INTERACTIVE ENTERTAINMENT LTD, 10-K, 1999-08-20

INTERACTIVE ENTERTAINMENT LTD
10-K, 1999-08-20
MISCELLANEOUS MANUFACTURING INDUSTRIES

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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FORM 10-K

(Mark One)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the fiscal year ended December 31, 1998.

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

For the transition period from .

Commission File No. 0-22622

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

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BERMUDA I.R.S. No. 98-0170199
(Jurisdiction of Incorporation) (I.R.S. Employer Identification No.)
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P. O. Box 241603
MEMPHIS, TN 38124
(Address of principal executive offices)

Registrant's telephone number, including area code: 901 685-0200

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:

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Title of each class Name of each exchange on which registered
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Common Stock, Par Value $0.01 per share OTC Bulletin Board
(the "Common Stock")
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SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

None

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
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]

The aggregate market value of the voting stock held by non-affiliates of
the registrant based upon the closing price of $0.08 for the Common Stock as
reported by the OTC Bulletin Board July 30, 1999 is $3,167,047.

The number of shares outstanding of the issuer's Common Stock, as of July
30, 1999: 46,475,000

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for the 1999 Annual Meeting of
Shareholders, which has been filed, are incorporated by reference into Part
III hereof.

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INTERACTIVE ENTERTAINMENT LIMITED

ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

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Page
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Part I
Item 1 Corporate History and Development..................... 1
Business Overview..................................... 1
Recent Developments................................... 2
The Product........................................... 3
The Industry.......................................... 3
Competition........................................... 4
Market and Marketing.................................. 4
Manufacturing......................................... 4
Sky Games System Acquisition.......................... 4
The Amalgamations..................................... 5
Major Customers....................................... 6
Employees............................................. 6
Item 2 Properties............................................ 6
Item 3 Legal Proceedings..................................... 6
Item 4 Submission of Matters to a Vote of Security Holders... 6
Part II
Market for Registrant's Common Equity and Related
Item 5 Stockholder Matters................................... 6
Item 6 Selected Financial Data............................... 9
Management's Discussion and Analysis of Financial
Item 7 Condition and
Results of Operations................................ 9
Overview.............................................. 9
Results of Operations................................. 10
Liquidity and Capital Resources....................... 12
Forward-Looking Information........................... 14
Item 8 Financial Statements and Supplementary Data........... 14
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................. 14
Part III
Item 10 Directors and Executive Officers of the Registrant.... 14
Item 11 Executive Compensation................................ 14
Security Ownership of Certain Beneficial Owners and
Item 12 Management............................................ 14
Item 13 Certain Relationships and Related Transactions........ 14
Part IV
Exhibits, Financial Statement Schedules and Reports on
Item 14 Form 8-K.............................................. 15
Signatures............................................ 19
Financial Statements.................................. F-1
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PART I

Item 1. Business

Corporate History and Development

Interactive Entertainment Limited (the "Company" or "IEL") was incorporated
pursuant to the laws of the Province of British Columbia on January 28, 1981
under the name Tu-Tahl Petro Inc. On May 10, 1990, the Company changed its
name to Creator Capital Inc. The Company was reincorporated through the
continuance of its corporate existence from the Province of British Columbia
to the Yukon Territory on July 15, 1992. On January 23, 1995, the Company
changed its name to Sky Games International Ltd. ("SGI"). Effective February
22, 1995, the Company continued its corporate existence from the Yukon
Territory to Bermuda as an exempted company under the Companies Act 1981
(Bermuda) (the "Bermuda Act"). In June, 1997, the Company changed its name to
Interactive Entertainment Limited following consummation of the amalgamation
of the Company's wholly-owned subsidiary, SGI Holding Corporation Limited
("SGIH"), and SGIH's formerly 80% owned subsidiary, then known as Interactive
Entertainment Limited ("Old IEL"), which was followed immediately by an
amalgamation of SGI with the survivor of the first amalgamation, (the
"Amalgamations"). Unless the context otherwise requires, the term "Company"
refers to Interactive Entertainment Limited, its wholly-owned subsidiaries,
IEL (Singapore) Pte. Ltd., Sky Games International Corporation ("SGIC"), and
Creator Island Equities Inc., and for periods prior to June 17, 1997, also
SGIH and Old IEL, which was the Company's principal operating subsidiary from
December 30, 1994, through such Amalgamations. Also included is Inflight
Interactive Limited, a wholly-owned subsidiary of the Company, from January
13, 1998.

The initial purpose of the Company was natural resource exploration and
development; however, beginning in January 1991 the Company concentrated its
efforts on acquiring, developing and commercializing a gaming technology
marketed as Sky Games(TM) for inflight use by international airline passengers
and patrons in other non-traditional gaming venues. In pursuit of this
purpose, the Company in 1991 acquired the principal assets of Nevada-based Sky
Games International, Inc. ("SGII"). In late 1994, the Company formed Old IEL
as a joint venture with subsidiaries of Harrah's Entertainment, Inc.,
("Harrah's"), which resulted in the transfer to Old IEL of the Company's
inflight gaming business and the execution of a management agreement with
Harrah's with respect to Old IEL and other related relationships. Pursuant to
such management agreement, Old IEL's operations were managed by a Harrah's
subsidiary. The description herein of the Company's operations from December
30, 1994 through June 17, 1997 with respect to inflight gaming activities
refers to the operations of Old IEL under the management of this subsidiary of
Harrah's. Until the Amalgamations, because the management of the business of
Old IEL had been substantially delegated to a third party manager the
management and affairs of the Company were subject to numerous contractual
requirements and limitations.

Business Overview

The Sky Games system was developed to introduce gaming to international
airline passengers. The system is designed to enable users to play a number of
casino-type games from their seats by way of a built-in, color, interactive,
in-seat monitor. The product design in its current form has been possible
since the introduction of audio-video interactive inflight entertainment
hardware ("IFE") systems. The Sky Games system has been integrated with the
IFE systems offered by Matsushita Avionics Systems Corporation ("MASC") and is
also intended to be interfaced with systems manufactured by other leading
manufacturers including, among others, Sextant Avionique In-Flight Systems,
Rockwell Collins, Sony Trans Com Inc. and The Network Connection, Inc.

The Company believes that an opportunity exists to introduce casino games
on international air flights, based on the following factors: (i) many
commercial international air routes involve long flights which create the
opportunity for the entertainment of passengers; (ii) many airlines have
indicated that they view IFE systems as a source of additional revenue; (iii)
in certain parts of the world and in certain markets, gaming is increasing in
popularity and public acceptance; and (iv) as with all casino style gaming,
the odds are in favor of the "house"
<PAGE>

when played over a period of time. The Company has conducted limited field
surveys in conjunction with affiliates of Harrah's to measure passenger
reaction to inflight gaming in general and to gather statistical information
related to game preferences, projected passenger participation, betting limits
and acceptance of the Company's software design. While, these surveys support
the Company's belief regarding inflight gaming, operations on Singapore
Airlines ("SIA") did not validate the surveys.

In April of 1996, the Company announced the signing of contracts for the
provision of gaming services to SIA. The term would commence with SIA's
acceptance, for use on its aircraft, of the Company's gaming software. However,
the agreements are subject to a trial period and to termination by either party
upon the occurrence of specified events. SIA launched the first flight with
gaming on June 1, 1998. A second aircraft was added in mid-October.

The commencement of gaming operations on an airline requires the successful
installation on the airline's aircraft of an IFE system. The Company currently
does not manufacture, provide, install or service IFE systems. The Company
understands that in the past, several airlines have experienced difficulties
with the installation and testing of IFE systems, but based on discussions
among the Company, various airlines and the IFE system providers, the Company
believes that IFE systems are becoming more reliable.

On January 13, 1998, IEL completed the acquisition of all the outstanding
capital stock of Inflight Interactive Limited ("IIL") in exchange for 500,000
shares of the Company's $.01 par value common stock (the "Common Stock"). IIL
is a United Kingdom developer and provider of amusement games to the airline
industry. The games are marketed under the name Sky Plan and are operating on a
number of airlines, including Air China, American Airlines Cathay Pacific,
Continental, Egypt Air, Lauda Air, Malaysia Airlines, and Virgin Atlantic. The
purchase agreement provides for the Company to issue up to 250,000 additional
shares of Common Stock to the previous owners of IIL upon achievement of
certain milestones regarding implementation of the Company's Sky Games gaming
software with an international airline to be designated by the parties. The
acquisition was accounted for using the purchase method.

Recent Developments

On November 12, 1998, the Company announced that it had been unable to
attract the additional capital necessary for continued development of its Sky
Games inflight gaming business and that it had discontinued all operations
associated with the Sky Games product line and planned to conduct an orderly
disposition of all the assets related to the Sky Games product. The Company
stated that it would refocus its business efforts to concentrate exclusively on
its Sky Play PC games, non-gaming inflight customers and business. All
employees were terminated as of November 13, 1998. Some former employees have
been retained on a part-time contract basis to continue operations and support
the Sky Play product. On December 22, 1998, the company announced that it would
also seek bids for its Sky Play amusement game business.

Following these announcements, the company received a series of
communications from shareholders representing approximately 43% of the
company's shares stating a clear interest in seeing that the company retain its
assets and continue its operations. The Company subsequently ceased the sale of
assets. Although Sky Games is not currently operational, the Company continues
to operate the Sky Play business.

On March 22, 1999 SIA notified the Company that it was terminating the
agreements related to Sky Games.

Gordon Stevenson resigned as President and CEO and subsequently resigned
from the company's Board of Directors. Due to an increase in the number of
shares outstanding upon conversion of a portion of the Company's Class B Series
A Preference Shares, Harrah's ownership percentage has decreased to a level
that entitles them to one seat on the Board of Directors. Accordingly, Harrah's
representatives Charles Atwood and Judy Wormser have resigned from the Board.
Quinten Dreesmann, Laurence Geller, Phillip Gordon, and Amnon Shiboleth have
also resigned from the Board of Directors.

2
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The Product

The Sky Games system is a self-contained, computerized gaming system that
enables airline passengers to play popular casino-style games at their seats.
Airlines can add gaming to aircraft fitted with compatible IFE equipment with
only nominal retrofitting cost and little or no aircraft downtime.

The Sky Games software was designed and written in layers. This layered
approach effectively insulates the top-level applications (gaming software)
from the specifics of the underlying hardware. The first level of software is
composed of device and system drivers. Where the hardware is unique to the
specific system, the drivers are provided by the hardware supplier. As
additional layers of software are added, the interface becomes less hardware
specific. The goal is to reach a level of abstraction sufficiently removed
from the hardware details so that the application software needs to have
little, or perhaps no, direct knowledge of the hardware that is supporting the
operating environment. This top-level interface is the Application Programming
Interface ("API"). The IEL software is written to the Microsoft Windows API.
The service integrator will provide an API or APIs that will extend the
Windows API by providing access to IFE specific functions. Any Intel based
platform that can support Microsoft Windows will provide the necessary
operating environment for the gaming software.

In order to operate the Sky Games system in commercial settings, the
Company must provide additional hardware and software systems necessary to
properly record and account for gaming activities by patrons. The Company
designed accounting and financial control systems for the management of
inflight gaming operations. Inflight gaming transactions were conducted
through major credit cards. The major credit card companies have developed
rules for the use of their cards in connection with inflight gaming wherein,
presently, the maximum purchase of gaming credits on a credit card is U.S.
$350 and winnings are capped at U.S. $3,500.

Sky Play offers airlines the choice of up to 18 amusement games. Unlike
Nintento-style games, which are designed to keep the player challenged and
interested over long periods of time, and which generally require player skill
developed over a period of time, IEL has selected and developed the Sky Play
amusement games which have very simple rules, are already well known or easy
to learn and are very simple to play.

The Company has been granted federal registration of the Sky Games logo and
the slogan "We Make Time Fly" by the U.S. Patent and Trademark Office. In
addition, the Company has applied for registration of the Sky Casinos
International logo and the marks "Sea Games International" and "Sky Play." At
this time the Company has not applied for any patents. Upon completion of
successful testing results, an assessment will be made of the Company's gaming
systems and designs and patent applications may be filed where appropriate.
The Company's proprietary software is copyrighted and contains security
features designed to "lock" the software if it is tampered with.

The Industry

The Boeing Company's 1999 Current Market Outlook forecast passenger traffic
growth of 4.7% annually over the next 20 years. The report noted that, to meet
that growth, airlines are expected to add over 20,000 airplanes worth more
than $1.38 trillion to their fleets. Boeing estimates that approximately 26%
of these new aircraft will be intermediate and large aircraft which IEL
believes will represent a substantial market for IFE systems and inflight
content.

Industry statistics indicate that gaming, in general, is gaining increased
market acceptance in many regions of the world and that U.S. casino revenue
increased from U.S. $8.9 billion in 1991 to U.S. $22.8 billion in 1996. North
Americans account for only a portion of the worldwide gaming industry. Casino
gambling, for example, also exists in Australia, the Bahamas, Canada, Denmark,
Chile, Germany, Great Britain, Malaysia, Monaco, the Netherlands, Puerto Rico,
South Africa, Switzerland, Turkey and Uruguay. The U.S. Department of
Transportation estimated in March, 1996, that the potential inflight gaming
revenue for non-U.S. airlines is approximately $480 million per year.

3
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The Company anticipates that the IFE industry will grow rapidly over the
next three to five years as airlines commit to interactive IFE hardware based
on improved product reliability and demonstrated revenue generation.
Accordingly, the Company is committed to building its core business by
focusing initially on the airline market but also investigating the potential
of other venues such as cruise ships, ferry boats, trains and hotel rooms.

Competition

The Company has had two primary competitors for its inflight gaming
systems, including InterGame and Interactive Flight Technologies, Inc.
("IFT"). InterGame installed its system on Lauda Air in March 1998. IFT
launched inflight gaming with Swissair in January 1997. IFT has subsequently
announced that it would sell its inflight gaming business to The Network
Connection, Inc. and exit the business. These companies may have significantly
greater financial and technical resources than the Company, and there can be
no assurance that the Company will be able to compete effectively with such
companies if it reenters the inflight gaming business. The Company believes
that in the event inflight gaming and related activities become more
established, additional competitors with alternate approaches are likely to
enter the business. Other inflight offerings, such as shopping and movies,
could also be considered as indirect competition.

The Company has several competitors for its amusement games most of whom
are small companies like IEL. The Company believes that it is the only
provider of amusement games to the airline industry with games operational on
more than one IFE platform.

Market and Marketing

In the very competitive airline market, airlines are seeking a distinctive,
competitive edge to attract and retain paying customers. Entertainment and
service systems are forming a part of airlines' current business strategy.

The Company's primary target market for Sky Games has been Asian and
Pacific Rim airlines whose passengers, with certain exceptions, generally have
a broad cultural acceptance of gaming. The Company believes that the Latin
American and European markets may also hold strong potential. Gaming is
prohibited on the aircraft of U.S. commercial air carriers and on all flights
to and from the United States.

The Company believes that the principal benefits of its product to the
airlines will be the ability to enhance entertainment offerings to passengers
and airline participation in a potential revenue stream. IFE systems are
capital intensive; however, providing passenger service and comfort,
especially for first and business class travelers, is a major area of
competition for airlines.

The target market for Sky Play has been domestic and foreign airlines which
have committed to the purchase of or installed IFE systems.

Manufacturing

As a software producer and operator, the Company has no manufacturing
capability. The Company's software is designed to interface with in-cabin
hardware, including onboard computers, file servers, distribution and
communication systems, manufactured by various suppliers for the airlines.

Sky Games System Acquisition

On November 7, 1991, the Company entered into an agreement, with subsequent
amendments, with Sky Games International, Inc. ("SGII") to purchase
technology, proprietary rights and prototypes of the casino games known as
"Sky Games." The purchase price of the assets was 300,000 shares of the
Company's $.01 par value common stock (the "Common Stock") issued to SGII at a
deemed price of $1.65 per share, plus an additional 3,000,000 shares of Common
Stock held 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"). Of the 3,000,000 shares, 2,000,000 were issued to SGII
and 1,000,000 shares to Anthony Clements, an advisor to and director of the
Company. The Performance Shares are held in escrow by Montreal Trust Company
of Canada.

4
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As of April 30, 1997, the holders of the Performance Shares have agreed with
the Company to tender such shares to the Company when and if they are released
from the escrow, and the Company has agreed to cancel such shares. The holders
of the Performance Shares have also granted an irrevocable proxy to a bank
which has irrevocably agreed not to vote such shares. Since the Performance
Shares are subject to cancellation and may not be voted, management of the
Company does not consider the Performance Shares to be outstanding.

The Amalgamations

Effective as of December 30, 1994, the Company, through SGIH, and Harrah's
Interactive Investment Company ("HIIC") completed the formation of Old IEL as
a joint venture corporation incorporated as an exempted company under the
Bermuda Act. At the same time, (i) Old IEL entered into a management agreement
(the "Management Agreement") with Harrah's Interactive Entertainment Company
(the "Manager"), (ii) the prior consulting agreement between Harrah's and SGIC
was terminated, (iii) SGIC assigned all right, title and interest in the Sky
Games system and related trademarks and trade names to the Company, and (iv)
the Company licensed the Sky Games system and certain related trademarks and
trade names to Old IEL. In connection with the Amalgamations, the contractual
agreements with the affiliates of Harrah's were terminated.

The ownership interests of the Company and HIIC in Old IEL were 80% and
20%, respectively, prior to the Amalgamations. The Company and HIIC had funded
a total of $5 million to Old IEL. Additional capital, if not available from
third parties, was to have been provided by the Company and HIIC in proportion
to their shareholdings. The Executive Committee of Old IEL was to determine
whether additional capital was to be provided as equity or debt. Under the
shareholders agreement, each party had certain options with respect to the
other party's stock. The shareholders agreement was terminated effective June
17, 1997.

The Manager had been granted and had assumed broad responsibility for
managing the business of Old IEL, including completing the development of and
improving the Sky Games software and all other systems, marketing to airlines
and customers and day-to-day gaming operations. The Management Agreement had a
two-year term, but could have been renewed at the Manager's option for
successive two-year terms up to a maximum term of 10 years. The Manager had a
right of first negotiation on a renewal agreement. Management fees were
dependent on the amount of gross revenues with a maximum fee of 7.5% of gross
revenues and a minimum monthly fee of $10,000. Old IEL was required to pay all
operating costs (including capital expenditures) of the business, which
included the cost of services and goods provided by the Manager and its
affiliates under the Management Agreement.

The Manager could have declared a default under the Management Agreement if
IEL, SGIH, any of SGIH's affiliates or any of their officers, directors or
employees committed any act that the Manager determined could have affected
any gaming license or approval (whether or not any regulatory action was
commenced or threatened) held by the Manager, any of its affiliates, Old IEL,
SGIH or any of SGIH's affiliates.

The Amalgamations were consummated on June 17, 1997, and, in conjunction
with the Amalgamations, the Management Agreement was terminated, and
management of the Company assumed direct responsibility for day to day
operations. The Company also entered into a Continuing Services Agreement with
Harrah's for certain services.

The Company had exclusively licensed Old IEL to use certain of the Sky
Games trademarks, trade names and other trade rights. This license was
replaced in the Amalgamations by a similar license to Harrah's for use of the
Company's software, as it existed on June 17, 1997, in traditional casino
venues owned, operated or managed by Harrah's. The license is royalty-free,
worldwide and non-terminable.

In 1994, the Company terminated certain contractual rights previously
granted to BEA in connection with the development of an earlier generation
product for inflight gaming use. In connection with this termination, the
Company issued a U.S. $2,500,000 convertible promissory note due March 30,
1997. The unpaid balance of the note, including accrued interest, was
exchanged for Redeemable Convertible Class A Preference Shares in the Company
on June 16, 1997.

5
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Major Customers

The Company's Sky Play customers include Air China, American Airlines,
Cathay Pacific Airways, Continental, Egypt Air, Lauda Air, Malaysia Airlines
and Virgin Atlantic Airways. The two largest customers account for
approximately 40% of Sky Play revenue.

Employees

All employees were terminated as of November 13, 1998. Some former
employees have been retained on a part-time contract basis to continue
operations and support the Sky Play product. As of July 30, 1999 the Company
had no employees.

Item 2. Properties

Not applicable.

Item 3. Legal Proceedings

The Company is not currently a party to any material pending legal
proceedings.

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

Not applicable

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

Since March 25, 1999, the Company's Common Stock has been traded on the OTC
Bulletin Board under the symbol "IELSF." From July 8, 1997 until March 24,
1999, the Company's Common Stock was traded on the Nasdaq SmallCap Market
under the symbol "IELSF." From March 1, 1994 until July 8, 1997, the Company's
shares traded on the Nasdaq SmallCap Market under the symbol "SKYGF."

On October 5, 1998, the Company was notified by Nasdaq that the Company's
shares had failed to maintain a bid price greater than or equal to $1.00 per
share for the prior thirty consecutive trading days and were subject to
delisting effective January 5, 1999. Maintenance of a $1.00 stock price is
required for continued listing of the Company's Common Stock on The Nasdaq
SmallCap Market. The Company delayed the delisting by requesting a hearing
before a Nasdaq panel. The hearing was held on February 26, 1999 at which time
the company requested an extension to May 31, 1999 following the company's
annual meeting at which the shareholders would have been asked to approve a
reverse stock split designed to bring the company back into compliance. The
delisting of March 24, 1999 reflects the hearing panel's decision not to grant
that extension. According to written notice received by the company, "the
Panel noted that the Company has failed to comply with the minimum bid price
requirement... In addition, the Panel lacked confidence in the Company's
ability to sustain compliance with the minimum bid price requirement
subsequent to the effectuation of a reverse stock split, particularly in light
of the floating rate' convertible preferred stock currently outstanding." The
company filed an appeal of the delisting but subsequently withdrew the appeal,
since it believed it would not be able to maintain other Nasdaq SmallCap
listing requirements.

The table below sets forth, for each fiscal quarter within the last two
years, the reported high and low closing prices of the Common Stock as
reported by the Nasdaq SmallCap Market.

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Ten Months
Twelve Months Ended Ended December
December 31, 1998 31, 1997
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High Low High Low
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First Quarter......................... $ 3.6250 $ 2.4375 $5.0000 $4.1250
Second Quarter........................ $ 3.7500 $ 2.3125 $4.6250 $2.6250
Third Quarter......................... $ 3.0000 $ 0.6250 $4.9375 $2.3750
Fourth Quarter........................ $ 0.7813 $ 0.0313 $4.5000 $2.3750
</TABLE>

6
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As of May 12, 1998, there were 245 shareholders of record. Since certain of
the shares of Common Stock are held by brokers or other nominees, the number
of record holders may not be representative of the number of beneficial
holders. The Company believes there are approximately 2,600 beneficial holders
of the Company's Common Stock.

The Company has not paid any cash dividends on its Common Stock and does
not anticipate paying any such dividends in the foreseeable future.

In June, 1997, the company issued 2,737 Class A Preference Shares in
exchange for a promissory note in the amount of $2,737,000. During 1998, the
Company and the holder agreed that the Company would redeem the Class A
Preference Shares in installments beginning June 30, 1998. As of August 31,
1998, the Company had redeemed 500 shares at their redemption price of $1,000
per share. The Company was unable to redeem additional shares. As of June 10,
1999, 2,237 Class A Preference Shares remained outstanding and were
convertible into 19,552,221 shares of Common Stock on that date. If the Class
A Preference Shares are converted into Common Stock, HIIC has the right to
receive additional shares of Common Stock at $0.01 per share. As of June 10,
1999, HIIC would be entitled to receive 2,397,303 shares. The actual number of
shares of Common Stock issuable upon conversion may be higher or lower and is
based on a discount to the 20 day average of the mean closing bid and ask
price of the Company's Common Stock and is inversely proportional to the
market price of the Company's Common Stock i.e. if the average share price
decreases, the number of shares of Common Stock issuable increases. Dividends
on the Class A Preference Shares have been paid through September 30, 1998 and
are in arrears for subsequent periods.

In October 1997, the Company completed an agreement with an investor for
the private placement of 925,747 shares of Common Stock for an aggregate
purchase price of $3.0 million. $1.5 million (approximately $1,352,000 net of
offering expenses), ("Tranche A"), was received upon closing while the
remaining $1.5 million ("Tranche B") was to be funded upon and was contingent
upon completion of the first flight with the Company's software available in
all seats of a Singapore Airlines aircraft prior to April 22, 1998. For each
five shares of Common Stock purchased and held for a minimum of six months,
the investor was to have received one warrant for the purchase of additional
shares. Warrants were to be exercisable at a price of $3.8125 per share for 18
months from their issue. As of April 2, 1998 the Company and the investor
agreed to amended terms under which 50% of the remaining portion ($750,000)
was funded immediately while the other 50% was to be funded under the terms of
the original agreement. The subscription price for the Common Stock purchased
in Tranche B was revised to $2.62125. Warrants issuable under Tranche A will
not be issued. However, for each of the 286,123 Common Shares purchased in
Tranche B, 0.85 of a warrant to purchase Common Stock will be issued after a
six month holding period for the Common Stock purchased in Tranche B. The
warrants, if issued, will have an exercise price of $2.62125 and a term of 18
months. The first $750,000 was funded under the amended terms; however, the
flight required for funding of the second $750,000 did not take place prior to
April 22, 1998. Subsequently, IEL and the investor agreed to a $750,000
purchase on the same terms. This additional investment was consummated on June
5, 1998.

7
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an aggregate purchase price of $2,000,000 following the installation of the
Company's gaming software on an SIA aircraft and the availability of the
software to paying passengers in the entire cabin. The Company's option with
respect to the second tranche, was set to expire on June 17, 1998. Upon
agreement of the parties, funding of the second tranche was deferred until a
registration statement for resale of Common Stock issued upon conversion of
the Series A Class B Preference Shares had been declared effective by the SEC.
The registration statement was declared effective on July 15, and the
additional funding of $2,000,000 was completed on July 24, 1998. The original
purchasers of the company's Class B Series A Convertible Preference Shares
converted 600 of the shares into Common Stock, retained 120 shares, and have
sold the remaining 2,280 of the convertible preference shares in private
sales. As of June 10, 1999, 1,280 shares of the Class B Series A Preference
Shares had been submitted for conversion into 28,550,710 shares of Common
Stock. All Common Stock issuable upon the conversions has been issued except
for 3,492,426 shares which the Company lacks the authority to issue since
issuance would cause the Company to exceed its maximum authorized capital.
Subsequent to the conversions, the holders of the Class B Series A Preference
Shares agreed to amend the conversion terms so that the Floating Conversion
Price will not be less than $0.25 per share. Assuming that shareholders of the
Company approve an increase in the authorized capital of the Company, a total
of 1,720 shares of the Class B Series A Preference Shares will be outstanding.
As of June 10, 1999 these 1,720 Class B Series A Preference Shares were
convertible into 6,880,000 shares of Common Stock. The actual number of shares
of Common Stock issued upon conversion may be higher or lower and is based on
a discount to the average of the lowest three closing bid prices of the
Company's Common Stock during the last 30 trading days and is inversely
proportional to the market price of the Company's Common Stock i.e. a lower
market price would result in a greater number of shares of Common Stock being
issued upon conversion.

As of February 20, 1998, the Company sold 300 shares of Series B Class B
Convertible Preferred Stock at $1,000 per share. The Series B Class B
Convertible Preferred Shares have the same dividend and conversion features as
the Series A Class B Convertible Preferred Shares. The investor also received
a warrant to purchase 18,515 shares of Common Stock at a price of $3.2038 for
18 months. As of June 10, 1999, 38 shares of the Series B Class B shares had
been converted into 663,274 shares of Common Stock and 262 shares remained
outstanding. As of June 10, 1999, the 262 outstanding Series B Class B
Preference Shares were convertible into 2,465,882 shares of Common Stock. The
actual number of shares of Common stock issued upon conversion may be higher
or lower and is based on a discount to the average of the lowest three closing
bid prices of the Company's Common Stock during the last 30 trading days and
is inversely proportional to the market price of the Company Common Stock i.e.
if the average share price decreases, the number of shares of Common Stock
issued upon conversion will increase.

It is the Company's intent to renegotiate the conversion terms of the Class
A Preference Shares and the Class B Series B Preference Shares in an attempt
to eliminate the floating conversion price.

8
<PAGE>

Item 6. Selected Financial Data

(in thousands except per share and share data)

<TABLE>
<CAPTION>
Twelve Months Ten Months Twelve Months Ended
Ended Ended February 28 or 29,
December 31, December 31, -----------------------------
1998 1997 1997 1996 1995
------------- ------------ --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Loss before
extraordinary item... $ 29,056 $ 16,312 $ 4,180 $ 4,167 $ 5,684
Extraordinary loss.... -- 1,824 -- -- --
---------- ---------- --------- --------- ---------
Net loss................ $ 29,056 $ 18,136 $ 4,180 $ 4,167 $ 5,684
========== ========== ========= ========= =========
Loss per share before
extraordinary item..... $ 1.40 $ 1.06 $ 0.46 $ 0.52 $ 0.79
Extraordinary item...... -- 0.12 -- -- --
---------- ---------- --------- --------- ---------
Loss per share.......... $ 1.40 $ 1.18 $ 0.46 $ 0.52 $ 0.79
========== ========== ========= ========= =========
Weighted number of
common shares
outstanding (1)........ 20,998,189 15,562,834 9,043,687 7,942,332 7,160,279
Number of common shares
outstanding at period
end(1)................. 24,367,414 19,428,334 9,789,020 8,521,434 7,290,624
</TABLE>

<TABLE>
<CAPTION>
As of February 28 or
As of December 31, 29,
------------------- ----------------------
1998 1997 1997 1996 1995
--------- --------- ------ ------ ------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Working capital (deficit)........ $ (330) $ 697 $ (172) $ (280) $ (522)
Total assets..................... $ 2,509 27,511 3,525 3,861 3,602
Long term debt................... -- 530 2,600 2,346 2,550
Redeemable preferred stock....... 2,237 2,737 -- -- --
Shareholders' equity (deficit)... 1,885 26,337 (333) (54) (695)
Equity (deficit) per common
share........................... $ 0.08 $ 1.36 $(0.03) $(0.01) $(0.10)
</TABLE>
- --------
(1) Excludes Performance Shares

Item 7. Management's 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 January 28, 1981. The Company's activities have been
focused on providing inflight 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 an affiliate of Harrah's Entertainment, Inc. ("Harrah's"), to form a
corporation then known as Interactive Entertainment Limited ("Old IEL"), the
result of which was that Old IEL became owned 80% by SGIH and 20% by Harrah's.
Pursuant to a management agreement, (the "Management Agreement"), Old IEL was
managed by 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, (the "Amalgamation Agreement"), Old IEL was merged into SGIH and then
into SGI (the "Amalgamations"). Prior to the Amalgamations, 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 of Directors. As a
result of the amalgamation of Old IEL and SGIH and the termination of the
Management Agreement, the outstanding shares of Old IEL common stock held by
Harrah's were converted into

9
<PAGE>

5,879,040 shares of $.01 par value common stock of the Company (the "Common
Stock"). Harrah's also received 1,007,875 shares of Common Stock upon
conversion of a loan, (the "Harrah's Loan"), made to Old IEL. Harrah's
therefore became the largest shareholder of the Company holding approximately
38.6% of the outstanding shares at the time of the amalgamation.

Pursuant to the Amalgamation Agreement, Harrah's was provided with the right
to appoint persons to the Board and to specified committees in a number
generally proportionate to their share holdings calculated on a "fully diluted"
basis as defined in the Company's bye-laws. 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 of Common Stock
computed on a fully-diluted basis.

Upon consummation of the Amalgamations, SGI changed its name to Interactive
Entertainment Limited.

The Company has yet to generate any significant operating revenues and has
no assurance of future revenues. Its principal activities through December 31,
1998, consisted of developing, testing and marketing the inflight gaming
software and marketing and supporting its amusement game software. As of
December 31, 1998, IEL had a contract to provide its gaming software to
Singapore Airlines, ("SIA"), which has various termination provisions. On March
22, 1999, SIA notified the Company that it was exercising its termination
rights under the contract. The contract with Singapore Airlines was the
Company's only contract to provide its gaming software to an airline. 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 limit the prospects for additional contracts. The
Company continues to provide its amusement game software to Air China, American
Airlines, Cathay Pacific Airways, Continental, Egypt Air, Lauda Air, Malaysia
Airlines and Virgin Atlantic.

The Company does not believe that it has exposure to the "Year 2000
Problem." Software developed by the Company is compliant with dates in the year
2000. The Company uses commercial software produced by a variety of vendors and
believes that all of its major systems are compliant.

On January 13, 1998, the Company completed the acquisition of all of the
outstanding stock of Inflight Interactive Limited ("IIL") in exchange for
500,000 shares of the Company's Common Stock. IIL is a U. K. developer and
provider of amusement games to the airline industry. IIL's games are currently
operating on Air China, American Airlines, Cathay Pacific, Continental, Egypt
Air, Lauda Air, Malaysia Airlines, and Virgin Atlantic. During 1998, the number
of airline customers increased from five to seven, and the number of installed
aircraft (excluding trials) increased from 54 to 79. The agreement also
provides for the Company to issue up to 250,000 additional shares of Common
Stock to the former owners of IIL upon achievement of certain milestones
regarding implementation of the Company's software with an international
airline to be designated by the parties.

Results of Operations

In April, 1997, the Board of Directors of the Company approved a change in
the Company's fiscal year from the end of February to the end of December.

Twelve Months Ended December 31, 1998 and Ten Months Ended December 31, 1997

Revenue increased from zero to approximately $266,000. The revenue increase
is due to the acquisition of IIL in January, 1998 and the associated revenues.
Inflight gaming did not contribute significantly to revenues in 1998.

General and administrative expenses increased by approximately $306,000
primarily due to comparison of a twelve month period in 1998 to a ten month
period in 1997.

Consulting and contract labor expenses decreased by $2.7 million. The 1997
period included an expense of $2.4 million for Grymyr consulting agreement.

10
<PAGE>

Legal expenses decreased by $345,000. The 1997 period included high
expenses related to the Amalgamations.

Interest expenses decreased by $4.3 million. Interest in 1998 was limited
to interest paid on the Company's convertible debentures which were converted
to Common Stock during the first quarter of the year. Interest in 1997
included $3.5 million for the beneficial conversion feature of the Harrah's
Loan.

Depreciation and amortization expenses increased by $4.2 million. $496,000
of the increase is attributable to amortization of goodwill created with the
January, 1998 purchase of IIL. $413,000 of the increase is attributable to
amortization of the cost of development of the Company's gaming software which
began in June, 1998 when the software was placed in service. The remainder of
the increase is attributable to amortization of the excess of the purchase
price over assets acquired when the Company purchased the minority interest in
Old IEL previously owned by Harrah's; this was included for approximately six
months during the 1997 period and for eleven months of the 1998 period.

The Company incurred $287,000 in expenses related to the closing of the Sky
Games operations. This expense was primarily for severance payments to former
employees.

Following the closing of the Sky Games operations, the Company wrote off
$1.9 million for the value of the Singapore Airlines agreements and the
remainder of the unamortized goodwill in the amount of $13.2 million related
to the June, 1997 purchase of the minority interest in Old IEL. The Company
also wrote down the carrying value of its software by $1.4 million.

Ten Months Ended December 31, 1997 and Twelve Months Ended February 28,
1997

General and administrative expense increased by approximately $1.5 million.
This includes an increase in payroll and related costs of approximately
$307,000 due to increased staffing and an expense in the amount of $650,000
for the value of Company stock granted to Geller & Co. whose stock became
vested following the Amalgamations. Accounting and audit fees increased by
$93,000 as a result of increased reporting requirements following a change in
the Company's status from a foreign private issuer. Travel expenses increased
by $75,000 due to increased travel for marketing and product development.
Recruiting and relocation expenses increased by $82,000 as a result of the
Company building a permanent staff and reducing reliance on contractors. In
conjunction with the Amalgamations, the Company purchased business insurance
resulting in a cost of $79,000; the Company previously had no business
insurance. Rent increased by $92,000 primarily as a result of relocation of
operations from Harrah's corporate headquarters to dedicated leased space for
the Company.

Expenses for consulting and contract labor increased by approximately $1.9
million. These expenses would have decreased by $500,000 except for the $2.4
million expense for the value of 586,077 shares of Common Stock issued to
James P. Grymyr, a former director of the Company, in payment of a consulting
agreement in the second quarter.

Legal expenses increased by approximately $411,000 due to the Amalgamations
and increased financing and reporting activities of the Company.

Interest expense, including amortization of finance fees on Company debt,
totaled $4,478,000 for the ten month period ending December, 1997 and $300,000
for the twelve month period ending February, 1997. The expense for the current
period is composed of $3.5 million for the beneficial conversion feature of
the Harrah's loan, interest on convertible debentures and amortization of
finance fees related to the debentures, while the prior period expense is
related to interest on the convertible note due to B/E Aerospace ("BEA"). The
remainder of the convertible debentures were converted into Common Stock
during the first quarter of 1998, and any unamortized finance fees as of
December 31, 1997 were expensed.

Depreciation and amortization expenses increased by $4.6 million due to
amortization of the excess of the purchase price over assets acquired when the
Company purchased the minority interest in Old IEL previously owned by
Harrah's. There were no comparable expenses in the prior period.

11
<PAGE>

Write-down of assets for the ten months ended December 31, 1997 includes an
adjustment of $449,000 in the value of real estate and other assets owned by
the Company's wholly-owned subsidiary, Creator Island Equities, Inc. These
assets were sold in November, 1997 at the approximate book value following the
adjustment. In December, 1997 the Company wrote off the remaining $210,000
book value of inventory owned by SGIC. The inventory consisted of parts for a
computer gaming system that had previously been in development with BEA. The
$1.3 million write-down of assets for the twelve months ended February 28,
1997 includes the write-off of $138,000 in notes receivable owed to SGIC, the
forgiveness of $550,000 in debt to SGIC in connection with an agreement to
cancel the Performance Shares, and interim write-downs of $442,000 on the
Creator Island Equities real estate and $210,000 on the SGIC inventory.
Following the write-down and disposition of assets, the Company has no
significant remaining assets that are not strategic to its current business
objectives.

An extraordinary expense of $1,824,000 was recorded during the 1997 period
for early extinguishment of the note due to BEA when it was exchanged for the
Class A Preference Shares. There was no extraordinary expense in the prior
period.

Liquidity and Capital Resources

At December 31, 1998 the Company had a working capital deficit of
approximately $330,000. The Company's primary source of funding has been
through sales of its equity and securities convertible into Common Stock. It
is not likely that the Company will be able to continue operations without
additional capital.

12
<PAGE>

On December 17, 1997, the Company issued 1,000 shares of Series A
Convertible Preference Shares of the Company's Class B Preferred Stock for a
total consideration of $1,000.000. The Class B Series A Preference Shares are
convertible into a number of shares of Common Stock, determined by dividing
the stated value of $1,000 per share by the lesser of: $3.2038 (the "Fixed
Conversion Price") and a price (the "Floating Conversion Price") calculated as
85% of the average of the three lowest closing bid prices for the Common Stock
during the thirty trading days occurring immediately prior to, but not
including, the conversion date. Dividends are cumulative and may be paid, at
the option of the Company and with prior notice, in additional shares of
Common Stock at an annual dividend rate of 8%. Warrants for the purchase of
61,718 shares of Common Stock were issued in connection with the issuance of
the Series A Class B Convertible Preference Shares. The warrants, which have
an exercise price of $3.2038, are exercisable beginning June 17, 1998 and
expire on December 17, 1999. Under the agreement, the Company had the option
of selling a second tranche with 123,432 warrants for an aggregate purchase
price of $2,000,000 following the installation of the Company's gaming
software on an SIA aircraft and the availability of the software to paying
passengers in the entire cabin. The Company's option with respect to the
second tranche, was set to expire on June 17, 1998. Upon agreement of the
parties, funding of the second tranche was deferred until a registration
statement for resale of Common Stock issued upon conversion of the Series A
Class B Preference Shares had been declared effective by the SEC. The
registration statement was declared effective on July 15, and the additional
funding of $2,000,000 was completed on July 24, 1998. The original purchasers
of the company's Class B Series A Convertible Preference Shares converted 600
of the shares into Common Stock, retained 120 shares, and have sold the
remaining 2,280 of the convertible preference shares in private sales. As of
June 10, 1999, 1,280 shares of the Class B Series A Preference Shares had been
submitted for conversion into 28,550,710 shares of Common Stock. All Common
Stock issuable upon the conversions has been issued except for 3,492,426
shares which the Company lacks the authority to issue since issuance would
cause the Company to exceed its maximum authorized capital. Subsequent to the
conversions, the holders of the Class B Series A Preference Shares agreed to
amend the conversion terms so that the Floating Conversion Price will not be
less than $0.25 per share. Assuming that shareholders of the Company approve
an increase in the authorized capital of the Company, a total of 1,720 shares
of the Class B Series A Preference Shares will be outstanding. As of June 10,
1999 these 1,720 Class B Series A Preference Shares were convertible into
6,880,000 shares of Common Stock. The actual number of shares of Common Stock
issued upon conversion may be higher or lower and is based on a discount to
the average of the lowest three closing bid prices of the Company's Common
Stock during the last 30 trading days and is inversely proportional to the
market price of the Company's Common Stock i.e. a lower market price would
result in a greater number of shares of Common Stock being issued upon
conversion.

It is the Company's intent to renegotiate the conversion terms of the Class
A Preference Shares and the Class B Series B Preference Shares in an attempt
to eliminate the floating conversion price.

Until the Company receives sufficient cash flow from operations, additional
funding will be required to allow the Company to continue operations during
1999. 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. If adequate
funds are not available from operations or additional sources of funding, the
Company's business will suffer a material adverse effect.

13
<PAGE>

Forward-Looking Information

This Form 10-K contains forward-looking statements that include, among
others, statements concerning the Company's plans to implement its software
products, commence generating revenue from certain of its products,
expectations as to funding its capital requirements, the impact of
competition, future plans and strategies, statements which include the words
"believe," "expect," and "anticipate" and other statements of expectations,
beliefs, anticipated developments and other matters that are not historical
facts. These statements reflect the Company's views with respect to such
matters. Management cautions the reader that these forward-looking statements
are subject to risks and uncertainties that could cause actual events or
results to materially differ from those expressed or implied by the
statements.

Item 8. Financial Statements and Supplementary Data

Financial Statements and Supplementary Data are provided as an exhibit to
Item 14.

Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

Not applicable

PART III

Item 10. Directors and Executive Officers of the Registrant

Directors

See the information set forth in the sections of the Proxy Statement
entitled "Election of Directors" and "Section 16(a) Beneficial Ownership
Reporting Compliance," which sections are incorporated herein by reference.

Executive Officers

See the information set forth in the section of the Proxy Statement
entitled "Executive Officers and Significant Employees," which section is
incorporated herein by reference.

Item 11. Executive Compensation

See the information set forth in sections of the Proxy Statement entitled
"Executive Compensation," "Summary Compensation Table," and "Option Grants in
the Last Fiscal Year" which sections are incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management

See the information set forth under "Security Ownership by Directors,
Officers and Five Percent (or More) Shareholders" as set forth in the Proxy
Statement and incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions

See the information set forth in the section of the Proxy Statement
entitled "Certain Relationships and Related Transactions," which section is
incorporated herein by reference.

14
<PAGE>

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a) Exhibits

1. Financial Statements

Consolidated Balance Sheets at December 31, 1998 and December 31,
1997.

Consolidated Statements of Operations for:
Twelve Months Ended December 31, 1998
Ten Months Ended December 31, 1997
Twelve Months Ended February 28, 1997

Consolidated Statements of Shareholder's Equity
February 29, 1996 through December 31, 1998

Statements of Cash Flow
Twelve Months Ended December 31, 1998
Ten Months Ended December 31, 1997
Twelve Months Ended February 28, 1997

Notes to Consolidated Financial Statements

2. Financial Statement Schedule

15
<PAGE>

3. Other Exhibits

<TABLE>
<CAPTION>
Exhibit Description
------- -----------
<C> <S>
2. Plan and Agreement of Merger and Amalgamation, dated as of May
13, 1997, among the Company, SGI Holding Corporation Limited,
IEL and Harrah's Interactive Investment Company. (Incorporated
by reference to the same numbered exhibit to the Registrant's
Form 8-K as filed with the SEC on June 27, 1997.)

3.i(a) Articles of Incorporation (Yukon Territory). (Incorporated by
reference to Exhibit 1.1 to the Registrant's Annual Report on
Form 20-F (File No. 0-22622) as filed with the SEC on October
12, 1993.)

3.i(b) Certificate of Continuance (Bermuda). (Incorporated by reference
to Exhibit 1.2 to the Registrant's Annual Report on Form 20-F
(File No. 0-22622) as filed with the SEC on September 16, 1996.)

3.ii Bye-Laws as amended. (Incororated by reference to the same
numbered exhibit to the Registrant's Annual Report on Form 10-
K/A No. 2 as filed with the SEC on July 8, 1998.)

4.1 Escrow Agreement dated May 27, 1992, as amended, among Montreal
Trust Company of Canada, the Company and certain shareholders.
(Incorporated by reference to Exhibit 3.2 to the Registrant's
Annual Report on Form 20-F (File No. 0-22622) as filed with the
SEC on October 12, 1993.)

4.2 Redemption Agreement, dated as of February 25, 1997, between the
Company and Anthony Clements and Rex Fortescue. (Incorporated by
reference to Exhibit 3.12 to the Registrant's Annual Report on
Form 20-F (File No. 0-22622) as filed with the SEC on September
12, 1997.)

4.3 Redemption and Cancellation Agreement, dated as of April 30,
1997, between the Company and Sky Games International, Inc.
(Incorporated by reference to Exhibit 3.13 to the Registrant's
Annual Report on Form 20-F (File No. 0-22622) as filed with the
SEC on September 12, 1997.)

4.4 Shareholder Rights Agreement, dated June 17, 1997, between the
Company and Harrah's Interactive Investment Company.
(Incorporated by reference to Exhibit 3.15 to the Registrant's
Annual Report on Form 20-F (File No. 0-22622) as filed with the
SEC on September 12, 1997.)

4.5 Registration and Preemptive Rights Agreement, dated June 17,
1997, between the Company and Harrah's Interactive Investment
Company. (Incorporated by reference to the Exhibit 4(a) to the
Registrant's Form 8-K as filed with the SEC on June 27, 1997.)

4.6 Registration Rights Agreement, dated June 17, 1997, between the
Company and B/E Aerospace, Inc. (Incorporated by reference to
the Exhibit 4(b) to the Registrant's Form
8-K as filed with the SEC on June 27, 1997.)

4.7 Subscription Agreement, dated as of October 22, 1997, between
the Company and Henderson International Investments Limited.
(Incorporated by reference to Exhibit 3.22 to the Registrant's
Quarterly Report on Form 10-Q/A No. 1 as filed with the SEC on
July 8, 1998.)

4.8 Subscription Agreement, dated as of October 22, 1997, between
the Company and Michael A. Irwin. (Incorporated by reference to
Exhibit 3.23 to the Registrant's Quarterly Report on Form 10-Q/A
as filed with the SEC on July 8, 1998.)

</TABLE>

16
<PAGE>

<TABLE>
<CAPTION>
Exhibit Description
------- -----------
<C> <S>
4.9 First Amendment to Registration and Preemptive rights Agreement
dated March 18, 1998 between the Company and Harrah's
Interactive Investment Company. (Incorporated by reference to
Exhibit 99.22 to the Registrant's Amended Registration Statement
on Form
S-3 as filed with the SEC on July 15, 1998.)

4.10 First Amendment to Subscription Agreement between the Company
and Henderson International Investments Limited dated as of
April 2, 1998. (Incorporated by reference to Exhibit 99.23 to
the Registrant's Amended Registration Statement on Form S-3 as
filed with the SEC on July 15, 1998).

4.11 Securities Purchase Agreement between the Company and each of
Marshall Capital Management, Inc. (formerly Proprietary
Convertible Investment Group, Inc.) and CC Investments, LDC
dated as of December 17, 1997. (Incorporated by reference to
Exhibit 99 to the Registrant's Form 8-K as filed with the SEC on
December 24, 1997.)

4.12 Registration Rights Agreement between the Company and each of
Marshall Capital Management, Inc. (formerly Proprietary
Convertible Investment Group, Inc.) and CC Investments, LDC
dated as of December 17, 1997. (Incorporated by reference to
Exhibit 4(c) to the Registrant's Form 8-K as filed with the SEC
on December 24, 1997.)

4.13 Securities Purchase Agreement between the Company and Palisades
Holding, Inc. dated February 20, 1998. (Incorporated by
reference to Exhibit 99.6 to the Registrant's Amended
Registration Statement on Form S-3 as filed with the SEC on July
15, 1998.)

4.14 Registation Rights Agreement between the Company and Palisades
Holding, Inc. dated February 20, 1998. (Incorporated by
reference to Exhibit 99.5 to the Registrant's Amended
Registration Statement on Form S-3 as filed with the SEC on July
15, 1998.)

4.15 Securities Agreement between the Company and B/E Aerospace, Inc.
dated June 25, 1998. (Incorporated by reference to Exhibit 99.1
to the Registrant's Form 8-K filed with the SEC July 2, 1998.)

10.5* Services Agreement, dated as of November 7, 1995, between IEL
and Singapore Airlines Limited. (Incorporated by reference to
Exhibit 3.9 to the Registrant's Annual Report on Form 20-F (File
No. 0-22622) as filed with the SEC on September 16, 1996.)

10.6* Software License and Software Services Agreement, dated as of
November 7, 1995, between IEL and Singapore Airlines Limited.
(Incorporated by reference to Exhibit 3.10 to the Registrant's
Annual Report on Form 20-F (File No. 0-22622) as filed with the
SEC on September 16, 1996.)

10.7 Sublease Agreement dated as of June 5, 1997, between IEL and
Harrah's Operating Company, Inc. (Incorporated by reference to
Exhibit 3.11 to the Registrant's Annual Report on Form 20-F
(File No. 0-22622) as filed with the SEC on September 12, 1997.

10.8 Consulting Agreement, dated as of April 30, 1997, between the
Company and James P. Grymyr. (Incorporated by reference to
Exhibit 3.14 to the Registrant's Annual Report on Form 20-F
(File No. 0-22622) as filed with the SEC on September 12, 1997.

10.9* Software License Agreement, dated June 17, 1997, between the
Company and Harrah's Interactive Investment Company.
(Incorporated by reference to Exhibit 3.16 to the Registrant's
Annual Report on Form 20-F (File No. 0-22622) as filed with the
SEC on September 12, 1997.)

</TABLE>

17
<PAGE>

<TABLE>
<CAPTION>
Exhibit Description
------- -----------
<C> <S>
10.10 Continuing Services Agreement, dated June 17, 1997, between the
Company and Harrah's Interactive Entertainment Company.
(Incorporated by reference to Exhibit 3.17 to the Registrant's
Annual Report on Form 20-F (File No. 0-22622) as filed with the
SEC on September 12, 1997.)

10.11 Termination Agreement and Release, dated as of June 17, 1997,
among the Company, SGI Holding Corporation Limited, IEL,
Harrah's Interactive Investment Company, and Harrah's
Interactive Entertainment Company. (Incorporated by reference to
Exhibit 3.21 to the Registrant's Annual Report on Form 20-F
(File No. 0-22622) as filed with the SEC on September 12, 1997.)

27** Financial Data Schedule.
</TABLE>

*Confidential treatment has been granted.
**Submitted herewith.

(b) Reports Filed on Form 8-K

18
<PAGE>

SIGNATURES

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

/s/ Michael A. Irwin
By: _________________________________
Assistant Secretary
Dated: August 19, 1999

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----

<S> <C> <C>
/s/ John M. Boushy Director August 19, 1999
____________________________________
John M. Boushy

/s/ Anthony P. Clements Director August 19, 1999
____________________________________
Anthony P. Clements

/s/ David Lamm Chief Financial Officer August 19, 1999
____________________________________
David Lamm

/s/ Michael A. Irwin Controller and Principal August 19, 1999
____________________________________ Accounting Officer
Michael A. Irwin
</TABLE>

19
<PAGE>

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors
Interactive Entertainment Limited

We have audited the accompanying balance sheet of Interactive Entertainment
Limited as of December 31, 1998, and the related statements of operations,
shareholders' equity, and cash flows for the year ended December 31, 1998.
These financial statements are the responsibility of the company's management.
Our responsibility is to express an opinion on these financial statements
based on our audit. The consolidated financial statements of Interactive
Entertainment Limited and subsidiaries for the 10 month period ended December
31, 1997 were audited by other auditors whose report dated February 11, 1998
expressed an unqualified opinion on those statements.

We conducted our audit in accordance with generally accepted audited
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principle used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Company as of December 31,
1998, and the results of operations and cash flows for the year ended December
31, 1998 in conformity with generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has limited operations, products, or
facilities, and requires significant resources to implement its plan of
operations that raises substantial doubt about its ability to be a going
concern. Management's plans in regard to these matters are also described in
Note 1. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.

BUCKLEY DODDS
Chartered Accountants

Vancouver, BC
August 6, 1999

F-1
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED

CONSOLIDATED BALANCE SHEETS

(Unaudited)

<TABLE>
<CAPTION>
December 31, December 31,
ASSETS 1998 1997
------ ------------ ------------
<S> <C> <C>
Current assets
Cash and cash equivalents........................ $ 95,642 $ 1,239,864
Accounts and notes receivable, less allowance for
doubtful accounts
of $46,828...................................... 82,356 3,859
Prepaid expenses................................. 115,232 97,205
------------ ------------
Total current assets........................... 293,230 1,340,928
------------ ------------
Furniture, fixtures and equipment, at cost......... 729,578 974,568
Less: accumulated depreciation................... (259,457) (154,610)
------------ ------------
Furniture, fixtures and equipment, net......... 470,121 819,958
Software development costs, net.................... 702,117 2,376,782
Singapore Airlines agreement....................... -- 1,855,800
Other assets....................................... -- 165,599
Goodwill........................................... 1,043,289 20,952,284
------------ ------------
Total assets................................... $ 2,508,757 $ 27,511,351
============ ============
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
<S> <C> <C>
Current liabilities
Accounts payable and accrued expenses............ $ 623,614 $ 644,051
------------ ------------
Total current liabilities...................... 623,614 644,051
Convertible debentures............................. -- 530,000
Shareholders' equity
Class A preferred shares, $0.01 par value,
authorized--3,000 shares, outstanding--2,237
shares and 2,737 shares......................... 22 27
Class B preferred shares, $0.01 par value,
authorized--5,000,000 shares, outstanding--2,662
shares and 1,000 shares......................... 27 10
Common shares, $0.01 par value, authorized--
50,000,000 shares, outstanding--24,367,414 and
19,428,334 shares............................... 243,674 194,283
Additional paid-in capital....................... 65,895,695 60,951,919
Accumulated deficit.............................. (64,254,275) (34,808,939)
------------ ------------
1,885,143 26,337,300
------------ ------------
Total liabilities and shareholders' equity..... $ 2,508,757 $ 27,511,351
============ ============
</TABLE>

F-2
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

<TABLE>
<CAPTION>
Twelve Months Ten Months Twelve Months
Ended Ended Ended
December 31, December February 28,
1998 31, 1997 1997
------------- ----------- -------------
<S> <C> <C> <C>
Revenue............................... $ 266,259 $ -- $ --
Operating Expenses
General and administrative.......... 2,639,601 2,376,127 875,779
Consulting and contract labor....... 343,667 3,092,289 1,195,068
Marketing........................... 174,058 351,582 378,037
Management fees..................... -- 107,584 211,000
Legal............................... 295,781 640,456 229,353
Interest expense.................... 188,249 4,478,244 300,388
Depreciation and amortization....... 8,917,960 4,669,730 87,976
Amalgamation expense................ -- 100,000 --
Interest income..................... (34,865) (17,616) (63,738)
Business discontinuation expenses... 287,298 -- --
Write-down/sale of assets........... 16,510,507 676,899 1,339,279
----------- ----------- ----------
Loss before minority interest and
extraordinary item................... 29,055,997 16,475,295 4,553,142
Minority Interest..................... -- (163,842) (372,829)
----------- ----------- ----------
Loss before extraordinary item........ 29,055,997 16,311,453 4,180,313
Early extinguishment of debt........ -- 1,824,222 --
----------- ----------- ----------
Net Loss.............................. $29,055,997 $18,135,675 $4,180,313
=========== =========== ==========
BASIC AND DILUTED LOSS PER SHARE
Numerator for basic and diluted loss
per share:
Loss before extraordinary item...... $29,055,097 $16,311,453 $4,180,313
Preferred stock dividends........... 389,339 206,512 --
----------- ----------- ----------
Loss to common shareholders before
extraordinary item................. 29,445,336 16,517,965 4,180,313
Extraordinary item.................. -- 1,824,222 --
----------- ----------- ----------
Loss to common shareholders......... $29,445,336 $18,342,187 $4,180,313
=========== =========== ==========
Denominator for basic and diluted loss
per share--weighted average shares
outstanding.......................... 20,988,199 15,562,834 9,043,687
=========== =========== ==========
Loss before extraordinary item........ $ 1.40 $ 1.06 $ 0.46
Extraordinary loss.................... -- 0.12 --
----------- ----------- ----------
Net loss per share.................... $ 1.40 $ 1.18 $ 0.46
=========== =========== ==========
</TABLE>

F-3
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
Class A Class B
Preferred Stock Preferred Stock Common Stock
---------------- ---------------- --------------------- Additional
Number Number Number Paid-in Accumulated
of Shares Amount of Shares Amount of Shares Amount Capital Deficit Total
--------- ------ --------- ------ ----------- -------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, February 29,
1996................... 12,046,434 $ 97,451 $12,134,813 $(12,286,439) $ (54,175)
Net loss............... (4,180,313) (4,180,313)
Exercise of warrants... 893,086 6,547 2,784,961 2,791,508
Exercise of stock
options............... 37,500 276 63,833 64,109
Issuance of shares on
debt conversion....... 162,000 1,191 563,809 565,000
Issuance of shares..... 175,000 1,287 479,963 481,250
----- --- ----- --- ----------- -------- ----------- ------------ -----------
Balance, February 28,
1997................... 13,314,020 106,752 16,027,379 (16,466,752) (332,621)
Net loss............... (18,135,675) (18,135,675)
Preferred stock
dividends............. (206,512) (206,512)
Change in par value.... 26,387 (26,387) --
Issuance of shares on
debenture conversion.. 808,520 8,085 1,625,165 1,633,250
Issuance of shares as
interest on
debentures............ 44,289 443 140,120 140,563
Beneficial conversion
feature on convertible
debentures............ 628,041 628,041
Cancellation of
performance shares.... (3,525,000) (35,250) 35,250 --
Issuance of shares in
connection with
cancellation of
performance shares.... 588,923 5,889 1,834,495 1,840,384
Issuance of shares for
consulting agreement.. 586,077 5,861 2,411,707 2,417,568
Issuance of shares in
connection with the
amalgamation.......... 7,086,915 70,870 31,141,628 31,212,498
Issuance of Class A
preferred stock....... 2,737 27 2,737,416 2,737,443
Beneficial conversion
feature on Class A
preferred stock....... 1,824,222 1,824,222
Issuance of Class B
preferred stock....... 1,000 10 934,000 934,010
Issuance of warrants... 92,223 92,223
Issuance of shares..... 524,590 5,246 1,546,660 1,551,906
----- --- ----- --- ----------- -------- ----------- ------------ -----------
Balance, December 31,
1997................... 2,737 $27 1,000 $10 19,428,334 $194,283 $60,951,919 $(34,808,939) $26,337,300
Net income (loss)...... (29,055,997) (29,055,997)
Preferred stock
dividends............. (389,339) (389,339)
Purchase of Inflight
Interactive Ltd....... 500,000 5,000 1,534,438 23,062 1,562,500
Issuance of shares..... 572,246 5,722 1,404,278 1,410,000
Issuance of shares on
debenture conversion.. 250,299 2,503 527,497 530,000
Issuance of shares as
interest on
debentures............ 2,563 26 5,467 5,493
Redemption of Class A
preferred stock....... (500) (5) (499,995) (500,000)
Issuance of Class B
preferred stock....... 2,300 23 2,275,977 2,276,000
Conversion of Class B
preferred into common. (638) (6) 3,613,972 36,140 (36,134)
Issuance of options for
consulting............ 51,000 51,000
Capital raising
activity.............. (341,814) (341,814)
Eliminate effect of
purchased retained
earnings.............. 23,062 (23,062)
----- --- ----- --- ----------- -------- ----------- ------------ -----------
Balance, December 31,
1998................... 2,237 $22 2,662 $27 $24,367,414 $243,674 $65,895,695 $(64,254,275) $ 1,885,143
===== === ===== === =========== ======== =========== ============ ===========
</TABLE>

F-4
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

<TABLE>
<CAPTION>
Twelve Ten Months Twelve Months
Months Ended Ended Ended
December 31, December 31, February 28,
1998 1997 1997
------------ ------------ -------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net Loss............................ $(29,055,997) $(18,135,675) $(4,180,313)
Reconciliation of net loss to net
cash used in operating activities
Depreciation and amortization..... 8,917,960 4,669,730 87,976
Write-down/sale of assets......... 16,510,507 676,899 1,339,279
Other............................. 14,693 1,939 --
Minority interest................. -- (163,842) (372,829)
Issuance of warrants.............. -- 92,223 --
Issuance of shares for financing
fee.............................. -- 650,000 --
Issuance of shares for consulting
agreement........................ -- 2,417,568 --
Issuance of options for
consulting....................... 50,000 -- --
Extraordinary loss on debt
conversion....................... -- 1,824,222 --
Non-cash interest expense......... 5,494 4,372,115 --
Changes in assets/liabilities
Accounts receivable............. (78,497) 115,909 16,915
Prepaid expenses................ (18,027) (35,230) (58,246)
Other assets.................... 165,599 (165,599) --
Accounts payable and accrued
expenses....................... (20,437) (335,897) 157,096
------------ ------------ -----------
Net cash used in operating
activities................... (3,508,705) (4,015,638) (3,010,122)
------------ ------------ -----------
INVESTING ACTIVITIES
Purchases of furniture and
fixtures and equipment........... (7,672) (683,786) (231,812)
Proceeds from sales of property
and equipment.................... 10,388 435,034 --
Notes receivable.................. -- -- 35,971
Software development.............. (101,280) (572,349) (963,974)
------------ ------------ -----------
Net cash used in investing
activities................... (98,564) (821,101) (1,159,815)
------------ ------------ -----------
FINANCING ACTIVITIES
Issuance of common stock.......... 1,310,563 1,551,906 3,336,867
Issuance of preferred stock....... 2,041,823 934,010 --
Advances from (to) affiliated
companies........................ -- 1,007,875 11,103
Borrowings on note payable........ -- -- 322,819
Proceeds from issuance of
debentures....................... -- 2,163,250 --
Redemption of preferred stock..... (500,000) -- --
Payment of preferred stock
dividends........................ (389,339) (206,512) --
Non-controlling interest.......... -- -- 400,000
------------ ------------ -----------
Net cash provided by financing
activities................... 2,463,047 5,450,529 4,070,789
------------ ------------ -----------
Net decrease in cash.............. (1,144,222) 613,790 (99,148)
Cash, beginning of period......... 1,239,864 626,074 725,222
------------ ------------ -----------
Cash, end of period............... $ 95,642 $ 1,239,864 $ 626,074
============ ============ ===========
Supplemental Cash Flow
Information:
Cash paid for income taxes........ $ 434 $ 7,469 $ 13,000
============ ============ ===========
Cash paid for interest............ $ 182,756 $ 10,893 $ --
============ ============ ===========
</TABLE>

F-5
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1--NATURE OF OPERATIONS

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 activities have been focused on providing inflight
gaming and entertainment software and services by developing, implementing and
operating or licensing computerized video gaming and other entertainment
software on, but not limited to the aircraft of international commercial air
carriers. Gaming software has been marketed using the name Sky Games(TM), and
the entertainment software is marketed using the name Sky Play.

The Company entered into a contract to provide its gaming software to one
international airline, Singapore Airlines ("SIA"). SIA has selected the
Matsushita Avionics Systems Corporation ("MASC") hardware platform and
operating system for its interactive entertainment system. Following an
extensive series of integration tests, laboratory tests and aircraft trials,
SIA launched the first flight with gaming on June 1, 1998 on one aircraft. A
second aircraft was added in mid-October. On November 12, 1998, the Company
announced that it had been unable to attract the additional capital necessary
for continued development of its Sky Games inflight gaming business and that
it had discontinued all operations associated with the Sky Games product line
and would begin to liquidate assets related to the Sky Games business. The
Company also announced that it would refocus its business efforts to
concentrate exclusively on its Sky Plan entertainment games business. All
employees were terminated as of November 13, 1998. On December 22, 1998, the
Company announced that it would also entertain bids for the Sky Play business.
In March, 1999 the Company received notification from SIA that it was electing
to terminate the contract.

Subsequently, the original purchasers of the Company's Class B Series A
Convertible Preference Shares (the "Preference Shares") sold a total of 2,280
of the Preference Shares in private sales. 680 shares of the Preference Shares
were converted by the various new holders into approximately 22.1 million
shares of the Company's $0.01 par value common stock ("Common Stock")
representing in excess of 47% of the total common shares outstanding. The new
holders of the Preference Shares expressed concern at the direction of the
Company and requested that liquidation of the Sky Games assets be
discontinued. Seven of the ten members of the Board of Directors resigned from
the Board.

The Company is currently earning sufficient revenue and generating
sufficient cash flow from the Sky Play operations to meet its current
operating expenses. Shareholders will elect a full Board of Directors at the
next annual meeting to determine the future direction of the Company. In this
regard, management expects the future direction will include expansion of the
Sky Play operations, and may include marketing of the Sky Games gaming
software and expansion into other related markets utilizing its technology.
This is contingent on the raising of sufficient resources to expand the
Company's operations, products and facilities.

On January 13, 1998, the Company completed the acquisition of all the
outstanding capital stock of Inflight Interactive Limited ("IIL") in exchange
for 500,000 shares of Common Stock. IIL is a United Kingdom developer and
provider of amusement games to the airline industry. The games are marketed
under the name Sky Play and are currently operating on a number of airlines,
including Air China, American Airlines, Cathay Pacific, Continental, Egyptair,
Lauda Air, Malaysia Airlines and Virgin Atlantic.

NOTE 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 have been capitalized until the software was
available for general release to customers, in accordance with the provisions
of Statement of Financial Accounting Standards No. 86,

F-6
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise
Marketed. Amortization of the software costs over a three year period started
in June, 1998 upon release of the software to SIA.

Property and Equipment

The Company's property and equipment is recorded at cost and depreciated
using the straight-line and declining balance methods 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.
Depreciation expense was approximately $214,000, $111,000 and $88,000 for the
year ended December 31, 1998, the ten month period ended December 31, 1997 and
the twelve month period ended February 28, 1997, respectively.

Goodwill

The goodwill, which arose from the acquisition of IIL is being amortized on
a straight-line basis over three years. Management regularly evaluates whether
or not the future undiscounted cash flows are sufficient to recover the
carrying amount of this asset. Additionally, management continually monitors
such factors as 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 assets 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
acquisition (January 13, 1998) through December 31, 1998 totaled approximately
$496,000.

Impairment of Long-Lived Assets

In accordance with Statement of Financial Accounting Standard 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, and as discussed below,
significant impairments of long-lived assets occurred during the year ended
December 31, 1998.

The goodwill, which arose from the acquisition of the minority interest of
Old IEL discussed in Note 3, was being amortized on a straight-line basis over
three years. During the year ended December 31, 1998, management determined
that, with the cessation of gaming operations, the future undiscounted cash
flows were not sufficient to recover the carrying amount of this asset and,
accordingly, an impairment had occurred and unamortized goodwill in the amount
of $13.2 million was written off.

In conjunction with the acquisition of the minority interest of Old IEL,
the Company allocated approximately $1,856,000 of the purchase price to the
value of the agreement with Singapore Airlines. This amount was to be
amortized on a straight-line basis over the term of the agreement. The
agreement was for an initial three year term which was to begin upon the
earlier of (a) nine months from the date of the first successful commercial
installation of the software or (b) upon installation of the software in eight
aircraft. Management determined that, with the cessation of gaming operations,
the value of the contract was impaired and the value was written off.

The Company also allocated a portion of the purchase price of the
acquisition of the minority interest of Old IEL to the value of the Company's
software. Additional direct development costs were also incurred for a total
cost of $2.5 million. Upon the cessation of inflight gaming, it was determined
that an impairment had occurred since the future cash flows were not
sufficient to recover the carrying amount of the asset. Since a portion of the
asset continues to have value for the Company's continuing operations future
cash flows were re-estimated resulting in a write down of $1.4 million.

Stock-Based Compensation

The Company accounts for employee stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees, (APB No. 25) and related
interpretations.

F-7
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Loss Per Share

In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings per Share (SFAS No. 128). SFAS No. 128 replaced the calculation of
primary and fully diluted earnings per share with basic and diluted earnings
per share. Unlike primary earnings per share, basic earnings per share
excludes any dilutive effects of options, warrants and convertible securities.
Diluted earnings per share is very similar to the previously reported fully
diluted earnings per share. For the periods ended December 31, 1998, December
31, 1997, February 28, 1997, there is no difference between basic and diluted
loss per share as all stock options, warrants, convertible debentures and
convertible preferred stock are antidilutive for the periods presented. All
loss per share amounts for all periods have been presented, and where
appropriate, restated to conform to the SFAS No. 128 requirements.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect amounts reported in the financial statements and
accompanying notes and in determining the impairment of long-lived assets.
Actual results could differ from those estimates.

Principles of Consolidation

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 Yukon Territory corporation),
IEL (Singapore) Pte. Ltd. (a Singapore corporation), and, since January 13,
1998, Inflight Interactive Limited (a U.K. corporation). For periods prior to
the acquisition of the minority interest in Old IEL discussed in Note 3, the
consolidated financial statements also include the accounts of SGI Holding
Corporation Ltd. and the Company's 80% ownership of Old IEL. All material
intercompany transactions have been eliminated in consolidation.

Comprehensive Income

The Company adopted SFAS No. 130 Reporting Comprehensive Income effective
January 1, 1998. SFAS No. 130 established standards for the reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements. The requirements of SFAS No. 130 include: (a)
classifying items of other comprehensive income by their nature in a financial
statement and (b) displaying the accumulated balance of other comprehensive
income separately from retained earnings and additional paid-in capital in the
equity section of the balance sheet. The Company's comprehensive income (loss)
is substantially equivalent to net income (loss) for the twelve months ended
December 31, 1998, the ten months ended December 31, 1997 and the twelve
months ended February 28, 1997.

Segment Reporting

In 1998, the Company adopted SFAS No. 131 Disclosures about Segments of an
Enterprise and Related Information effective for fiscal years beginning after
December 15, 1997. This statement requires financial statements to disclose
information about products and services, geographic areas and major customers
based on a management approach. The management approach requires disclosing
financial and descriptive information about an enterprise's reportable
operating segments based on reporting information the way management organizes
the segments for making decisions and assessing performance. It also
eliminates the requirement to disclose additional information about
subsidiaries that were not consolidated. For the year ending December 31,
1998, the adoption had no material impact to the Company's disclosure
information and its results of operations.

F-8
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Foreign Currency Translation

Foreign currency assets and liabilities are translated into United States
dollars at the exchange rate prevailing at the balance sheet date. Revenue and
expenses are translated at the average exchange rate during the year.
Translation gains and losses are not material.

Revenue Recognition

Revenue for Sky Games was recognized at the end of each month upon
accumulation of monthly gaming totals and calculation of the settlement with
Singapore Airlines. Revenue for Sky Play is recognized each month upon the
invoicing of customers.

NOTE 3--ACQUISITION OF MINORITY INTEREST

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
"Amalgamation"). As part of the Amalgamation, 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.

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

Prior to the Amalgamation, 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 Amalgamation, the outstanding principal and accrued interest of
the Harrah's Loan converted automatically into 1,007,875 shares of Common
Stock at $1.00 per share. Since the Harrah's Loan was convertible into Common
Stock at less than the current market, a beneficial conversion feature was
included in the Harrah's Loan. This beneficial conversion feature was valued
at $3,466,000 and has been included in interest expense for the ten months
ended December 31, 1997.

NOTE 4--CONVERTIBLE DEBENTURES

During the ten months ended December 31, 1997, the Company issued
$2,163,250 of 8% convertible debentures due in 1999. At December 31, 1997,
$1,633,250 of the debentures had been converted into 808,520 shares of Common
Stock. The outstanding balance of convertible debentures as of December 31,
1997 totaled $530,000.

Subscription dates ranged from July 7 through September 29, 1997. The
debentures were convertible 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.

F-9
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The debentures contained a feature that provided for conversion into Common
Stock at a price below the current market at the time of issue. The value of
this beneficial conversion feature, totaling approximately $628,000, was
capitalized in other assets with a corresponding increase to additional paid-
in capital. Placement fees of $149,000 incurred upon sale of the debentures
were also capitalized. The value of the conversion feature and the placement
fees were amortized to interest expense over the original life of the
debenture. Any unamortized amount was expensed upon conversion of the
debenture. At December 31, 1997, the unamortized deferred interest charge and
unamortized placement fees of $148,000 were included in other assets. The last
portion of the debentures were converted into Common Stock during the first
quarter of 1998.

NOTE 5--LEASES

The Company leased certain facilities under an operating lease expiring
April 30, 1999. Total lease and rent payments amounted to $105,600, $139,000,
and $38,000, for the twelve month period ended December 31, 1998, the ten
month period ending December 31, 1997 and the twelve month periods ending
February 28, 1997, respectively.

NOTE 6--EMPLOYEE BENEFITS

On July 1, 1997, the Company established an employee savings plan that
qualifies under Section 401(k). All employees of the Company may participate
after completion of one year of service by deferring from 1 percent to 16
percent of their eligible compensation. There is no provision for Company
contributions to the Plan.

NOTE 7--SHAREHOLDERS' EQUITY

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, an agreement was reached
with BEA to exchange the note in the amount of $2,737,000, including accrued
and unpaid interest, for Class A Preference Shares at $1,000 per share. The
exchange for 2,737 Class A Preference Shares was completed in June, 1997.
During 1998, the Company and BEA agreed that the Company would redeem the
Class A Preference Shares in installments beginning June 30, 1998. As of
August 31, 1998, the Company had redeemed 500 shares at their redemption price
of $1,000 per share. The Company was unable to redeem additional shares.

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. Dividends on the Class A Preference Shares were $228,305 in 1998
of which $50,756 for the fourth quarter remained unpaid and in arrears at year
end. The Class A Preference Shares do not have any voting rights. As of June
10, 1999, 2,237 Class A Preference Shares remained outstanding and were
convertible into 19,552,221 shares of Common Stock on that date. If the Class
A Preference Shares are converted into Common Stock, HIIC has the right to
receive additional shares of Common

F-10
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Stock at $0.01 per share. As of June 10, 1999, HIIC would be entitled to
receive 2,397,303 shares. The actual number of shares of Common Stock issuable
upon conversion may be higher or lower and is based on a discount to the 20
day average of the mean closing bid and ask price of the Company's Common
Stock and is inversely proportional to the market price of the Company's
Common Stock i.e. if the average share price decreases, the number of shares
of Common Stock issuable increases.

Since the Preference Shares were convertible into Common Stock at less than
the market value at the time of issue, a beneficial conversion feature existed
requiring that the Preference Shares be valued at the market value of the
underlying Common Stock. Since the resulting valuation of the Preference
Shares exceeded the balance of the note, an extraordinary expense of
approximately $1,824,000 was incurred during the ten months ended December 31,
1997 for early extinguishment of the note.

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

On December 17, 1997, the Company issued 1,000 shares of Series A
Convertible Preference Shares of the Company's Class B Preferred Stock for a
total consideration of $1,000,000. The Class B Series A Preference Shares are
convertible into a number of shares of Common Stock, determined by dividing
the stated value of $1,000 per share by the lesser of: $3.2038 (the "Fixed
Conversion Price") and a price (the "Floating Conversion Price") calculated as
85% of the average of the three lowest closing bid prices for the Common Stock
during the thirty trading days occurring immediately prior to, but not
including, the conversion date. Dividends are cumulative and may be paid, at
the option of the Company and with prior notice, in additional shares of
Common Stock at an annual dividend rate of 8%. Warrants for the purchase of
61,718 shares of Common Stock were issued in connection with the issuance of
the Series A Class B Convertible Preference Shares. The warrants, which have
an exercise price of $3.2038, are exercisable beginning June 17, 1998 and
expire on December 17, 1999. Under the agreement, the Company had the option
of selling a second tranche with 123,432 warrants for an aggregate purchase
price of $2,000,000 following the installation of the Company's gaming
software on an SIA aircraft and the availability of the software to paying
passengers in the entire cabin. The Company's option with respect to the
second tranche, was set to expire on June 17, 1998. Upon agreement of the
parties, funding of the second tranche was deferred until a registration
statement for resale of Common Stock issued upon conversions of the Series A
Class B Preference Shares had been declared effective by the SEC. The
registration statement was declared effective on July 15, and the additional
funding of $2,000,000 was completed on July 24, 1998. The original purchasers
of the company's Class B Series A Convertible Preference Shares converted 600
of the shares into Common Stock, retained 120 shares, and have sold the
remaining 2,280 of the convertible preference shares in private sales. As of
June 10, 1999, 1,280 shares of the Class B Series A Preference Shares had been
submitted for conversion into 28,550,710 shares of Common Stock. All Common
Stock issuable upon the conversions has been issued except for 3,492,426
shares which the Company lacks the authority to issue since issuance would
cause the Company to exceed its maximum authorized capital. Subsequent to the
conversions, the holders of the Class B Series A Preference Shares agreed to
amend the conversion terms so that the Floating Conversion Price will not be
less than $0.25 per share. Assuming that shareholders of the Company

F-11
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

approve an increase in the authorized capital of the Company, a total of 1,720
shares of the Class B Series A Preference Shares will be outstanding. As of
June 10, 1999 these 1,720 Class B Series A Preference Shares were convertible
into 6,880,000 shares of Common Stock. The actual number of shares of Common
Stock issued upon conversion may be higher or lower and is based on a discount
to the average of the lowest three closing bid prices of the Company's Common
Stock during the last 30 trading days and is inversely proportional to the
market price of the Company's Common Stock i.e. a lower market price would
result in a greater number of shares of Common Stock being issued upon
conversion.

In October 1997, the Company completed an agreement with an investor for
the private placement of 925,747 shares of Common Stock for an aggregate
purchase price of $3.0 million, $1.5 million (approximately $1,352,000 net of
offering expenses), ("Tranche A"), was received upon closing while the
remaining $1.5 million ("Tranche B") was to be funded upon and was contingent
upon completion of the first flight with the Company's software available in
all seats of a Singapore Airlines aircraft prior to April 22, 1998. For each
five shares of Common Stock purchased and held for a minimum of six months,
the investor was to have received one warrant for the purchase of additional
shares. Warrants were to be exercisable at a price of $3.8125 per share for 18
months from their issue. As of April 2, 1998 the Company and the investor
agreed to amended terms under which 50% of the remaining portion ($750,000)
was funded immediately while the other 50% was to be funded under the terms of
the original agreement. The subscription price for the Common Stock purchased
in Tranche B was revised to $2.62125. Warrants issuable under Tranche A will
not be issued. However, for each of the 286,123 Common Shares purchased in
Tranche B, 0.85 of a warrant to purchase Common Stock will be issued after a
six month holding period for the Common Stock purchased in Tranche B. The
warrants, if issued, will have an exercise price of $2.62125 and a term of 18
months. The first $750,000 was funded under the amended terms; however, the
flight required for funding of the second $750,000 did not take place prior to
April 22, 1998. Subsequently, IEL and the investor agreed to a $750,000
purchase on the same terms. This additional investment was consummated on June
5, 1998.

During the ten months ended December 31, 1997, the Company changed the par
value of the Common Stock from C$.01 (Canadian dollars) to $.01 (United States
dollars). The change in par value did not affect any of the existing rights of
shareholders and has been recorded as an adjustment to additional paid-in
capital and Common Stock.

As of December 31, 1998, potential issuance of Common Stock pursuant to
stock option plans and warrants totaled 3,742,761 shares. As of June 10, 1999,
an additional 34,787,832 shares would be required for the convertible
preferred stock and preemptive rights agreements.

NOTE 8--STOCK OPTIONS

The Company follows APB No. 25 in accounting for its employee stock
options. Under APB No. 25, no compensation expense is recognized because the
exercise price of the Company's incentive employee stock options is equal to
or greater than the market price of the underlying stock on the date of grant.

Prior to February 28, 1995, the Directors of the Company issued stock
options to employees and directors under individual agreements between the
Company and the individuals. Exercise prices and terms were determined by the
Board of Directors. At December 31, 1998, no stock options issued prior to
February 28, 1995 are outstanding.

During the year ended February 29, 1996, the Company established and the
Company's shareholders subsequently approved the 1996 Stock Program for the
then upper management, directors and major shareholders of the Company. Under
this plan, the Company could grant options to purchase up to 1,500,000 shares
of Common Stock at prices not less than the fair market value of the stock on
the day of grant. The 1,130,000 options issued under the 1996 Stock Program
are exercisable upon the grant date and expire during 2001 through 2002. No
further grants under the 1996 Stock Program will be made by the Company.

F-12
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The Company adopted on December 6, 1996, a Directors Stock Ownership 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. On
October 17, 1997, the Board of Directors of the Company approved an amendment
changing the grant date from December 10 to the date of the first meeting of
the Board of Directors following the Company's Annual General Meeting of
shareholders. The 240,000 options granted under this plan are exercisable upon
the grant date and expire ten years after the grant date.

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 Compensation Committee of the Board of Directors has the
authority to determine the allocation and vesting requirements for such
options issued under the MIP. The exercise price of stock options granted
under the MIP is the market price of the Common Stock on the date of the
grant. A total of 1,200,000 options will vest specifically on the earlier of
sustaining certain stock price levels or ten years from the date of the grant.
The remaining 390,341 options outstanding under this plan vested upon
employees remaining with the Company for a specified period of time.
Approximately 1.4 million non-vested options held by employees were canceled
during 1998 following termination of employees.

A summary of the Company's stock option activity and related information
follows:

<TABLE>
<CAPTION>
Twelve Months
Twelve Months Ended Ten Months Ended Ended February 28,
December 31, 1998 December 31, 1997 1997
-------------------- ------------------ -------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
# Options Price # Options Price # Options Price
---------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of period.............. 3,817,950 $3.11 1,190,000 $3.06 1,167,500 $2.98
Granted............... 2,434,150 1.52 2,627,950 3.14 60,000 4.13
Exercised............. -- -- -- -- (37,500) 2.32
Expired............... (3,291,759) 2.21 -- -- -- --
---------- ----- --------- ----- --------- -----
Outstanding at end of
period................. 2,960,341 $2.81 3,817,950 $3.11 1,190,000 $3.06
========== ===== ========= ===== ========= =====
Options exercisable at
end of period.......... 1,760,341 $2.68 1,190,000 $3.06 1,190,000 $3.06
========== ===== ========= ===== ========= =====
Weighted average fair
value of options
granted during the
period................. $1.52 $1.99 $2.61
===== ===== =====
</TABLE>

Exercise prices for stock options outstanding at December 31, 1998, ranged
from $0.970 to $4.13. The weighted average remaining life of the outstanding
stock options is approximately 6 years.

Pro forma information regarding net loss and loss per share is required by
Statement of Financial Accounting Standards No. 123, Accounting for Stock-
Based Compensation (SFAS No. 123) and has been determined as if the Company
had accounted for its employee stock options under the fair value method. The
fair value for these options at the date of grant was estimated using a Black-
Scholes option pricing model with the following weighted average assumptions
for the year ended December 31, 1998, the ten months ended December 31, 1997
and the year ended February 28, 1997, respectively: volatility factor of the
expected market value of the Company's Common Stock of 2.808, 0.715 and 0.715;
weighted average expected life of the options of 5 years for each period;
risk-free interest rate of 5.75% for each period; and no dividend payments.

The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require

F-13
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information follows:

<TABLE>
<CAPTION>
Twelve Twelve
Months Ten Months Months
Ended Ended Ended
December December February
31, 1998 31, 1997 28, 1997
----------- ----------- ----------
<S> <C> <C> <C>
Net loss..................................... $29,055,997 $18,135,675 $4,180,313
SFAS No. 123 compensation expense............ 3,332,306 438,574 156,600
----------- ----------- ----------
SFAS No. 123 pro forma net loss.............. $32,388,303 $18,574,249 $4,336,913
=========== =========== ==========
Basic and diluted pro forma loss per share... $ 1.54 $ 1.21 $ 0.48
=========== =========== ==========
</TABLE>

Because SFAS No. 123 applies only to stock-based compensation awards for
the fiscal year ended February 29, 1996 and future years, the pro forma
disclosures under SFAS No. 123 are not likely to be indicative of future
disclosures until the disclosures reflect all outstanding, nonvested awards.

NOTE 9--STOCK WARRANTS

As of December 31, 1998, the Company had outstanding stock warrants for
782,420 shares of its Common Stock as follows:

<TABLE>
<CAPTION>
Exercise
Number of Warrants Price Expiration Date
------------------ -------- ---------------
<S> <C> <C>
12,343 $3.81 October 22, 1999
185,152 $3.20 December 17, 1999
18,515 $3.20 February 20, 2000
243,205 $2.62 April 21, 2000
243,205 $2.62 June 5, 2000
4,900 $4.00 June 30, 2002
17,500 $4.80 June 30, 2002
57,600 $4.80 August 31, 2002
</TABLE>

NOTE 10--INCOME TAXES

As a Bermuda exempted company, the Company is not currently subject to
income tax filing requirements in Bermuda. The Company operates in the U.S. as
a branch of a foreign corporation. As a foreign corporation with a U.S. trade
or business, the Company will be subject to tax in the U.S. on the income
earned that is effectively connected with that trade or business. Tax
carryforward in taxable jurisdictions have not been determined. Deferred tax
assets, if any, would be fully reserved. Other than the tax associated with
the U.S. earned interest income, there are no income tax provisions, benefits,
liabilities or assets reflected in the accompanying financial statements.

F-14
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 11--WRITE-DOWN OF ASSETS

The following assets were written down to a nominal or current value in the
period due to impairment in the assets value: (See Note 2, Impairment of Long-
Lived Assets).

<TABLE>
<CAPTION>
Ten Months Ended
Twelve Months Ended December 31, Twelve Months Ended
December 31, 1998 1997 February 28, 1997
------------------- ---------------- -------------------
<S> <C> <C> <C>
Land.................... -- $449,267 $ 442,238
Furniture, fixtures and
equipment.............. $ 134,589 18,045 --
Other assets............ -- 209,587 209,587
Software under
development............ 1,362,934 -- --
Notes receivables....... -- -- 137,803
Due from affiliated
company (Note 13)...... -- -- 549,651
Singapore Airlines
Agreement.............. $ 1,855,800 -- --
Goodwill................ $13,157,184 -- --
----------- -------- ----------
$16,510,507 $676,899 $1,339,279
=========== ======== ==========
</TABLE>

NOTE 12--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. The Management Agreement was terminated June
17, 1997, in conjunction with the Amalgamation. Management fees totaled $0,
$36,000, and $120,000 for the twelve month period ending December 31, 1998,
the ten month period ending December 31, 1997, and the twelve month period
ending February 28, 1997, respectively.

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 twelve month period ending December 31, 1998, the ten
month period ending December 31, 1997 and the twelve month period ending
February 28, 1997 totaled $0, $143,000, and $1,085,000, respectively.

The Company was charged a fee by Harrah's for administrative services
(including legal, accounting, information technology and office occupancy).
This arrangement ended with termination of the Management Agreement. The
Company was charged approximately $ 0, $150,000, and $523,000, and during the
twelve month period ended December 31, 1998, the ten month period ended
December 31, 1997, and the twelve month period ended February 28, 1997,
respectively.

On June 17, 1997, the Company entered into a Continuing Services Agreement
with Harrah's under which Harrah's provides certain telecommunications,
computer systems support and consulting services to the Company. The Company
incurred a cost of approximately $124,000 and $101,000 during the twelve month
period ended December 31, 1998 and the ten month period ending December 31,
1997, respectively.

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. Payments under this Sublease Agreement aggregate to
approximately $132,000 in 1998 and $44,000 in 1999. In conjunction with the
Sublease Agreement and with the Amalgamation, the Company purchased certain
leasehold improvements, computer hardware, computer software and office
equipment from Harrah's. The total purchase price was approximately $42,000.

F-15
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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 reimbursed
Harrah's for a portion of the development costs which totaled $70,000 and
$180,000 for the ten months ended December 31, 1997 and the year ended
February 28, 1997, respectively.

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

The Company paid approximately $291,000 and $335,000 during the ten months
ended December 31, 1997 and the twelve months ended February 28, 1997,
respectively, to directors and companies with common directors for management
and consulting services and for reimbursement of expenses.

On April 30, 1997, the Company entered into a Consulting Agreement with
James P. Grymyr, then 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 included in the Statements of Operations for the ten months ended
December 31, 1997, as consulting and contract labor.

Geller & Co., of which Laurence Geller is Chairman, performed consulting
services for the Company pursuant to a retainer agreement that commenced in
February, 1996 and terminated August 14, 1997. Geller & Co. was paid a monthly
retainer of $5,000. Pursuant to Geller & Co.'s retainer, a grant of options
for 200,000 shares of Common Stock with an exercise price of $3.00 and a term
of ten years was also made to Geller & Co. On May 29, 1997, the Company
granted an additional 1,000,000 options with the same terms above to Geller &
Co. for Laurence Geller's services as Chairman of the Board. 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 Amalgamation
which occurred June 17, 1997 constituted a major financing, and, consequently,
the 200,000 share success fee has vested and an expense of $650,000 was
recognized. This amount is included on the Consolidated Statement of
Operations as general and administrative expense. Mr. Geller was Chairman of
the Board of Directors of the Company from September 30, 1996 until February
23, 1999. The annual compensation of the Chairman of the Board is $100,000 and
is unpaid until the Company generates revenue.

NOTE 13--AGREEMENT REGARDING REDEMPTION OF PERFORMANCE SHARES

When the Company acquired the rights to the inflight gaming software from
Sky Games International, Inc. ("SGII") on November 7, 1991, a portion of the
consideration was 3,000,000 shares of Common Stock which, according to then
applicable requirements, were placed in escrow, to be released on the basis of
one share for each U.S. $1.78 of net cash flow generated from the assets over
a ten-year period (the "Performance Shares"). The Performance Shares were
issued at a deemed price of $.1155 per share with 2,000,000 shares issued to
SGII (87% of the outstanding stock of which was owned by James P. Grymyr,
formerly 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,

F-16
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

as of April 30, 1997, have agreed to allow the Company to redeem and cancel the
Performance Shares when and if they are released from escrow for any reason
whatsoever (the "Redemption Agreement"). As consideration for such agreement to
tender the Performance Shares for cancellation by the Company in the event they
are ever released from the escrow, the Company has issued to Messrs. Clements
and Fortescue, 333,333 and 175,000 shares of Common Stock, respectively. SGII,
as of April 30, 1997, has also agreed that it will tender the 2,000,000
Performance Shares which it holds for cancellation by the Company when and if
such Performance Shares are released from escrow for any reason whatsoever. As
consideration of such agreement, in February, 1997, the Company expensed the
outstanding balance of a note made by SGII to the Company in the approximate
amount of $550,000 and has issued to SGII 80,590 shares of Common Stock (the
"Redemption and Cancellation Agreement"). In the event the Performance Shares
are not released prior to six months after the end of the Company's financial
year ending in the year 2002, the Performance Shares will automatically be
canceled in accordance with the terms of the escrow agreement. The value of the
588,923 shares of Common Stock issued as consideration for the agreement was
determined to be approximately $1,840,000 based on the closing price of the
Company's Common Stock on the date the 588,923 shares were issued. This amount
was included as additional purchase price for the acquisition of Harrah's 20%
ownership interest in Old IEL.

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

The Performance Shares have no rights and, therefore, are excluded from per
share calculations for all periods presented. Effective April 30, 1997, the
Performance Shares were no longer considered outstanding for financial
statement purposes.

NOTE 14--SUBSEQUENT EVENTS

On November 12, 1998, the Company announced that it had been unable to
attract the additional capital necessary for continued development of its Sky
Games inflight gaming business and that it had discontinued all operations
associated with the Sky Games product line and planned to conduct an orderly
disposition of all the assets related to the Sky Games product. The Company
stated that it would refocus its business efforts to concentrate exclusively on
its Sky Plan PC games, non-gaming inflight customers and business. All
employees were terminated as of November 13, 1998. Some former employees have
been retained on a part-time contract basis to continue operations and support
the Sky Play product. On December 22, 1998, the company announced that it would
also seek bids for its Sky Play amusement game business.

On March 22, 1999 SIA notified the Company that it was terminating the
agreements related to Sky Games.

F-17
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Class B Series A Preference Shares, Harrah's ownership percentage has
decreased to a level that entitles them to one seat on the Board of Directors.
Accordingly, Harrah's representatives Charles Atwood and Judy Wormser have
resigned from the Board. Quinten Dreesmann, Laurence Geller, Phillip Gordon,
and Amnon Shiboleth have also resigned from the Board of Directors.

NOTE 15--QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

Financial results by quarter are as follows:

<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Twelve Months ended December
31, 1998
Net Loss.................... $3,380,246 $3,351,232 $3,333,166 $18,991,353
========== ========== ========== ===========
Basic and diluted loss per
share...................... $ 0.17 $ 0.17 $ 0.17 $ 0.84
========== ========== ========== ===========
Ten Months ended December
31, 1997
Loss before extraordinary
item....................... $ 219,148(1) $8,007,080(2) $4,116,187 $ 3,969,038
Extraordinary loss.......... -- 1,824,222(3) -- --
---------- ---------- ---------- -----------
Net loss.................... $ 219,148(1) $9,831,302(2) $4,116,187 $ 3,969,038
========== ========== ========== ===========
Basic and diluted loss per
share:
Loss per share before
extraordinary item....... $ 0.02(1) $ 0.73(1) $ 0.23 $ 0.21
Extraordinary loss per
share.................... -- 0.16(3) -- --
---------- ---------- ---------- -----------
Loss per share............ $ 0.02(1) 0.89(2) $ 0.23 $ 0.21
========== ========== ========== ===========
</TABLE>
- --------
(1) Due to the change in the Company's fiscal year end from the last day in
February to December 31, the first quarter amounts represent the results
of operations from March 1, 1997 to March 31, 1997.
(2) Includes effect of the Amalgamation.
(3) Loss on early extinguishment of debt.

F-18
<PAGE>

INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES

SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS

YEAR ENDED DECEMBER 31, 1998, TEN MONTHS ENDED DECEMBER 31, 1997

<TABLE>
<CAPTION>
Balance at Charged to Balance at
Beginning Costs and End of
of Period Expenses Deductions Period
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Year ended December 31,
1998:
None
Ten months ended December
31, 1997:
Allowance for Doubtful
Accounts............... $-- $46,828 $-- $46,828
Year ended February 28,
1997:
None
</TABLE>

F-19

<PAGE>

<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted from
the Consolidated Balance Sheets and the Consolidated Statements of Operations
and is qualified in its entirety by reference to such financial statements.
</LEGEND>

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 95,642
<SECURITIES> 0
<RECEIVABLES> 129,184
<ALLOWANCES> 48,828
<INVENTORY> 0
<CURRENT-ASSETS> 293,230
<PP&E> 729,578
<DEPRECIATION> (259,457)
<TOTAL-ASSETS> 2,508,757
<CURRENT-LIABILITIES> 623,614
<BONDS> 0
0
49
<COMMON> 243,674
<OTHER-SE> 1,641,420
<TOTAL-LIABILITY-AND-EQUITY> 2,508,757
<SALES> 266,259
<TOTAL-REVENUES> 266,259
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 29,322,256
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 188,249
<INCOME-PRETAX> (29,055,997)
<INCOME-TAX> 0
<INCOME-CONTINUING> (29,055,997)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (29,055,097)
<EPS-BASIC> (1.40)
<EPS-DILUTED> (1.40)

</TABLE>