability to maintain a sufficient level of financing for its new
     business strategy. Additional factors which are beyond the Company's
     control and could influence results include market acceptance of the
     Company's products and adoption of the Internet as a medium of commerce and
     communications. See the discussion of the Company's business and a
     description of the various factors that could materially affect the ability
     of the Company to achieve the anticipated results described in the forward
     looking statement which is included in Item 1 of the Company's Report on
     Form 10-K for the year ended December 31, 1997.


ITEM 3.     Quantitative and Qualitative Disclosures about Market Risk

Not applicable

                                       16
<PAGE>
 
                                7TH LEVEL, INC.

                          Part II.  Other Information


Item 1.    Legal Proceedings

               Technology Edutainment Network Laboratory Co., Ltd. v. 7th Level,
               -----------------------------------------------------------------
          Inc., United States District Court for the Central District of
          ----                                                          
          California, Case No. 98-3923 AAH (JGx).  On May 19, 1998, plaintiff
          Technology Endutainment Network Laboratory Co., Ltd. ("TEN") filed a
          suit against the Company for alleged breach of contract and related
          claims concerning a contract for development of CD-ROM software,
          seeking $246,000 in alleged damages (the "Action"), and secured an
          order for the issuance of a writ of attachment in the amount of
          $144,000 which was not issued.  On June 29, 1998, TEN instituted
          arbitration proceedings before the American Arbitration Association on
          the same claims it brought in the Action (the "Arbitration").  The
          Company filed defenses and a counterclaim against TEN in the
          Arbitration, seeking $366,000.  On September 16, 1998, the Company and
          TEN entered into a confidential settlement agreement fully and finally
          resolving these matters between them and resulting in dismissal with
          prejudice of both the Action and the Arbitration.

               Thomas Randolph and Kay Randolph v. 7th Level, Inc., San
               ---------------------------------------------------     
          Francisco Superior Court, Case No. 998675.  On October 20, 1998,
          plaintiffs Thomas Randolph and Kay Randolph filed suit against the
          Company for alleged wrongful termination (of Thomas Randolph) and
          alleged breach of contract and covenant of good faith and fair dealing
          arising out of Thomas Randolph's position as the Company's former head
          of its 7th Level Asia Pacific subsidiary.  The complaint seeks
          unspecified compensatory and punitive damages.  The Company believes
          the plaintiffs' claims are without merit and intends to vigorously
          defend itself and expects to file cross-claims against plaintiffs.



Item 2.   Changes in Securities

               On July 9, 1998, the Certificate of Amendment including the
          increase in the number of authorized shares of Common Stock was
          approved by stockholders and on July 10, 1998, the Certificate of
          Amendment was filed with the Secretary of State of the State of
          Delaware.  On July 13, 1998, the holders of the Notes exchanged the
          Notes for 4,500 shares of the Company's Series B Convertible Preferred
          Stock and warrants to purchase 1,125,000 shares of Common Stock at an
          exercise price of $0.01 per share.  Also on July 13, 1998, the
          automatic exchange of 5,500 shares of Series A Preferred Stock for
          5,500 shares of Series B Convertible Preferred Stock was effected.

               The information concerning the Notes, the Series A Preferred
          Stock, the Series B Convertible Preferred Stock and the warrants
          issued with respect to the Notes and the Series A Preferred Stock set
          forth in Part 1, Item 2, "Management's Discussion and Analysis of
          Financial Condition and Results of Operations" in the second and third
          paragraphs under "Liquidity and Capital

                                       17
<PAGE>
 
          Resources" on pages thirteen of this Report is incorporated herein by
          reference.

               The Company believes the sale of the Notes and the warrants
          issued in connection therewith qualifies as a transaction by an issuer
          not involving a public offering within the meaning of Section 4(2) of
          the Securities Act of 1933, as amended (the "Securities Act"), based
          on the manner of offering (a negotiated sale to two "accredited
          investors" (as defined in Rule 501 of Regulation D under the
          Securities Act) without general solicitation) and the purchasers'
          financial status, investment experience and investment intent, as
          represented to the Company.

               The Company believes the sale of the Series A Preferred Stock and
          the warrants issued in connection therewith qualifies as a transaction
          by an issuer not involving a public offering within the meaning of
          Section 4(2) of the Securities Act based on the manner of offering (a
          negotiated sale to "accredited investors" (as defined in Rule 501 of
          Regulation D under the Securities Act) and to two non-accredited
          investors without general solicitation) and the purchasers' financial
          status, investment experience and investment intent, as represented to
          the Company.


Item 6.   Exhibits and Reports on Form 8-K

(a)             Exhibits

          27 -   Financial data schedule

(b)       Reports on Form 8-K

               Registrant filed a Current Report on Form 8-K, dated July 9,
          1998, in respect to the proposals approved at the annual meeting of
          stockholders, the filing of the Certificate of Amendment, the
          automatic conversion of Series A Preferred Stock to Series B
          Convertible Preferred Stock and the exchange of the Notes for Series B
          Convertible Preferred Stock. (Item 5).

                                       18
<PAGE>
 
                                7TH LEVEL, INC.

                                   Signature

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

                                        7TH LEVEL, INC.


Date: March 29, 1999                    By: /s/ Marc E. Landy
                                            ------------------------------------
                                            Marc E. Landy
                                            Chief Financial Officer

                                       19