<PAGE>
 
                    U.S. Securities and Exchange Commission
                            Washington, D.C. 20549

                                  FORM 10-KSB

[X]  ANNUAL REPORT UNDER SECTION 13 OF 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

     For the fiscal year ended      May 30, 1998
                                    ------------
 
[ ]  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT OF 1934
 
     For the transition period from               to
                                   ---------------  ---------------

                        Commission file number  0-21634
                                               ---------


                            METRO GLOBAL MEDIA, INC.
              ----------------------------------------------------
              (Exact name of small business issuer in its charter)

            Delaware                                     65-0025871
----------------------------------           ----------------------------------
 (State or other jurisdiction of                       (IRS Employer
  incorporation or organization)                     Identification No.)

         1060 PARK AVENUE, CRANSTON, RHODE ISLAND               02910
        ---------------------------------------------------------------
         (Address of principal executive offices)            (Zip Code)

Issuer's telephone number                    (401) 942-7876
                            ----------------------------------------------------

Securities registered under Section 12(b) of the Exchange Act:

      Title of each class              Name of each exchange on which registered

------------------------------------   -----------------------------------------

------------------------------------   -----------------------------------------

Securities registered under Section 12(g) of the Exchange Act:

                                 Common Stock
                  ------------------------------------------
                               (Title of class)

                  ------------------------------------------
                                (Title of class)

     Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 
   -------     ------

     Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B is not contained in this form, and no disclosure will 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-KSB
of any amendment to this Form 10-KSB. [ ]

     State issuer's revenue for its most recent fiscal year.   $20,391,134
                                                              --------------

     State the aggregate market value of the voting and non-voting common equity
held by non-affiliates computed by reference to the price at which the common
equity was sold or the average bid and asked price of such common equity, as of
a specified date withing the past 60 days.  (See definition of affiliate in Rule
12b-2 of the Exchange Act.):

                         $18,533,111 at July 31, 1998
                  ------------------------------------------

Note: If determining whether a person is an affiliate will involve an
unreasonable effort and expense, the Issuer may calculate the aggregate market
value of the common equity held by non-affiliates on the basis of reasonable
assumptions, if the assumptions are stated.
<PAGE>
 
                  (ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
                          DURING THE PAST FIVE YEARS)

     Check whether the issuer has filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court.   Yes          No 
                                                   -------      -------

                  (APPLICABLE ONLY TO CORPORATE REGISTRANTS)

     State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date:   5,907,562 at July 31, 1998
                                                   ---------------------------



                      DOCUMENTS INCORPORATED BY REFERENCE

If the followings documents are incorporated by reference, briefly describe them
and identify the part of the Form 10-KSB (e.g., Part I, Part II, etc.) into
which the document is incorporated: (1) any annual report to security holders;
(2) any proxy or information statement; and (3) any prospectus filed pursuant to
the Rule 42(b) or (c) of the Securities Act of 1993 ("Securities Act").  The
listed documents should be clearly described for identification purposes (e.g.,
annual report to security holders for fiscal year ended December 24, 1990).

Transitional Small Business Disclosure Format (Check one):

Yes          No     X
    --------    ---------
<PAGE>
 
                               TABLE OF CONTENTS

                                    PART I
                                    ------
<TABLE>
<CAPTION>
 
<S>                                                              <C>
ITEM 1.  BUSINESS...............................................  4
 
ITEM 2.  PROPERTIES............................................. 17
 
ITEM 3.  LEGAL PROCEEDINGS...................................... 17
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.... 18

                                    PART II
                                    -------

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
         STOCKHOLDER MATTERS.................................... 19
 
ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL    
         CONDITION AND RESULTS OF OPERATIONS.................... 19
 
ITEM 7.  FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA............. 24
 
ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON     
         ACCOUNTING AND FINANCIAL DISCLOSURES................... 24

                                   PART III
                                   --------
 
ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
         PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE
         ACT.................................................... 25
 
ITEM 10. EXECUTIVE COMPENSATION................................. 26
 
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND     
         MANAGEMENT............................................. 27
 
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS......... 28

                                    PART IV
                                    -------

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K....................... 30

INDEX TO FINANCIAL STATEMENTS................................... F-0
</TABLE> 

                                       3
<PAGE>
 
                                    PART I
                                    ------

ITEM 1.  BUSINESS
------------------

(a)  General Development of Business

     Metro Global Media, Inc. (the "Company") was incorporated, under the name
     South Pointe Enterprises, Inc. in Florida in November 1987. In February,
     1996, the Company changed its name from South Pointe Enterprises, Inc. to
     Metro Global Media, Inc.

     In November, 1996 the Company merged into an inactive subsidiary (Metro
Sub, Inc.) under the laws of the state of Delaware and simultaneously changed
its name back to Metro Global Media, Inc.

     The Initial Offering Prospectus did not disclose any specific business or
activity in which the Company would be engaged but rather was a "Blank Check"
offering whereby the Company sought to identify, investigate and if warranted,
acquire an interest in a business opportunity.  As more fully set forth below,
the Company has acquired all of the issued and outstanding stock of North Star
Distribu  tors, Inc., who subsequently changed its name to Metro, Inc.
("Metro").

(b)  Narrative Description of Business.

MOTION PICTURE PRODUCTION AND DISTRIBUTION.
-------------------------------------------

     Metro produces and distributes adult motion picture entertainment.  This
includes the production and financing of feature films (full length motion
pictures produced on film), feature videos (full length motion pictures produced
on videotape),and video compilations,  distributed primarily on videocassettes;
the distribution of pay television and cable programming; and the ownership and
administration of film copyrights.  Metro's motion picture productions  feature
men and women in a variety of erotic and adult sexual situations.   The
Classification and Rating Administration of the Motion Picture Association of
America (the "MPAA"), a motion picture industry trade association, assigns
ratings for age group suitability for theatrical and home video distribution of
motion pictures.  Submission of a motion picture to the MPAA for rating is
voluntary, and Metro does not submit its motion pictures to the MPAA for review.
However, with the exception of several titles which have been re-edited for
cable television, most of the films and videos distributed by Metro, if so
rated, would most likely fall into the "NC-17 --No Children Under 17
Admitted"/1/  rating category because of depiction of nudity and their sexually
explicit content.

     Metro owns or has distribution rights to a library in excess of 3,000
titles available on videocas  sette.  The Company has sold approximately
2,100,000 videocassettes during the fiscal year ended May 30, 1998, primarily to
retail stores and wholesalers located in the United States. Many of Metro's
original motion picture programs have been re-edited and licensed to cable
television operators.  Several of the titles in Metro's motion picture library
have been obtained from third parties under distribution agreements pursuant to
which Metro has acquired perpetual distribution rights, and in some cases
limited foreign distribution rights, to the motion picture. Metro continues to
expand its video distribution into international markets and has entered into
license agreements with international distributors 

----------------------
/1/  "NC-17: No Children Under 17 Admitted" is a registered trademark of the  
Classification and Rating Administration of the Motion Picture Association of 
America, Inc.                                                                  

                                       4
<PAGE>
 
granting distribution rights to several of its motion picture titles in several
countries outside the United States. Metro is in the process of converting its
top selling films and videos into the DVD format, which is expected to be the
format of the future. Sales of DVD releases have surpassed the sales of the
videocassettes on a title-by-title basis, and are expected to continually
increase.

     During fiscal 1998, the Company released 3 new feature films, 75 feature
videos, and 200 video compilations.  During 1999, the Company expects to release
9 feature films, 138 feature videos, including 36 Magma titles, and 240
compilations, a 39% increase over fiscal 1998.  The Company will continue to
actively seek to acquire distribution rights to additional titles produced by
third parties, and increase its efforts to distribute its library and new titles
into domestic cable and satellite television markets as well as new
international markets.  See "Management Discussion and Analysis of Financial
Condition and Results of Operations."

PRODUCTION
----------

     Metro produces films and videos either solely or under arrangements with
other producers, and is generally the principal source of financing for these
motion pictures.  In addition, Metro purchases outright, or licenses for
distribution, completed films and videos produced by others.  Acquired
distribution rights may be limited to specified territories, specified media
and/or particular periods of time.

     Motion pictures shot on film generally offer better production quality,
utilize more elaborate production techniques and incur higher production costs
than motion pictures shot on videotape.  Many of Metro's new feature film
releases are edited into several versions depending on the media through which
they are distributed.  Metro has licensed several of its films and videos for
showing on the Playboy Channel, a cable television channel produced by the
publishers of Playboy Magazine/2/, as well as pay-per-view television.  In
general, versions of the films edited for cable or pay-per-view television are
less sexually explicit than the versions edited for home video distribution.
The Company has negotiated a variety of exclusive and non-exclusive licensing
arrangements with several cable and pay television operators for several of its
feature releases that have been produced during the past two fiscal years,
including arrangements which permits unlimited showings for a defined duration
in exchange for a one-time lump sum royalty payment, arrangements for which the
Company is paid a fee based on the number of subscribers to the cable station
and the number of  times the Company's motion picture is shown, and arrangements
pursuant to which the Company receives a commission based upon the revenues
received by the pay television operators as a result of a showing of the
Company's motion picture.

     In May 1998, the Company entered into a licensing deal with New Frontier
Media, Inc. ("New Frontier"), a publicly traded adult satellite network company.
New Frontier, through its wholly owned subsidiary Colorado Satellite
Broadcasting ("CSB") launched "TeN:The Erotic Network" in August of 1998.  New
Frontier also owns the Extasy Network which consists of three 24 hour direct to
home satellite channels.  Metro will produce films and videos on a continuing
basis to be broadcast on these networks.  This deal involves the licensing of
titles from the Company's library as well as new release titles.

----------------------
/2/  "Playboy" is a registered trademark of Playboy Enterprises, Inc. 

                                       5
<PAGE>
 
     Additionally, in July 1998, the Company signed an agreement with Cable
Entertainment Distributors ("CED") to represent Metro for adult programming
through cable, television, satellite and stand-alone systems throughout the
United States.  As part of the agreement, the Company signed an output agreement
with Playboy Entertainment Group.  Under the agreement, the Company will supply
Playboy with a minimum guarantee of 175 titles, of which 103 will be selected
from Metro's existing film library and the balance from new productions over the
next two years.

DISTRIBUTION
------------

     Metro distributes, for home video use, pre-recorded videocassette, CD-ROM,
video CD and DVD products, containing motion pictures owned or licensed by
Metro. Wholesale distribution of Metro's home video products is accomplished
through a distribution network of wholesalers located throughout the United
States and Europe. Metro has contracted with video distributors in many major
cities throughout the United States and Europe for the distribution of its home
video products.

     In addition, Metro operates a regional distributorship for its own motion
picture titles as well as the motion picture titles of other companies to retail
outlets located throughout New England and upstate New York. Metro's New England
region fulfillment activities are conducted from a centralized 64,000 sq. ft.
facility in Cranston, Rhode Island.

     In January 1996, the Company entered into a Distributorship Agreement with
Phantasm Video Productions, BV of Holland ("Phantasm"), one of the largest
distributors of adult entertainment products in Europe.  Pursuant to the
Distributorship Agreement, Metro will provide Phantasm with a minimum average of
12 new titles per month during the term of the Agreement, and Phantasm shall
serve as the exclusive distributor throughout Europe for those titles purchased
by Phantasm for a 3 year period from release date.  Under the Distributorship
Agreement, Phantasm is required to purchase a minimum of 75,000 units during
each six month period during the term of the Agreement.  In August, 1996, the
Company acquired the option to purchase all of  the operating subsidiaries of
Phantasm Holdings, BV of Holland.  Under the terms of the Option Agreement, the
Company has the option to acquire, at any time prior to July 31, 1999, the stock
of Phantasm Videoproductions, B.V. Holland, Malibu Video produc  tions GmbH of
Germany, and Phantasm Videoproductions SARL of France, at a purchase price to be
determined based on a multiple of earnings of these companies for the two years
prior to the date of exercise of the option.  Phantasm breeched the distribution
agreement and was not in compliance with the terms of the Option Agreement.
During fiscal 1998, the Company terminated the Agreement.

     In July, 1996, the Company opened an international sales office in
Flensburg, Germany. This sales office handles the sales of video rights
throughout the world. This office also handles all international sales of 
CD-ROM, video CD, DVD products and magazines. Due to the termination of the
agreement with Phantasm, this office will now handle the sale and distribution
of Metro's finished goods product throughout Europe. The sales office was
incorporated as a Gmbh in August 1998 and will be consoli dated in the financial
statements of Metro beginning in the first quarter of fiscal 1999.

DUPLICATION AND FULFILLMENT
---------------------------

     Metro creates and designs all artwork for promotional items and packaging
and contracts for printing services.  Over 50% of all videocassettes are
duplicated at Metro's own duplicating facility located in Los Angeles County,
California, with the remaining being contracted to independent laboratories.
Metro markets and sells completed cassettes to distributors, retailers and mail
order outlets in the United States. All international orders are handled from
Metro's sales offices in Flensburg, Germany.

                                       6
<PAGE>
 
COMPETITION
-----------

     The production and distribution of home video and cable television products
are highly competitive, as each competes with the other as well as with other
forms of entertainment.  Furthermore, there is increased competition in the
television industry evidenced by the increasing number and variety of basic
cable and pay television services now available.  Revenues for motion picture
entertainment product depends in part upon general economic conditions, but the
competitive position of a producer or distributor is still greatly affected by
the quality of, and public response to, the entertainment product it makes
available to the marketplace.  There is strong competition throughout the home
video industry, both from home video subsidiaries of several major motion
picture studios and from independent companies.  Nearly all of Metro's products
compete with other products and services that utilize leisure time or disposable
income.

MAGAZINE PUBLISHING AND DISTRIBUTION.
-------------------------------------

     Metro publishes and distributes a variety of adult magazines and paperback
books.  Metro publishes several special interest magazines under various
tradenames which it distributes through wholesalers located throughout the
United States, Canada and Europe.  For example, the Company publishes several
magazines featuring pictures of men and women engaged in erotic and sexually
situations, magazines oriented to readers with specific sexual preferences, and
magazines featuring photographs and short stories contributed by photographers
and writers.  Metro currently publishes 10 magazines which are distributed on a
bi-monthly or quarterly basis.

     During fiscal 1998, Maxstone Media Group published four magazines under the
AMATEURS EXTRA title.  Distribution of this title was handled by outside
distributors.  Beginning in fiscal 1999, Maxstone will publish 12 magazine
titles including a newly formatted magazine entitled AMAZING. This new format
will be printed in seven languages and distribution agreements have been
committed in all European countries as well as South Africa, Australia and New
Zealand.  The North American distribution will be handled by Metro.  Each of the
planned new publications will contain exclusive photos from Metro's extensive
film and video library in an effort to cross-promote the product line in
countries where Metro's video products are currently distributed.

     On July 31, 1998, the Company acquired Fanzine, a publishing company which
produces a line of event driven, mainstream magazines, which are translated into
seven languages and distributed to over twenty different nations.  During fiscal
1998, Fanzine released Hit Sensations and Hit Sensations Specials on music,
television, sports and Hollywood celebrities.  Since inception,  in the summer
of 1997, consumers have spent over $20 million in purchases of better than 90
Fanzine domestic and foreign releases.

     Fanzine intends to expand their product base with a line of high-quality
academic calendars as well as the launch of four  major new monthly celebrity
magazines, CELEBRITY STYLE, TEEN CELEBRITY, GYM and BURN.

     CELEBRITY STYLE and TEEN CELEBRITY (two of the largest launches in the
entire magazine industry in 1998) will each distribute better than 700,000
copies on newsstands throughout the United States and Canada beginning in
October of 1998.  Both publications take advantage of the heightened 

                                       7
<PAGE>
 
interest in entertainment celebrities and their lifestyles. Competitive sales
data indicates that this genre is currently hotter than any other. GYM and BURN
will offer practical health, fitness and nutritional advice for today's male
reader. Like CELEBRITY STYLE and TEEN CELEBRITY, GYM and BURN will feature
strong editorial content as well as exceptional packaging quality. They are
scheduled to hit newsstands during the first quarter of 1999, with projected
distributions of 250,000 each.

PRODUCTION AND FULFILLMENT
--------------------------

     Production for Metro is done by several independent companies.  Production
contracts are entered into on a series rather than a single title basis and are
fixed-price with provisions for cost of labor, material and specification
adjustments.  These contracts, subject to certain limitations, may be terminated
by Metro or the production company.

     All of Metro's publications are printed by independent third parties.
Metro has had a longstand  ing relationship with a printer in the United States,
who is also a printer of other magazines that compete with Metro.  Nonetheless,
Metro believes that generally there is an adequate supply of printing services
available to Metro at competitive prices, should the need arise.  All of Metro's
production and printing activities are coordinated through its facility located
in Los Angeles County, California.

     Wholesale distribution of Metro's publications is accomplished through a
distribution network of wholesalers located throughout the United States and
Canada.  Metro has contracted with magazine distributors in many major cities
throughout the United States for the distribution of its publications.

     During fiscal 1999, the Company entered into consulting agreements with two
individuals with expertise in the production, marketing, sale and distribution
of magazines and other periodicals.  The consultants shall provide such services
as reasonably necessary to promote and further the appointment of Metro as a
secondary national distributor of periodicals for publishers and distributors
that Metro is not presently servicing.  The consultants will coordinate with
publishers and distributors for the appointment of Metro as a secondary
distributor and establish and maintain, for Metro, a customer base for such
periodicals.

     In addition, Metro operates a regional distributorship for its own
publications as well as adult magazines produced by other parties to retail
outlets located throughout New England and upstate New York.  Metro's New
England and New York 's region fulfillment activities are conducted from a
centralized facility in Cranston, Rhode Island.

     Fanzine's extensive group of publications utilizes the services of multiple
printers, all of whom perform their services on terms which are extremely
beneficial to the Company.  The on-going relationships with these printers allow
the Company a flexibility of options that few others can match. Distribution for
the Fanzine line is realized through mass market circulation to supermarkets,
drugstores, convenience stores, discount/department, newsstands and
transportation centers.  Additionally, Fanzine has direct-to retail
relationships with many major North American bookstore chains.

COMPETITION
-----------

     Metro meets with direct competition from other publishers of adult
magazines and paperback books as well as all other forms of print media adult
entertainment, including several more well-known national publications with
substantially larger circulation than those of Metro.

                                       8
<PAGE>
 
RETAIL AND FRANCHISE SALES
--------------------------

     In May 1994, the Company formed Airborne For Men, Ltd., a wholly-owned
subsidiary which engaged in (i) the retail sale of adult entertainment products
through company owned Airborne For Men/TM/ retail stores and (ii) the sale of
franchises to operate Airborne For Men/TM/ retail stores.  Airborne For Men/TM/
stores are upscale, adult-oriented establishments decorated in a aviation-theme
motif, and represent a complete departure from traditional outlets for adult
entertainment products. Airborne For Men/TM/ stores differ markedly from
traditional adult video retailers both in product line and presentation. In
addition to selling adult video and magazine products, each Airborne For Men/TM/
store sells nationally recognized name brand men's casual clothing and
accessories such as leather bomber jackets, footwear, underwear and shaving
supplies.

     In September 1994, Airborne For Men, Ltd. completed the acquisition of 100%
of the outstand ing capital stock of Eastern Sales, Inc., a Rhode Island
corporation. See "Certain Relationships and Related Transactions." Eastern
Sales, Inc. operates a retail adult video and book store in Johnston, Rhode
Island, which opened as the first company owned Airborne For Men/TM/ retail
store in October 1994. The exterior of the Johnston, Rhode Island store has a
building-wide mural reflecting Airborne's military/aviation motif, with a
Quonset-hut style entrance and a World War II vintage jeep projecting from the
facade. In April, 1995 the Company's first Airborne For Men/TM/ franchise opened
in Providence, Rhode Island. The Company opened a second Airborne For Men/TM/
store in East Providence, Rhode Island in March 1995, and a third Airborne For
Men store in Northboro, Massachusetts in May 1995.

     Effective January 31, 1996, Airborne for Men, Ltd. sold to Capital Video
Corporation the stock of its wholly owned subsidiary A.F.M. Limited and
effective November 30, 1995, Airborne for Men, Ltd. sold to Capital Video
Corporation the stock of its wholly owned subsidiaries, Eastern Sales, Inc., a
Rhode Island corporation, and Airoldco, Inc. (formerly known as Airborne East,
Inc.), a Rhode Island corporation.

     As a result of the transaction, Airborne for Men, Ltd. has a total of 6
franchisee-owned Airborne for Men/TM/ retail stores (of which five are owned by
Capital Video Corporation) as of May 30, 1997. The transaction reflected
Airborne's desire to shift its focus from retail store management to franchise
development, thereby permitting the company to open Airborne for Men locations
without incurring the start-up expenses associated with completing the store
build out and compiling an opening inventory. The transaction improved the
Company's overall cash flow because it significantly reduced the Company's debt
service requirements and dramatically reduced the Company's debt-to-equity
ratio.

     In connection with the November 30, 1995 transaction, Capital Video
Corporation agreed to assume indebtedness of Airborne to Kenneth F. Guarino and
the indebtedness of Metro, Inc. to Metro Equipment Company and a portion of the
indebtedness of Metro, Inc. to Metro Equipment Company for a total of $622,928
plus accrued interest of $103,656.

     In connection with the January 31, 1996 transaction, Capital Video
Corporation agreed to assume the balance of indebtedness of Metro, Inc. to
Northstar as well as a portion of the indebtedness of Metro, Inc. to Metro Plus
Company totaling $350,361.

     Capital Video Corporation, which operates a chain of 34 retail video and
magazine stores throughout New England and upstate New York, of which 5 are
Airborne for Men/TM/ franchises, and Airborne For Men, Ltd. agreed to waive the
standard Airborne for Men/TM/ franchise fees. Because of Capital Video's
extensive retail experience in the industry, Airborne anticipates that it will
be required to

                                       9
<PAGE>
 
provide less management, inventory control and marketing services to Capital
than it would to a less experienced franchisee; accordingly, Airborne agreed to
reduce by 50% its standard Airborne for Men royalty fees.  In connection with
the acquisition of A.F.M., Limited, Capital Video Corporation and Airborne For
Men, Ltd. agreed that the store owned by A.F. M. Limited would constitute the
first of Capital's four (4) conversion stores and that Capital would be
permitted to satisfy its remaining three store obligation either by converting
existing Capital Video locations or opening new Airborne For Men/TM/ locations
on or before December, 1996. No franchise fees were recognized for fiscal year
May, 1997.

     To enhance Airborne's growth opportunities, the Company has employed a
strategy of pursuing franchised Airborne For Men/TM/ retail stores. The extent
to which a prospective market will be developed, will be determined by
evaluating a number of different criteria, including available resources and the
interest generated by prospective franchisees. Airborne retained a franchise
development consultant to assist in the preparation of a retail store franchise
package, and has completed registration of its Franchise Offering Circular in
the States of Rhode Island, New York, California and Connecticut, and has
received an exemption from the registration requirements in the State of
Florida. In addition, as a result of its franchise registration in Rhode Island,
Airborne is permitted to offer franchises in approximately 28 states, including
Massachusetts, Pennsylvania and New Jersey, in which registration of franchise
offerings is not required.

     Under Airborne's franchising program, the Company will grant to a franchise
owner the right to develop one or a specified number of Airborne For Men/TM/
retail stores at an approved location. Prior to the opening of an Airborne For
Men/TM/ franchise, franchisees will be required to execute Airborne's standard
franchise agreement. This form of agreement governs the operation of a single
Airborne For Men store for a period of ten years. Airborne For Men/TM/
franchisees will be required to pay Airborne an initial franchise fee of $20,000
plus an additional $10,000 if the Company selects the sight, a sign lease
expense of $6,000 to $10,000, weekly royalties ranging from 5% to 8% of gross
sales, and weekly advertising fees of 1% of gross sales. Each franchise owner
will have the sole responsibility for all financial commitments relating to the
opening and operation of an Airborne For Men/TM/ franchise, including rent,
utilities, payroll and other incidental expenses. In addition, franchisees will
be required to purchase all of its video and magazine inventory from Metro and
all of its mens casual wear and accessories from approved vendors, and will be
required to expend an additional 2% of gross sales on advertising expenses. The
estimated total initial investment per franchise will range from approximately
$165,000 to $230,000, depending on the amount of leasehold improvements,
inventory and other start-up expenses required for the proposed franchise
location.

     Airborne will assist franchisees by approving prospective Airborne For
Men/TM/ locations and, if necessary, by finding and securing appropriate
Airborne For Men/TM/ locations. In addition, Airborne will provide franchisees
with specifications and layouts for each approved Airborne For Men/TM/ location,
an initial training program, a start-up marketing program, and on-site
consultation and guidance as requested. Airborne will provide extensive product
and support services to its franchise owners, and will derive income from
providing these products and services. With the possible exception of offering
net 30-day terms on sales of inventory to credit worthy franchisees, Airborne
does not intend to provide financing to prospective franchisees. Airborne has
not set specific requirements as to who may become an Airborne for Men/TM/
franchisee; rather, franchisees will be approved by Airborne based upon
management's assessment of the prospective franchisee's net worth, available
working capital, business acumen and financial ability to successfully operate
an Airborne For Men/TM/ franchise.

                                       10
<PAGE>
 
     The Company has incurred an additional $19,500 in costs associated with its
proposed franchise operation for the year ended May 30, 1997.  To date, the
Company has financed its investment in Airborne's franchise operations through
cash flow from operations.  (See "Management's Discussion and Analysis of
Financial Condition and Results of Operations ").  The Company anticipates that
the revenues derived from the sale of franchises will offset the costs
associated with offering and assisting franchisees in opening Airborne For Men
franchises.

     The Company is in the process of re-evaluating the Airborne concept.  The
Company is working with CVC in the launching of a new concept that will be
geared towards women and couples.  The Company has retained top designers and
marketing specialists to assist in the creation of this futuristic store.  CVC
has selected the flagship site and construction is underway.  The new store,
located in Rhode Island, is scheduled to open in November, 1998.  It is Metro's
intention to market this new store concept to attract new franchises.

COMPETITION
-----------

     Although the Company  has  distinguished Airborne For Men/TM/ stores from
traditional adult video retailers in product line and  presentation,  both
Company-owned and franchised Airborne For Men/TM/ stores compete with existing
adult video retailers who may be situated in better locations. Airborne's
franchise operation also competes with many well-established and successful
franchisers in the sale of franchises.

ARCUS MEDIA GROUP, INC.
-----------------------

     In October 1994, the Company formed Arcus Media Group, Inc. ("Arcus"), a
wholly-owned subsidiary.  In November 1994, Arcus acquired certain assets,
including equipment and key technical personnel, of Innovative Data Concepts
Incorporated, a Pennsylvania corporation previously engaged in computer software
development.  During the fourth quarter of fiscal 1995, Arcus determined that it
would be more efficient and cost effective to engage independent contractors to
digitize and convert the Company's motion pictures into the CD-ROM format, and
to acquire distribution rights to CD-ROM interactive games authorized by
independent software developers.  Accordingly, Arcus reduced its in-house
technical workforce and relocated its sales and marketing operation to the
Company's Rhode Island facility, and the approximately $419,000 in  unamortized
cost allocated to the previously capitalized employment contract was expensed at
May 30, 1995.  In May 1995, Arcus filed suit against IDC alleging
misrepresentation in connection with the transaction.  On May 30, 1996 the suit
filed by Arcus against IDC was settled.  As a result of the settlement the
Company received from IDC 75,000 shares of the 160,000 shares of the Company
originally issued to IDC as part of the November 10, 1994 Asset Purchase
Agreement.  Effective May 30, 1997 Arcus Media Group was liquidated and has
become a division of Metro, Inc. which will continue CD-Rom product sales and
development under the trade name Arcus Media Group.

     Metro has and intends to continue to digitize and convert selected titles
from the Company's existing film library to the CD-ROM format, under the Arcus
trade name.  Arcus has and will continue to develop technically sophisticated
products on the most popular personal computer platforms, currently Microsoft
Windows/3/ and Apple Macintosh CD-ROM, primarily for use in home personal
computers. Arcus has released 35 full-length CD-ROM titles in the hybrid
Windows/Macintosh platform 

-------------------
/3/ Microsoft and Windows are registered trademarks of Microsoft
Corporation.  Macintosh is a registered trademark of Apple Computer Inc.

                                       11
<PAGE>
 
as of May 31, 1998. To capture international sales opportunities, Arcus expects
to release these CD-ROM titles utilizing Video CD technology, which will permit
playback on both the CDI and MPEG platforms. Future product releases by Arcus
will be dependent on the continued market acceptance of its initial product
releases.

     Arcus' CD-ROM products enable viewers to enjoy full-screen, full-motion (30
frames per second) CD-ROM visual display.  Arcus' product development process
includes design, prototyping, programming, computer graphic design, animation,
sound and video recordings and quality assurance. Arcus has and expects to
continue to utilize third-party designers, artists and programmers to introduce
creative and technically superior products.  The success of software product
development is unpredict  able due to the technological complexity, inherent
uncertainty in anticipating technological develop  ments, the need for
coordinated efforts of numerous technical personnel in such development and the
difficulties in identifying and eliminating errors prior to product release.

     Preparation of master CD-ROM discs, user manuals and promotional materials
as well as duplication of the CD-ROM discs and printing of the user manuals and
packaging has been and will be performed by outside developers to Arcus'
specifications.  Arcus does not anticipate experiencing any material
difficulties and delays in the manufacture and packaging of its products.
Distribution of Arcus' CD-ROM products is accomplished through the same
distribution network of wholesalers and retailers to whom Metro distributes its
adult video products and computer software distributors and retailers. Order
fulfillment is coordinated through Metro's Rhode Island distribution facility.

     Sales of consumer software are highly dependent on the availability of
relatively  inexpensive personal computers.  Major computer manufactures have
continued to enhance their lower-end product offerings to consumers by
increasing the power and speed of these machines without significantly
increasing the price.  The inclusion of CD-ROM technology in home personal
computers and the decline in prices for CD-ROM hardware will contribute to the
demand for CD-ROM software products that can utilize the graphics, sound and
data capabilities of the latest hardware technology.

     Although Arcus intends to focus on digitizing selected titles from the
Company's existing film library for the foreseeable future, Arcus also intends
to engage in the distribution of other adult-theme digital multimedia projects
such as interactive games.  The Company launched its first CD-ROM inter-active
game in July of 1995, Virtual Valerie II, which has been quite successful.  The
revenue generated by Virtual Valerie II since its release through the fiscal
year ended May 30, 1998 in excess of $1,000,000.  Based on the success of its
first CD-ROM inter-active game offering, Arcus is continuing to look for other
opportunities in this arena.  Arcus' ability to successfully  market these
products will depend on  continued market acceptance of its initial products and
the availability of independently produced adult CD-ROM interactive games.

     During 1998, the Company created the "Amazing Interactive Digizine", a
magazine style format on a CD-Rom.  The Digizine features film clips and photos
of new release adult films, video centerfolds, fiction and product reviews.
Agreements have been put in place to release future issues of the Digizine
through established mass media distribution channels.  With its special
packaging, it will be available at newsstands, bookstores, video stores and
computer stores.

     In November, 1997, Arcus Media Group released the first adult related full
featured Digital Versatile Disk ("DVD") title, "Zazel".  "Zazel", an award
winning movie, featuring an automated photo gallery, full motion chapter index
and star biographies captured the adult entertainment audience.  After
completing four titles, Arcus Media Group released "Red Vibe Diaries", another
first in technology 

                                       12
<PAGE>
 
advancements. Fully automated menu icons drew the attention of "Forbes" magazine
and "U.S. News" for technological design advancements. With the Arcus
development team leading the new revolution in home video DVD, another first in
technological design breakthrough was at hand. True Perspective multiple angle
was introduced on "Taboo #17" and was immediately recognized by major motion
picture studios at the premier of the Las Vegas V.S.D.A. Show. True Perspective
technology allows the viewer to watch the same moment in time from two
distinctive angles.

     Additional features, never done before in the adult arena, were introduced
into the "Director's Cut" edition with director's narration, exclusive behind
the scenes footage and future DVD preview releases.  The Company plans to
release the DVDs with multiple language selection to enable immediate
international distribution to a pre-existing European market.  Metro has
released 9 DVD titles as of May 30, 1998 and 36 titles are currently being
developed.

     With funding planned for additional titles and incredible demand for this
high quality video format, Arcus continues to push the limits of DVD technology.
According to Adult Video News ("AVN") the industry's leading publication,
"Metro's DVD is a breakthrough in digital video and their CD-Rom technologies
are distinctive and groundbreaking.  The DVD is a step ahead of the rest, and
the Amazing Digizine is something to look forward to".

       The Company has no way of accurately assessing the amount of capital
resources that will be required to develop future projects, or the amount and
extent of financing that will be available to meet these requirements.  The
Company, in connection with the development of Arcus products,  incurred
approximately $200,000 to $250,000 of  operating costs  during fiscal 1998.  The
Company has financed, and will continue to finance, its investment in Arcus
brand products through cash flow from the Company's operations.

COMPETITION
-----------

     There are several competitors of Arcus that have already released adult CD-
ROM and DVD titles and interactive games, many of whom have significantly
greater financial, technical and marketing resources than those of Arcus.
Moreover, Arcus believes that new competitors are increasing their focus on the
consumer software market which will result in greater competition for Arcus.

WWW.AMAZINGONLINE.COM
---------------------

     With the launch of amazingonline.com website and the continued demand from
our members for information about purchasing our products, the launch of the
world's largest adult shopping mall was inevitable.  From design inception,
creating a full featured, user friendly shopping interface was the first
priority.  Customer identification with childproof functions were incorporated
into the design parameters.  Other features include order tracking, previous
customer billing and shipping information to simplify future purchases for the
consumer.   With all major video, novelty and lingerie manufactures' products
available and new release pre-ordering capabilities, future growth of online
purchasing is assured to be a substantial revenue source for years to come.  The
on-line mall commenced operations on July 1, 1998, and the user base has been
increasing weekly.

     At amazingonline.com, there are 2 separate sections available to the
public.  One section is created for visitors who wish to peruse the site and the
other is for those who are members who subscribe to the site for a monthly or
bi-monthly fee.  The members' section allows them to take full advantage of (a)
live shows; (b) 10 % discount on items advertised on our Shopping Mall; (c)
viewing access to exclusive star biographies; (d) an extensive photo gallery and
(e) video clips & previews and much more.

                                       13
<PAGE>
 
     In addition to our Shopping Mall, another area of concentration is our
"People Connection".  In this area of the site, developed from our Contact
Magazines, members have access to browse advertisements from real people in any 
geographical area and contact them directly.

     Our site also allows members the opportunity to download movie clips and
erotic stories, view live video and join adult chats.  Due to the way
amazingonline.com was created, this site offers a fully interactive online
experience.

DIRECT MAIL ORDER
-----------------

     Amazing Direct was formed in March 1998, as a direct mail order company.
The Company plans to build a customer data base through advertisement in adult
magazines as well as purchasing or renting customer lists.  Brochures are mailed
on a quarterly basis to approximately 150,000 active customers.  The company had
one mailing during fiscal 1998.  All orders are taken via phone or mail and sent
to the Cranston, RI warehouse for fulfillment.

     The Company anticipates over 100% growth during fiscal 1999, as the
customer database continues to expand.  Amazing Direct is currently matching
phone numbers and addresses from its audiotext business to target these
customers on the next catalog mailing.

COMPETITION
-----------

     Competition in the mail order business is high.  The Company competes with
such businesses as Adam and Eve, Leisure Time and Video Age.  It is the
Company's belief that it can continue to penetrate this line of business by
continuing to increase its database.

MAJOR CUSTOMERS
---------------

     Capital Video Corporation operates approximately 34 video and magazine
retail stores in the New England and upstate New York areas and accounted for
approximately 47% of Metro's net sales for the fiscal year ended May 30, 1998,
39% of Metro's net sales for the fiscal year ended May 31, 1997, and 32% of
Metro's net sales for the fiscal year ended May 31, 1996.  See "Certain
Relationships and Related Transactions".  No other customer accounted for more
than 10% of Metro's net sales for the fiscal years ended May 30, 1998, 1997 and
1996.

TRADEMARKS AND TRADE NAMES
--------------------------

     Metro owns or licenses numerous trademarks and copyrights that it uses in
its video and magazine businesses. Its most important trademarks are METRO/TM/,
INTROPICS/TM/, CAL VISTA/TM/, MAGMA/TM/, ULTRACOLOR PUBLICATIONS/TM/,
AMAZING/TM/, TOXXXIC/TM/, METRO PRIME CUTS/TM/, TABOO/TM/, ONLY THE BEST/TM/,
CASTING CALL/TM/, BABES ILLUSTRATED/TM/, SOHO/TM/, ARCUS/TM/, SUPERSHOTS/TM/,
RAGE/TM/ and PULSE/TM/. Airborne For Men, Ltd. has filed trademark
registration applications with respect to its AIRBORNE FOR MEN/TM/ tradename and
logo. The Company believes that the name recognition and image that it has
developed in each of its markets significantly enhance customer response to its
sales promotions. Accordingly, trademarks and copyrights are important to the
Company's business and the Company intends to aggressively defend them.

                                       14
<PAGE>
 
     The Company acquired the trademarks HIT SENSATIONS, CELEBRITY STYLE and
TEEN CELEBRITY through its acquisition of Fanzine.

     BUSINESS ACQUISITIONS AND OTHER ACTIVITIES.
     -------------------------------------------

     In August, 1997, Rocket Media Group, LLC, a wholly owned subsidiary of
Metro, Inc. entered into a joint venture with Salmill Enterprises, Inc. for the
purpose of magazine publishing.  Under the terms of the agreement, Rocket
contributed a sub-license agreement for the rights to certain titles, names and
materials and Salmill contributed its publishing and circulation expertise into
a newly formed entity Maxstone Media, LLC.  The Company recorded its capital
contributions at zero and included Maxstone Media's results from operations in
the consolidated financial statements.  Minority interest amounted to $18,220 at
May 30, 1998.

     In March, 1998, the Company acquired an 80% interest in Amazing Direct, a
Nevada Corporation by purchasing 400 shares of its outstanding stock at $2.00
per share.  Amazing Direct, a mail order company, has rights to a licensing
agreement to distribute certain products under the Hustler name.

     On July 31, 1998, the Company acquired 100% of the stock of Fanzine
International, Inc. ("Fanzine") for a preliminary purchase price of $7,500,000
in a transaction approved of by the Company's Board of Directors.  Fanzine,
which began operations on August 1, 1997,  publishes event driven, mainstream
magazines translated into seven languages and distributed worldwide.  The
acquisition price consists of $4,000,000 cash, and 1,000,000 restricted shares
of the Company's common stock with put option rights at $8.00 per share to be
exercised by the selling shareholder's during the second year on a quarterly
basis, if certain minimum earnings, as defined, are met.  However, during
Fanzines' first year of operations, the Company has the right to call the shares
at the greater of $6.00 per share or 75% of the market price.  The acquisition
agreement, also, provides for a reduction in purchase price if Fanzine's results
of operations do not meet certain minimum earnings.

     Management is presently obtaining an independent valuation to finalize the
preliminary estimated purchase price of $7,500,000.  The Company's right to
redeem its shares during the first year and on the selling shareholder's right
to put the shares to the Company in the second year could result in an estimated
increase in purchase price ranging from $2,500,000 to $4,500,000.  These
adjustments to the purchase price could have a material impact on the pro-forma
information, as presented below, and to the future consolidated results.

     The acquisition will be accounted for as a purchase.  The excess of the
purchase price over the fair market values of net assets acquired, which
include, among others, licences, trademarks, and distribution rights, will be
allocated principally to goodwill and amortized over fifteen years.

     The cash portion of $4,000,000 is being financed by a long-term convertible
debenture. Management anticipates financing the contingent consideration, if
any, to be paid in the near future through Fanzine's cash flow resulting from
profitable operations.

     As the acquired company (Fanzine) financial statements only include eleven
months of operations from inception through June 30, 1998, the following
selected unaudited pro-forma information 

                                       15
<PAGE>
 
is being provided to present a summary of the continued results of the Company
and Fanzine as if the acquisition had occurred on August 1, 1997:

Pro-Forma information (Unaudited)
(In thousands, except per share data)
<TABLE>
<CAPTION>
                        YEAR ENDED MAY 30, 1998 (ONLY)
                        ------------------------------
<S>                                                          <C>
 
               Net sales                                     $30,137
               Net Income                                      1,140
               Earnings Per Share:
                   Basic                                         .25
                   Diluted                                       .20
</TABLE>

The pro forma results include amortization of the intangibles and interest
expense on debt issued to finance the purchase.  The pro forma results are not
necessarily indicative of what actually would have occurred if the acquisition
had been completed as of the beginning of the fiscal period presented, nor are
they necessarily indicative of future consolidated results.

GOVERNMENT REGULATION
---------------------

     The right to distribute adult videocassettes, magazines and CD-ROM products
is protected by the First and Fourteenth Amendments to the United States
Constitution, which prohibit Congress or the various states from passing any law
abridging the freedom of speech.

     The First and Fourteenth Amendments, however, do not protect the
dissemination of obscene material, and several states and communities in which
Metro's products are distributed have enacted laws regulating the distribution
of obscene material with some offenses designed as misdemeanors and others as
felonies, depending on numerous factors.  The consequences for violating the
state statutes are as varied as the number of states enacting them.  Similarly,
18 U.S.C.(S)1460 - 1469 contain the federal prohibitions with respect to the
dissemination of obscene material, and the potential penalties for individuals
(including corporate directors, officers and employees) violating the federal
obscenity laws include fines, community service, probation, forfeiture of assets
and incarceration.  The range of possible sentences require calculations under
the Federal Sentencing Guidelines, and the amount of the fine and the length of
the period of the  incarceration under those guidelines are calculated based
upon the retail value of the unprotected materials.  Also taken into account in
determining the amount of the fine, length of incarceration  or other possible
penalty are whether the person accepts responsibility for his or her actions,
whether the person was a minimal or minor participant in the criminal activity,
whether the person was an organizer, leader, manager or supervisor, whether
multiple counts were involved, whether the person provided substantial
assistance to the government, and whether the person has a prior criminal
history.  In addition  federal law provides for the forfeiture of: (1) any
obscene material produced, transported, mailed, shipped or received in violation
of the obscenity laws; (2) any property, real or personal, constituting or
traceable to gross profits or other proceeds obtained from such offense; and (3)
any property, real or personal, used or intended to be used to commit or to
promote the commission of such offense, if the court in its discretion so
determines, taking into consideration the nature, scope and proportionality of
the use of the property in the offense.

     Because the Company is engaged primarily in the wholesale distribution of
its products to other wholesalers and/or retailers, the Company can regulate the
communities to which it distributes its 

                                       16
<PAGE>
 
products. Management has taken steps to ensure compliance with all federal,
state and local regulations regulating the content of its motion pictures and
print products, by staying abreast of all legal developments in the areas in
which its motion pictures and print products are distributed and by specifically
avoiding distribution of its motion pictures and print products in areas where
the local standards clearly or potentially prohibit these products. In addition,
the Company requires that certain video material be reviewed by an independent
advisory panel comprised of two psychologists, a certified sex therapist,
licensed marriage and family therapist, a certified sex educator and a licensed
independent clinical social worker. Their review is directed to aspects of
serious scientific value as set forth in the Miller test, because that aspect of
                                             ------
the test is not limited by community standards but is concerned with whether a
reasonable person would find such value in the material, taken as a whole. In
light of the Company's efforts to review, regulate and restrict the distribution
of its materials, management believes that the distribution of Metro's products
does not violate any statutes or regulations.

     Many of the communities in the areas in which Airborne intends to offer
Airborne For Men/TM/ franchises have enacted zoning ordinances restricting the
retail sale of adult entertainment products. Airborne intends to open Airborne
For Men/TM/ stores and to permit the opening of Airborne For Men/TM/ franchises
only in locations where the retail sale of adult entertainment products is
permitted.

     Distribution rights to video cassettes, magazines and CD-ROM products are
also granted legal protection under the copyright laws of the United States and
most foreign countries, which provide substantial civil and criminal sanctions
for unauthorized duplication and exhibition.  Metro plans to take all
appropriate and reasonable measures to secure and maintain copyright protection
for all of its products under the laws of all applicable jurisdictions.

EMPLOYEES.
----------

     As of May 30, 1998, the Company and its subsidiaries employed approximately
130 persons.  It is projected that the company and its subsidiaries will employ
approximately 150 persons by the end of fiscal 1999.

ITEM 2. PROPERTIES.
-------------------

     In June 1993, the Company relocated its principal administrative  offices
to an approximately 64,000 square foot office, warehouse and shipping complex
located in Cranston, Rhode Island.  See "Certain Relationships and Related
Transactions".  This facility houses Metro's administrative, editorial and
operational offices; the data center, customer service, and warehouse and
fulfillment facilities. Metro also leases approximately 32,000 square feet of
warehouse space in Los Angeles County, California.  This site also houses
Metro's duplicating laboratory.  Because Metro's Rhode Island warehouse facility
is not yet at full productive capacity, management of the Company believes that
its current facility is suitable and adequate for the foreseeable future.

     In November 1994, the Company relocated its principal executive office to a
2,500 square foot office in Cranston, Rhode Island.  See "Certain Relationships
and Related Transactions".

ITEM 3.  LEGAL PROCEEDINGS.
---------------------------

     There are no legal proceedings pending against the Company or its
subsidiaries other than routine litigation that is incidental to the business.

                                       17
<PAGE>
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
-----------------------------------------------------------

     None

                                       18
<PAGE>
 
                                    PART II
                                    -------

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
------------------------------------------------------------------------------

      The Company's Common Stock is traded in the over-the-counter market and
quoted on the NASDAQ Small Cap Market.  There is a limited market for the
Company's Common Stock and no assurances can be given that any trading market
will be sustained.
<TABLE>
<CAPTION>
                                             COMMON STOCK*
                                        HIGH BID       LOW BID
<S>                                     <C>            <C>
 
Fiscal Year Ended May 30, 1998
------------------------------
First Quarter                            $2.0000       $1.2500    
Second Quarter                           $1.5625       $1.1250    
Third Quarter                            $6.9690       $1.1250    
Fourth Quarter                           $5.0000       $1.8750    
 
Fiscal Year Ended May 30, 1997
------------------------------
First Quarter                            $2.8125       $1.8750
Second Quarter                           $3.6250       $1.6250
Third Quarter                            $2.6250       $1.1250
Fourth Quarter                           $2.1250       $1.0000
 
Fiscal Year Ended May 30, 1996
------------------------------
First Quarter                            $7.3750       $4.7500
Second Quarter                           $4.7500       $2.7500
Third Quarter                            $3.6250       $2.0000
Fourth Quarter                           $3.4375       $2.2500
</TABLE> 

*   Such market quotations reflect the high and low prices for the Company's
securities as quoted by dealers without retail mark-ups and may not necessarily
represent actual transactions.


     At July 31, 1998, there were in excess of 1,000 holders of record of the
Company's Common Stock.

     The Company did not pay any cash dividends during its last fiscal year and
the Board of Directors does not contemplate doing so in the near future.  Any
decision as to future payment of dividends will depend on the earnings and
financial condition of the Company and such other factors as the Board of
Directors deems relevant.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION 
-------------------------------------------------------------------
        AND RESULTS OF OPERATIONS
        -------------------------

FISCAL YEAR ENDED MAY 30 , 1998
COMPARED TO FISCAL YEAR ENDED MAY 31, 1997

     The Company had revenues of $20,391,134 for fiscal year 1998 as compared to
revenues of $18,355,868 for fiscal year 1997, an 11% increase.  Revenues consist
principally of sales of prerecorded video cassettes, magazines, novelties, CD's
and DVD's.  Increased revenues are primarily due to

                                       19
<PAGE>
 
(1) increased video sales of $1,403,000; (2) increased sales of novelties of
$587,000 and; (3) increased machine income of $128,000. These increases were
partially offset by a decrease in magazine revenue of $455,000 due to the
elimination of unprofitable issues and a consolidation of that product line in
fiscal 1997. Additionally, the Company recognized $255,595 of revenue in fiscal
1998 from its interest in Maxstone Media.

     The Company released 3 new feature films, 75 feature videos, 200 video
compilations and 20 video packs in fiscal 1998, an increase of 46.8% over the
prior fiscal year.  The Company intends to further increase its release schedule
in fiscal 1999 to 9 feature films, 138 feature videos and 240 video compilations
(a 39% increase) to accommodate recent licensing agreements which the Company
has entered into with New Frontier Media, Inc. and its subsidiaries, Cable
Entertainment Distributors and Playboy Entertainment.

     Cost of revenues (including amortization of film costs) increased 15.3% to
$13,330,798 in fiscal 1998 as compared to $11,564,466 in fiscal 1997.  Cost of
revenues as a percentage of revenues increased to 65.4% in 1998 as compared to
63% in fiscal 1997.  The principal reason for the increase in cost of revenues
is due to the increase in film amortization from $707,522 in 1997 to $1,490,440
in 1998, an increase of over 100%.  This increase in film amortization was a
result of the 46.8% increase in the new release schedule as well as an
adjustment to the amortization schedule based on revised estimates of revenues
over their expected useful lives.  Cost of revenues as a percentage of revenue
excluding revenues from Maxstone and film amortization costs remained constant
at 59% with the prior year.

     Selling general and administrative costs decreased by $807,637 or 11.5% to
$6,219,307 in 1998 as compared to $7,026,944 in 1997.  As a percentage of
revenues, selling, general and administrative expense were 30.5% in 1998 as
compared to 38.3% in 1997.  The primary reasons for the decrease in the expenses
are as follows: (1) decrease in advertising by $154,000 due to more concentrated
advertising; (2) decrease in artwork by 109,000; (3) decrease in bad debt
expense of $154,000 as there were no unusual charge-offs in 1998; (4) decrease
in repairs and maintenance by $103,000 as repair work in California was
completed in 1997 and; (5) a decrease in legal of $233,000 as there was no
material litigation in 1998.

     Other income (expense) increased ($156,406) to ($243,864) in 1998 as
compared to ($87,458) in 1997.  This increase is primarily due to a gain on
settlement of litigation in 1997 of $113,000 for which there is none in 1998,
and ($18,220) for the minority interest in the Maxstone joint venture in 1998.

     Net income increased $556,839 from a net loss of ($207,158) in 1997 to net
income of $349,681 in 1998.  As a result, the Company's earning per share
increased to $.09 per share for 1998 as compared to $(.06) in 1997,
notwithstanding the increase in weighted average shares outstanding as a result
of debt conversion and shares issued to consultants for compensation.

FISCAL YEAR ENDED MAY 31, 1997
COMPARED TO FISCAL YEAR ENDED MAY 31, 1996

     The Company had revenues of $18,355,868 the fiscal year ended May 31, 1997,
a 6% decrease over revenues of $19,526,010 for the fiscal year ended May 31,
1996.  Revenues consist principally of sales of prerecorded video cassettes,
magazines, novelties and CDS.  Lower revenues were primarily the result of the
following factors: (1) the sale of the Airborne retail stores in fiscal 1996
which accounted for approximately $600,000 in revenue vs zero in fiscal 1997;
(2) a reduction in magazine sales of approximately $610,000 due to the
elimination of unprofitable issues and a consolidation of that product 

                                       20
<PAGE>
 
line; (3) a reduction in the sales of CD ROM's of approximately $723,000 which
principally reflects the decrease in sales of the company's Virtual Valerie II
interactive game. These reductions were partially offset by an increase of
approximately $867,000 in the sale of cable and foreign film rights of some of
the titles contained in the Company's film and video library.

     The Company released 2 new feature films, 50 feature videos, 151 video
compilations and titles in fiscal 1997, an 22.2% decrease from the prior year.
This was the result of the complete reorganization and restructuring of the
Company's west coast operation.  The Company's new release schedule for the
fiscal year ended May 31, 1997 was significantly impacted.

     Cost of revenues (including amortization of film costs) for fiscal 1997
decreased 3.1% to $11,564,466  from $11,939,031 for fiscal 1996 corresponding to
the decrease in revenues for the year. Cost of revenues as a percentage of gross
revenues increased in 1997 to 63% as compared to 61.1% in 1996.  The primary
reason for the decrease was the reduced sales of the Company's own video product
resulting from the aforementioned reduced video production schedule,
substantially all of the revenue was replaced by sale of other vendor's video
product at lower margins.  Amortization of film costs decreased 62.2% to
$707,522 in 1997 versus $1,873,761 in fiscal 1996, principally because of a
decrease in new releases during 1997.

     Selling, general and administrative expenses for the fiscal year ended May
31, 1997, increased $279,562 or 4.1% to $7,026,944 from $6,747,382 for the
fiscal year ended May 31, 1996.  As a percentage of sales, selling, general and
administrative expenses were 38.3% of the revenues in 1997 as compared to 34.6%
in 1996, an increase of 3.7%.  The primary reason for the increase in selling,
general and administrative expenses is as follows: (1) $(42,200) of reduced
advertising costs due to less films and videos being released, better discounts
and more concentrated advertising; (2) increased bad debt expense of $290,000
including the write-off of the sale of foreign film rights of $211,000; (3)
increased equipment rental of duplicating and editing equipment of $136,800; (4)
increased freight due to a greater volume of smaller shipments of $60,900; (5)
increased payroll costs due to the restructuring of the Company's west coast
operation of $135,000; all of which were offset partially by a $(312,500)
reduction in professional fees, consisting mainly of reduced legal costs.

     Other income (expense) increased $(66,106) to $(87,158) in 1997 as compared
to ($21,352) in 1996.  The increase was primarily due to the following factors:
(1) a gain on settlement of litigation of $113,000 relating to the sale of
foreign film rights of a portion of the titles contained in the Company's film
library; (2) royalty income of $128,100 received from the Company's Airborne
franchises and; 3) interest expense of $(340,900) in fiscal 1997 as compared to
$(396,200) in fiscal 1996 which was lower due to the following: (a) the debt
assumption of approximately $973,000 in the sale of the Company's retail
Airborne stores; (b) a reduction in debt to a previous owner due to
indemnification of $200,000 and lastly; (c) lower interest rates.

     As a result of the factors detailed above, net income decreased $732,833 or
139.4% to $(207,158) in 1997 or $(.06) per share, from the net income of
$525,675 in 1996, or $0.17 per share.  The Company's earnings per share
decreased $.24 to $(.06) for the fiscal year ended May 31, 1997 versus $.17 per
share for fiscal 1996, notwithstanding an increase in weighted average number of
shares as a result of the warrant exercise and debt conversion discussed below.

                                       21
<PAGE>
 
FISCAL YEAR ENDED MAY 30 , 1998
COMPARED TO FISCAL YEAR ENDED MAY 31, 1997

LIQUIDITY AND CAPITAL RESOURCES

     The Company's financial position improved during fiscal 1998.  Cash
amounted to $184,995 at May 30, 1998 as compared to $57,724 at May 31, 1997.
Cash provided by operating activities amounted to $1,814,566 in 1998 and
$1,027,435 in 1997.  Sources of cash during 1998 are attributed to (1) cash
provided by operations of $1,814,566, (2) net proceeds of $846,500 for the
issuance of Series A Convertible Preferred Stock and (3) proceeds of $500,000 on
the issuance of two convertible debentures. The primary uses of cash in fiscal
1998 consisted of (1) investments in motion pictures and other films of
$2,279,676 (2) payments on short term borrowings of $366,975 (3) payments on
capital lease obligations of $281,554 and (4) purchases of property and
equipment of $105,590.

     Working capital improved to $3,378,438 at May 30, 1998 as compared to
$2,489,792 at May 31, 1997.  The net increase in accounts receivable of
$1,188,427 is due to increased sales in fiscal 1998. Inventory increased
slightly by $42,462.  Accounts payable and accrued expenses, increased by
$206,500 due to increased purchasing to support the increase in sales.

     During 1998, notes payable and accrued interest totaling $714,037 were
converted into 476,025 of the Company's common stock.

     On March 23, 1998, the Company entered into two 8% convertible debentures
totaling $500,000. Both notes are due on March 23, 1999, in either cash or
common stock, at a conversion rate of $2.25 per share.  Proceeds from the
debentures were used for working capital.

     During 1998, the Company entered into an Offshore Securities Subscription
Agreement for convertible Preferred Shares pursuant to regulation S of the U.S.
Securities Act of 1933.  Under the terms of the agreement, the Company is to
issue 2,175 shares of 1998 Series A Convertible Preferred Stock ("Series A
Shares") at a price of $1,000 per share with a 5% cumulative dividend payable in
common stock at conversion.  At May 30, 1998 the Company received proceeds of
$846,500, net of offering costs representing 855 shares.  Proceeds from such
agreement were used to fund working capital.  Substantially all of the proceeds
for the remaining 1320 shares were subsequently received.

     The Series A Shares are convertible at a rate of 100 shares plus accrued
dividends per week at 80% of the 15 day average closing bid price.  These Shares
are subject to a 24 month mandatory conversion feature.  Management is presently
obtaining fair values of the embedded beneficial conversion feature and warrants
which is expected to be reallocated out of the proceeds after May 30, 1998.
Such values will be recognized as dividends and amortized over the mandatory
conversion period of two years beginning in June of 1998.

     In addition to the Series A Shares the Company  issued 400,000 warrants to
purchase the Company's common stock at $1.50 per share commencing April 20, 1998
exercisable over 5 years.

     Of Metro's total accounts receivable at May 30, 1998 and May 31, 1997
$2,477,041 (48.6%) and $1,711,443 (41.9%), respectively, is owed by Capital
Video Corporation ("CVC"), a chain of retail stores of which a former
officer/shareholder of the Company is the sole shareholder.  Because of the
amount of this receivable and the concentration of business with CVC, this
receivable is monitored very closely.  Metro has the personal guarantee of its
one shareholder.  Accordingly, no allowance for related party receivables and no
related party bad debt expense has been recorded in the Company's financial
statements.

                                       22
<PAGE>
 
     At May 30, 1998, the Company's film and video release schedule for fiscal
1999 included 111 new film and video titles.  The completion of these movies
will require approximately $3,600,000 to $4,000,000.  Financing for these
activities will continue to be financed through operating cash flows as well as
funds borrowed under its line of credit.

     The Company funds its working capital requirements on a short-term basis
through funds generated by operations and borrowings under its line of credit
agreement.  Pursuant to a line of credit agreement with a finance company, the
Company's subsidiary, Metro, Inc. may borrow up to 75% of assigned accounts
receivable less than 90 days old, up to a maximum of $1,500,000.  The balance
due under the line of credit bears interest at the prime rate plus 5% per annum.
In addition, Metro pays the finance company a management fee equal to 3/4 of 1%
of sales submitted for inclusion in the net security value of the accounts
receivable, but not more than $7,500 per month.  The outstanding balance under
the line is secured by the accounts receivable of Metro, and the guarantees of
the Company and certain officer/shareholders.  As of May 30, 1998, short-term
borrowings under the line of credit totaled $530,272.

Capital Expenditures:

     Capital expenditures in fiscal 1998 amounted to $105,590 as compared to
$147,726 in fiscal 1997.  The Company anticipates that its capital expenditures
for 1999 will be approximately $100,000 to $150,000 primarily used for computer
equipment, duplicating and editing equipment.  The company currently has a
$500,000 lease line available of which approximately $350,000 was used during
1998. The Company believes the $150,000 remaining on the lease line is
sufficient for its anticipated needs.

     Management believes that funds provided by operations, existing and new
line of credit, are adequate to meet the anticipated short-term and long-term
capital needs.  Management believes that inflation has not had a material effect
on its operations.

FISCAL YEAR ENDED MAY 31 , 1997
COMPARED TO FISCAL YEAR ENDED MAY 31, 1996

LIQUIDITY AND CAPITAL RESOURCES

     The Company's financial position remains sound.  Cash and cash equivalents
amounted to $57,724 at year-end.  Cash provided by operating activities amounted
to $1,027,435 in fiscal 1997, $1,326,785 in fiscal 1996, and $1,557,928 in
fiscal 1995.  The Company's primary sources of cash in fiscal 1997 consisted of
(1) funds provided from operations $1,027,435 and (2) net proceeds from short-
term borrowings of $391,186.  The primary uses of cash in fiscal 1998 consisted
of (1) investments in motion pictures and other films $1,402,883; (2) payments
on capital lease obligations of $177,708; and (3) purchases of property and
equipment $147,726.

     Working capital amounted to $2,489,792 in fiscal 1997 as compared to
$3,332,590 in fiscal 1996.  The net increase in accounts receivable of $870,852
was primarily due to the increase of sales in April and May, 1997.  Inventory
decreased $362,023 due to better inventory management.  Accounts payable and
accrued expenses increased $802,883 due to improved vendor terms from tape
supplies and 

                                       23
<PAGE>
 
the inclusion of a $100,000 litigation settlement liability due November, 1997.
Increased spending for film production is another factor of the increase in
accounts payable.

     Of Metro's total accounts receivable at May 30, 1997 and 1996, $1,711,443
(41.9%) and $662,807, (21.0%),  respectively, is owed by Capital Video
Corporation ("CVC"), a chain of retail stores of which a former
officer/shareholder of the Company is the sole shareholder.  Because of the
amount of this receivable and the concentration of business with CVC, this
receivable is monitored very closely. Metro has the personal guaranty of its one
shareholder.  Accordingly, no allowance for related party receivables and no
related party bad debt expense has been recorded in the Company's financial
statements.

Forward Looking Statements

     This Form 10-KSB Report contains "forward-looking statements," including
statements in "Management's Discussion and Analysis of Financial Condition and
Results of Operations," as to expectations, beliefs, plans, objectives and
future financial performance, and assumptions underlying or concerning the
foregoing.  Such forward-looking statements involve risks and uncertainties
which could cause actual results or outcomes to differ materially from those
expressed in the forward-looking statements.  One such factor that could cause
actual results or outcomes to differ materially from those discussed in the
forward-looking statements would be government actions or initiatives, such as
attempts to limit or otherwise regulate the sale of adult-oriented materials,
including print, video and online materials.

Year 2000 Compliance

     As the year 2000 approaches, an issue has emerged regarding how existing
application software programs and operating systems can accommodate this date
value.  Failure to adequately address this issue could have potentially serious
repercussions.  The Company is in the process of working with the service
providers to prepare for the year 2000.  Based on information currently
available, the Company does not expect that it will incur significant operating
expenses or be required to incur material costs to year 2000 compliant.

 ITEM 7.  FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA.
 ----------------------------------------------------

     The consolidated financial statements and supplemental data of the Company
and the report of independent auditors thereon set forth at pages F-1 through F-
21 herein are incorporated herein by reference.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
-----------------------------------------------------------------------
        FINANCIAL DISCLOSURES.
        ----------------------

     None

                                       24
<PAGE>
 
                                   PART III
                                   --------

 ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; 
---------------------------------------------------------------------
         COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
         -------------------------------------------------

     The Directors and Executive Officers of the Company are as follows:
<TABLE>
<CAPTION>
 
Name                 Age  Position
----                 ---  --------               
<S>                  <C>  <C>
 
A. Daniel Geribo      53  Director, President and Secretary
Alan S. Casale        48  Director
Dolores Guglielmi     59  Director
Janet M. Hoey         35  Treasurer
</TABLE>

     A. Daniel Geribo was elected President in November, 1996 and has served as
President, Treasurer, Secretary and sole director of Capital Video Corporation,
which operates a chain of retail video stores in the New England and upstate New
York area since November 1994, and from September 1993 to November 1994 served
as General Manager of Capital Video Corporation.  From January 1983 to May 1993,
Mr. Geribo served as President of Unfinished Furniture House, Inc., a chain of
retail furniture stores.

     Alan S. Casale is a principal in the accounting firm of Casale, Caliri &
Jeroma since 1987.  Mr. Casale was formerly the principal of Cardello,
Riccitelli & Casale who were the auditors of record of the Company from December
1992 to February 1993, and audited the financial statements of Metro for the
years ended May 31, 1992 and May 31, 1991.

     Dolores Guglielmi has been a Registered Nurse Anesthetist for Associates in
Anesthesia, Inc. a medical services provider, for more than five years.

     Janet M. Hoey was elected Treasurer of the Company in December, 1997.  Ms.
Hoey was employed by the accounting firm of Ernst and Young from 1985 through
1990.  From 1990 through 1996 Ms. Hoey was employed as controller and financial
consultant for Quantum Resources, a forensic accounting and consulting company.
Prior to joining Metro, Ms. Hoey was employed by Barnstable County Supply as its
controller.  Ms. Hoey is a certified public accountant.

     In addition to the Directors and Executive Officers listed above,  Dennis
Nichols is expected to make a significant contribution to the business of the
Company and its subsidiaries.  Dennis Nichols has served as President and sole
director of Metro Inc. since its inception in 1990.  From March 1992 to November
1994, Mr. Nichols served as President, Treasurer, Secretary and director of
Capital Video Corporation, which operates a chain of retail video stores in the
New England and upstate New York area.

     No director or executive officer serves pursuant to any arrangement or
understanding between him or her and any other person(s), other than arrangement
or understandings with directors and officers acting solely in their capacity as
such.

                                       25
<PAGE>
 
ITEM 10.  EXECUTIVE COMPENSATION.
--------------------------------
<TABLE> 
<CAPTION> 
                                  ANNUAL COMPENSATION       LONG TERM COMPENSATION
                                 ---------------------   -----------------------------
                                                OTHER
NAME AND PRINCIPAL    FISCAL                    ANNUAL                       ALL OTHER
POSITION              YEAR       SALARY  BONUS  COMP.    AWARDS  PAYOUTS     COMP.
-------------------------------------------------------------------------------------- 
<S>                   <C>        <C>     <C>    <C>      <C>     <C>         <C>
A. DANIEL GERIBO        1998     $    -      -  $30,000       -        -          -
                                  
PRESIDENT               1997     $    -      -  $15,000
                                  
KENNETH F. GUARINO      1997     $74,200      -
                                  
PRESIDENT (2)           1996     $83,798      -
 
</TABLE>
(1) Mr. Geribo was elected President of the Company in November, 1996. His
services are valued at $30,000 per year.

(2) Mr. Guarino was elected President of Metro effective October 31, 1995 and he
resigned effective October 31, 1996.


  Aggregated Options / SAR Exercises in Last Fiscal Year and fiscal year-end 
  --------------------------------------------------------------------------
                              Option / SAR Values
                              -------------------
<TABLE>
<CAPTION>
                                                       Number of        
                                                      Securities            Value of    
                                                      Underlying          Unexercised   
                                                      Unexercised        In-the-Money   
                                                     Options/SARs at    Options/SARs at 
                                                        FY-End               FY-end      
 
Name                Shares Acquired      Value       Exercisable /       Exercisable /
                    on exercise (#)   Realized ($)   Unexercisable       Unexercisable
------------------------------------------------------------------------------------------
<S>                 <C>               <C>           <C>               <C>
Kenneth Guarino                  0           -         200,000/0                 -
                                                                               
A. Daniel Geribo                 0           -          10,000/0                 -
</TABLE>

     In September 1993, a disinterested majority of the Board of Directors
authorized the execution of an Employment Agreement with Kenneth F. Guarino,
effective as of January 1, 1993. By mutual agreement the employment agreement
was terminated on December 31, 1996. In addition, the Company granted Mr.
Guarino stock options to purchase up to 200,000 shares of Common Stock at a
purchase price of $1.50 per share, exercisable in four annual installments of
50,000 shares commencing January 1, 1994. In January, 1997 the term of the
options was extended to December 31, 2006. The requirement that the options be
exercised within 30 days after termination of employment was deleted. Except as
set forth above, no other executive officer received salary and bonus exceeding
$100,000 in any of the last three fiscal years.

                                       26
<PAGE>
 
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
-----------------------------------------------------------------------

     The following table sets forth certain information regarding the Company's
Common Stock beneficially owned as of July 31, 1998, (I) by each person who is
known by the Company to own beneficially more than 5% of the Company's common
stock, (ii) by each of the Company's directors, and by all executive officers
and directors as a group.

<TABLE>
<CAPTION>
                                         NO. OF SHARES OF     
                                           COMMON STOCK           PERCENTAGE OF       
         NAME AND ADDRESS               BENEFICIALLY OWNED    BENEFICIAL OWNERSHIP (1) 
<S>                                     <C>                   <C>
Officers and Directors
----------------------

A. Daniel Geribo                                10,000  (2)                      *
788 Reservoir Avenue, Suite 300
Cranston, RI 02910
                                                   
Alan S. Casale                                     620                           * 
1140 Reservoir Avenue
Cranston, RI  02920

Dolores Guglielmi
27 Sherman Avenue
Lincoln, RI  02865                              24,600                           *
 
All Executive Officers and 
 Directors as a group (4 people)                35,220                           *
      
 
Other 5% Beneficial Owners
--------------------------
Briana Investment Group, LP                  1,492,903                       24.44
c/o Helen Adderley, Esquire
Corner House
20 Parliament Street
Hamilton HM DX, Bermuda
 
Kenneth F. Guarino                             545,325  (3)                   8.93
50 Fort Avenue
Cranston, RI 02905
 
Metro Plus                                     385,000                        6.30
1060 Park Avenue
Cranston, RI 02910
</TABLE>


*    Beneficial ownership represents less than 1% of the outstanding common
     stock.

(1)  Assumes 5,907,562 shares of Common Stock issued and outstanding at July 31,
     1998 and 200,000 unexercised stock options.

(2)  Includes 10,000 unexercised stock options

(3)  Includes 200,000 unexercised stock options

                                       27
<PAGE>
 
ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
---------------------------------------------------------

     A. Daniel Geribo serves as the sole officer and director of, and Mr.
Guarino also serves as the operations manager and is 100% owner of, Capital
Video Corporation ("CVC") which operates a chain of retail video stores in the
New England and upstate New York area. Capital Video Corporation accounted for
$9,952,316 (47%), $7,134,774 (39%), and $6,297,550 (32%) of the net sales of
Metro, Inc. for the fiscal years ended May 30, 1998, 1997, and 1996
respectively. At May 30, 1998, $2,447,041 (47.1%) of Metro's outstanding
accounts receivable were due from Capital Video Corpora tion. At May 31, 1997,
$1,711,443 (41.9%) of Metro's outstanding accounts receivable were due from
Capital Video Corporation, secured by a security interest in all of the
inventory of Capital Video Corporation and the personal guaranty of Mr.
Guarino's wife. At May 30, 1996, $662,807 (21%) of Metro's outstanding accounts
receivable were due from Capital Video Corporation. The age of the accounts
receivable from CVC is as follows:

<TABLE>
<CAPTION>
                 Current   30-60 days   60-90 days  Over 90 days
                ---------  -----------  ----------  ------------
<S>             <C>        <C>          <C>         <C>
May 31, 1998     $998,408   $1,328,941    $149,692            $0
May 30, 1997     $814,473   $  612,796    $284,174            $0
May 30, 1996     $566,033   $   96,774    $      0            $0
</TABLE>

     The significant increase in Metro's accounts receivable from Capital Video
is the result of increased sales due to Capital opening new stores, and a
reflection of Capital's excellent payment history with Metro.  Metro has
permitted CVC to return to the previous net 60 day payment terms.  Manage  ment
of the Company has determined that, given the volume of business Capital Video
has historically provided to Metro, the value of the CVC inventory (which is
monitored by Metro and in which Metro retains a security interest), such aging
is reasonable and in the best interests of the Company.

     Effective May 1, 1993, Metro entered into a lease with  Castle Properties,
L.L.C. for an approximately 50,000 square foot office, warehouse and shipping
complex located in Cranston, Rhode Island.  This new facility houses Metro's
executive, administrative, editorial and operational offices, the data center
and customer service, warehouse and fulfillment facilities. The lease is for a
term of 10 years with two five-year renewal options, and provides for a fixed
annual rent of $245,200 for the first five years, triple net.  The annual rent
for lease years 6 through 10 as well as the rent for the renewal terms, if any,
shall be adjusted based on increases in the consumer price index.  Approximately
7,500 square feet of the facility is sublet to Capital Video Corporation under
an oral, month-to-month lease agreement for $9,000 per month for June, 1997 and
$4,000 per month thereafter. Castle Properties, L.L.C. is a Rhode Island limited
liability company principally owned by Mr. Guarino's wife.  In fiscal 1998, the
Company was granted a rent reduction of $81,733 which is being amortized over
the remaining term of the lease.

     On January 13, 1996, the Company entered into a lease agreement with
Centurion Financial Group, L.L.C. for approximately 5,000 square feet of office
space in Cranston, Rhode Island, with a monthly rent of $5,833.33, effective
June 1, 1994.  The lease is for a term of 5 years, with a 5 year renewal option.
Centurion Financial Group, L.L.C. is a Rhode Island limited liability company
principally owned by a trust for the benefit of Mr. Guarino's children.  This
lease was terminated by mutual agreement of the parties during the year ended
May 30, 1997.

     Effective May 8, 1997, Briana Investment Group, a British Virgin Island
limited partnership acquired 730,863 shares of common stock of the Registrant
from Capital Video Corporation and 742,050 shares of common stock of the
Registrant from Zeon Corporation.  In connection with the transaction, the
Registrant entered into a Registration Rights Agreement.

                                       28
<PAGE>
 
CONFLICTS OF INTEREST
---------------------

     Of necessity, some inherent conflict of interest is involved whenever
Officers, Directors and others acting on behalf of the Company supply services
or goods to the Company for compensation. Additional conflicts and non-arm's
length transactions may arise in the future when Company officers or directors
are involved in the management of any other company with which the Company
transacts business.  Conflicts may also arise with respect to opportunities
which come to the attention of such persons.  Conflicts may also arise with
respect to the amount of time and effort devoted to respective businesses and
opportunities.

     Many of the persons who perform services as officers, and directors to the
company are actively, and in the future will be, involved in businesses from
which they derive income, other than the Company. Their activities may include
information and management of business ventures, the legal profession, purchase
and sale of real estate and pursuit of other opportunities.  It is expected that
these persons will continue their separate business activities in conjunction
with their activities at the Company.

     Although the Board of Directors believes that members of Management will be
of great assistance to the Company in the fulfillment of its corporate mission,
some transactions may and will occur where the Company and a member of
Management will have conflicts in particular respects. Prospective investors are
specifically cautioned that such conflicts will occur as a routine matter in the
operation of the Company.  However, it is intended that, in accordance with
legal principals applicable to corporations, Company action will be determined
whenever possible by a disinterested majority of the Board of Directors.

     It is the Company's policy that all transactions in which an officer,
director or 5% shareholder has a direct or indirect interest be on terms no less
favorable to the Company than the Company would grant to or obtain from a
independent third-party in a arms-length transaction.  Because a majority of the
Broad of Directors are not affiliated with Capital Video Corporation, all
transactions between the Company or Metro and Capital Video Corporation have
been, and all future transactions will be, approved and/or ratified by a
disinterested majority of the Board of Directors.

                                       29
<PAGE>
 
                                    PART IV

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
------------------------------------------

(A) EXHIBITS.

     2.1  Stock Purchase Agreement dated July 31, 1998 by and among Robert
          Maiello, Michael Levine, Philip P. Salvatore, Bart Senior and Metro
          Global Media, Inc. as filed with the Commission on August 15, 1998 as
          Exhibit (1) on Form 8-K and incorporated herein by reference.
          
     3.1  Articles of Incorporation, as filed with the Commission on August 23,
          1988 as Exhibit 3.1 to the Registration Statement on Form S-18 and
          incorporated herein by reference.

     3.2  Bylaws, as filed with the Commission on August 23, 1988 as Exhibit 3.2
          to the Registration Statement on Form S-18 and incorporated herein by
          reference.

     3.3  Articles of Amendment of Articles of Incorporation of the Registrant,
          as filed with the Commission on January 17, 1995 as Exhibit 3.3 to the
          Quarterly Report on Form10-QSB for the fiscal quarter ended November
          30, 1994 and incorporated herein by reference.

     3.4  Amendment to Bylaws of the Registrant, as filed with the Commission on
          January 17, 1995 as Exhibit 3.4 to the Quarterly Report on Form 10-QSB
          for the fiscal quarter ended November 30, 1994 and incorporated herein
          by reference.

     3.5  Articles of Amendment of Articles of Incorporation of the Registrant,
          as filed with the Commission on August 28, 1996 as Exhibit 3.5 to the
          Form 10-KSB for the fiscal year ended May 30, 1996 and incorporated
          herein by reference.

     10.1 Stock Option Agreement dated September 9, 1993 between the Registrant
          and Kenneth F. Guarino, as filed with the Commission on February 3,
          1994 as Exhibit 10.2 to the Annual Report on Form 10-KSB for the
          fiscal year ended May 30, 1993 and incorporated herein by reference.

     10.2 Lease Agreement dated September 9, 1993 between Castle Properties,
          L.L.C. and Metro, Inc., as filed with the Commission on February 3,
          1994 as Exhibit 10.4 to the Annual Report on form 10-KSB for the
          fiscal year ended May 30, 1993 and incorporated herein by reference.

     10.3 Security Agreement dated September 24, 1993 between Metro, Inc. and
          Capital Video Corporation, as filed with the Commission on February 3,
          1994 as Exhibit 10.5 to the Annual Report on Form 10-KSB for the
          fiscal year ended May 30, 1993 and incorporated herein by reference.

     10.4 Lease Agreement dated January 13, 1995 between Centurion Financial
          Group, LLC and the Registrant, as filed with the Commission on January
          17, 1995 as Exhibit 10.13 to the Quarterly Report on Form 10-QSB for
          the fiscal quarter ended November 30, 1994 and incorporated herein by
          reference.

                                       30
<PAGE>
 
     10.5 Form of Airborne For Men, Ltd. Franchise Agreement, filed as Exhibit
          10.15 to the Post-Effective Amendment No. 14 to the Registration
          Statement on Form SB-2 and incorporated herein by reference.

     10.6  Promissory note of Metro, Inc. payable to the order of Kenneth F.
           Guarino dated as of May 24, 1995 in the principal amount of $63,393
           as filed with the Commission as Exhibit 10.13 to the Form 10-KSB for
           the fiscal year ended May 30, 1995 and incorporated herein by
           reference.

     10.7  Capital Stock Purchase Agreement dated as of November 30, 1995 by and
           between Airborne for Men, Ltd. and Capital Video Corporation, as
           filed with the Commission on December 10, 1995 as Exhibit 10.1 to
           Form 8-K and incorporated herein by reference.

     10.8  Debt Conversion Agreement between Capital Video Corporation and the
           Registrant, as filed with the Commission on December 11, 1995 as
           Exhibit 10.2 to the Form 8-K and incorporated herein by reference.

     10.9  Capital Stock Purchase Agreement dated as of January 31, 1996 by and
           between Airborne for Men, Ltd. and Capital Video Corporation as filed
           with the Commission on May 9, 1996 as Exhibit 10.1 to the Quarterly
           Report on Form 10-QSB for the fiscal quarter ended February 28, 1996
           and incorporated herein by reference.

     10.10 Amendment to Capital Stock Purchase Agreement dated as of November
           30, 1996 by and between Airborne For Men, Ltd. and Capital Video
           Corporation, as filed with the Commission on August 28, 1996 as
           Exhibit 10.16 to the Form 10-KSB for the fiscal year ended May 30,
           1996 and incorporated herein by reference.

     10.11 Amendment Agreement dated as of December 31, 1995 between Kenneth
           Guarino and the Registrant, as filed with the Commission on August
           28, 1996 as Exhibit 10.17 to the Form 10-KSB for the fiscal year
           ended May 30, 1996 and incorporated herein by reference.

     10.12 Amendment to Stock Option Agreement dated January 16, 1997 by and
           between Kenneth F. Guarino and the Registrant, as filed with the
           Commission on April 15, 1997 as Exhibit 10.1 to the Quarterly Report
           on Form 10-QSB for the quarter ended March 1, 1997 and incorporated
           herein by reference.

     10.13 Indemnification Agreement dated December 3, 1996 by Kenneth F.
           Guarino in favor of Registrant as filed with the Commission on April
           15, 1997 as Exhibit 10.2 to the Quar terly Report on Form 10-QSB for
           the quarter ended March 1, 1997 and incorporated herein by reference.

     10.14 Termination Agreement dated April 10, 1997 between Capital Video
           Corporation, Elvira Famiglietti and Metro, Inc. as filed with the
           Commission on April 15, 1997 as Exhibit 10.3 to the Quarterly Report
           on Form 10-QSB for the quarter ended March 1, 1997 and incorporated
           herein by reference.

                                       31
<PAGE>
 
     10.15 Description of Directors Compensation Arrangement, as filed with the
           Commission on April 15, 1997 as Exhibit 10.4 to the Quarterly Report
           on Form 10-QSB for the quarter ended March 1, 1997 and incorporated
           herein by reference.

     10.16 Registration Rights Agreement dated May 8, 1997 between Briana
           Investment Group, Ltd. and the Registrant, as filed with the
           Commission on May 8, 1997 as Exhibit 10.1 to Form 8-K and
           incorporated herein by reference.

     10.17 Employment Agreement dated July 31, 1998 between Robert Maiello and
           Metro Global Media, Inc. as filed with the Commission on August 15,
           1998 as Exhibit (2) on Form 8-K and incorporated herein by reference.

     10.18 Employment Agreement dated July 31, 1998 between Michael Levine and
           Metro Global Media, Inc. as filed with the Commission on August 15,
           1998 as Exhibit (3) on Form 8-K and incorporated herein by reference.

     10.19 Employment Agreement dated July 31, 1998 between Philip P. Salvatore
           and Metro Global Media, Inc. as filed with the Commission on August
           15, 1998 as Exhibit (4) on Form 8-K and incorporated herein by
           reference.

     10.20 Employment Agreement dated July 31, 1998 between Bart Senior and
           Metro Global Media, Inc. as filed with the Commission on August 15,
           1998 as Exhibit (5) on Form 8-K and incorporated herein by reference.

     21    Subsidiaries of the Registrant:

               Metro, Inc.
               Metro West Studios, Inc.
               Rocket Media Group, LLC
               Airborne for Men, Ltd.
 
     99.1  Letter from Ellis L. Levin, Director of Ten Eyck Associates, Inc.,
           dated March 5, 1998 as filed with the Commission on April 13, 1998 as
           Exhibit (1) on Form 8-KA and incorpo rated herein by reference.

     99.2  Letter from Trien Rosenberg, Rosenberg, Weinberg, Ciullo & Fazzari
           LLP, dated March 18, 1998 as filed with the Commission on April 13,
           1998 as Exhibit (2) on Form 8-KA and incorporated herein by
           reference.

(B)  REPORTS ON FORM 8-K

     The company filed a Form 8-K with the Securities and Exchange commission on
     December 23, 1997, to report the following:

     Item 5.  Other events

              After Thomas J. Blair, former director and chief financial officer
              of the Company resigned, The Company learned he had pled guilty to
              two felonies prior to his employment 

                                       32
<PAGE>
 
              with the Company. Based on the foregoing, the Commission found
              that Blair had been convicted of a felony within the meaning of
              Rule 102 (e) (2) of the Commission's Rules of Practice and on
              August 29, 1985 issued an order that Thomas J. Blair was forthwith
              permanently suspended from appearing or practicing before the
              Commission.

     The Registrant filed Form 8-K with the Commission on April 13, 1998 to
report the following:

     Item 5.  Other Events

              Pursuant to the Company's Form 8-K filing, dated December 23,
              1997, the Company engaged an independent consulting firm to
              investigate whether there were any irregulari ties with respect to
              the Company's accounting and financial reporting during Mr.
              Blair's tenure with the Company. To conduct this investigation,
              the Company retained Ten Eyck Associates, Inc. whom, on March 5,
              1998 issued a report to the Company stating that the investigation
              did not reveal any accounting or financial reporting
              irregularities. Further the investigation did not detect any
              transactions that appear to have been other than in the ordinary
              course of business. Based on the results of this investigation, on
              March 18, 1998, the Company's independent auditors retracted their
              previous cautionary letter with respect to the Company's financial
              statements and have once again concluded that their previously
              issued audit reports dated July 31, 1997 and August 9, 1996 on the
              Company's financial statements for the years ended May 31, 1997
              and May 31, 1996 may be relied upon as originally filed.

     The Registrant filed Form 8-K with the Commission on August 15, 1998 to
report the following:

     Item 2.  Acquisition or Disposition of Assets

              Pursuant to a Stock Purchase Agreement, on July 31, 1998, the
              Registrant purchased 100% of the stock of Fanzine International,
              Inc. ("Fanzine) for a total purchase price of $7,500,000
              consisting of $4,000,000 cash payable over a six month period from
              closing and 1,000,000 shares of the Company's common stock.
              Fanzine is a New Jersey based publishing company which produces a
              line of event driven, mainstream magazines translated into seven
              languages and distributed worldwide. The shares of the
              Registrant's restricted common stock were issued to Robert
              Maiello, Michael Levine, Philip Salvatore and Bart Senior, all of
              whom were the selling shareholders of Fanzine. None of these
              individuals were affiliates of the Company. The issuance of the
              restricted shares did not involve an underwriter and no discount
              or commission was paid in connection therewith. The acquisition
              will be accounted for as a purchase. The excess of the aggregate
              purchase price over the fair market values of net assets acquired
              which consisted mainly of licenses, trademarks, and publishing
              rights was allocated principally to good will. The final
              acquisition purchase price is subject to certain earn-out
              contingencies during the first five quarters following the
              closing. Also, the selling shareholders of Fanzine have the right
              to redeem their respective shares of the registrant at a price of
              $8 per share on a quarterly basis if certain minimum earning
              levels, as defined in the Stock Purchase Agreement are met during
              any four quarters of the first five quarters following the
              closing.

              The initial cash payable of $2,000,000 and the balance due was
              principally financed by long-tem convertible debentures.

                                       33
<PAGE>
 
                              S I G N A T U R E S

     Pursuant to the requirement of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused the report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                             METRO GLOBAL MEDIA, INC.

                             By: /s/ A. Daniel Geribo
                                ---------------------------------
                                A. Daniel Geribo, President

                                Date: September 11, 1998

     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 and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
 
Signature                                      Title                       Date
---------                                      -----                       ----
<S>                               <C>                               <C>

/s/ A. Daniel Geribo              President, (principal             September 11, 1998
--------------------------------  executive officer) and  Director
A. Daniel Geribo                  
 
/s/ Janet M. Hoey                 Secretary/Treasurer (principal    September 11, 1998
--------------------------------  financial and accounting
Janet M. Hoey                     officer)
                      
 
/s/ Alan S. Casale                Director                          September 11, 1998
--------------------------------
Alan S. Casale
 
/s/ Dolores Guglielmi             Director                          September 11, 1998
--------------------------------
Dolores Guglielmi
</TABLE>

                                       34
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

                         INDEX TO FINANCIAL STATEMENTS

<TABLE>
<S>                                                                         <C>
  
Independent Auditors' Report                                                F-1
                                                  
Consolidated Balance Sheets                                                 F-2
                                                  
Consolidated Statements of Operations                                       F-3
                                                  
Consolidated Statements of Shareholders' Equity                             F-4
                                                  
Consolidated Statements of Cash Flows                                       F-5
                                                  
Notes to Consolidated Financial Statements                                  F-8
 
</TABLE>

                                      F-0
<PAGE>
 
                         INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Shareholders of
Metro Global Media, Inc. and Subsidiaries
Cranston, Rhode Island

We have audited the accompanying consolidated balance sheets of Metro Global
Media, Inc. and Subsidiaries as of May 30, 1998 and May 31, 1997, and the
related consolidated statements of opera  tions, shareholders' equity, and cash
flows for each of the years in the three-year period ended May 30, 1998.  These
financial statements are the responsibility of the Company's management.  Our
responsibil  ity is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
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 principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Metro Global Media,
Inc. and Subsidiaries as of May 30, 1998 and May 31, 1997 and the results of
their operations and their cash flows for each of the years in the three-year
period ended May 30, 1998, in conformity with generally accepted accounting
principles.



                              TRIEN, ROSENBERG, ROSENBERG,
                                  WEINBERG, CIULLO, & FAZZARI, LLP

Morristown, New Jersey
July 24, 1998, except for
Note 13, as to which the
date is July 31, 1998

                                      F-1
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
FOR THE YEARS ENDED MAY 30, 1998 AND MAY 31, 1997
--------------------------------------------------------------------------------

                                     Assets
<TABLE> 
<CAPTION> 
                                                                          1998            1997
                                                                      -----------      -----------
<S>                                                                   <C>              <C> 
Current assets                                                           
--------------                                                           
   Cash                                                               $   184,995      $    57,724
   Accounts receivable, less allowance for doubtful accounts of          
      $163,030 and $22,082, respectively                                5,092,255        4,081,031 
   Inventory                                                            3,726,963        3,684,501 
   Recoverable income tax                                                   -              287,000 
   Deferred income taxes                                                  248,500          165,650
   Prepaid expenses and other current assets                               78,751           41,460
                                                                      -----------      -----------
          Total current assets                                          9,331,464        8,317,366
          --------------------                                                   
                                                                         
Motion pictures and other films at cost, less accumulated                
    amortization of $6,575,623 and $5,085,183, respectively             4,142,979        3,353,743
                                                                         
Property and equipment at cost, less accumulated depreciation and        
   amortization of $1,681,138 and $1,303,939, respectively              1,479,426        1,575,199 
                                                                         
Other assets                                                              483,472          292,235
                                                                         
          Total assets                                                $15,437,341      $13,538,543
          ------------                                                ===========      ===========
</TABLE> 
<PAGE>
 
                     Liabilities and Shareholders' Equity
                     ------------------------------------
<TABLE> 
<CAPTION> 
                                                                           1998                  1997                 
                                                                      --------------         ------------                 
<S>                                                                   <C>                    <C>         
Current liabilities                                                                                         
-------------------                                                                                         
   Current portion of long-term debt                                  $        -             $      137,651 
   Current portion of capital lease obligations                              363,956                222,962 
   Short-term borrowings                                                   1,030,272                897,247 
   Accounts payable and accrued expenses                                   4,232,679              4,206,577 
   Income taxes payable                                                      326,119                363,137 
                                                                      --------------         -------------- 
     Total current liabilities                                             5,953,026              5,827,574 
     -------------------------                                                                              
                                                                                                            
Long-term debt, less current portion                                                               395,988  
Capital lease obligations, less current portion                              351,538               361,591  
Deferred income taxes                                                         59,300                35,700  
                                                                      --------------         -------------- 
     Total liabilities                                                     6,363,864              6,620,853 
     -----------------                                                --------------          ------------- 
                                                                                                            
Minority interest                                                             18,220                  -
                                                                      --------------                   
Commitments and contingencies                                                                         
                                                                                                      
Shareholders' equity                                                                          
--------------------                                                                          
  Series A 5% cumulative convertible preferred stock, $.0001 par                              
     value, $1,000 stated value, authorized, issued and outstanding                           
     2,175 shares less 1.320 shares outstanding subscriptions                                 
     receivable.                                                             857,979                  -       
  Preferred stock, no par value; authorized 2,000,000 shares; issued                                          
     and outstanding, none                                                     -                      -       
  Common stock, $.0001 par value; authorized 10,000,000 shares;                                               
      issued and outstanding, 4,245,193 and 3,558,168 shares,                                                 
      respectively                                                               424                    356        
  Additional paid in capital                                               6,546,580              5,542,762  
  Retained earnings                                                        1,712,774              1,374,572 
                                                                      --------------          ------------- 
  Unearned compensation                                                    9,117,757              6,917,690         
                                                                             (62,500)                  -         
                                                                      --------------                                 
     Total shareholders' equity                                            9,055,257              6,917,690            
     --------------------------                                       --------------          -------------   
                                                                                                                       
     Total liabilities and shareholders' equity                       $   15,437,341          $  13,538,543         
     ------------------------------------------                       ==============          =============   
</TABLE> 

                See Notes to Consolidated Financial Statements

                                      F-2
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------
<TABLE> 
<CAPTION> 
                                                                    1998                  1997                    1996         
                                                                ------------          ------------            -----------         
<S>                                                             <C>                   <C>                     <C>                  
Revenues                                                         $20,391,134          $18,355,868             $19,526,010  
Cost of revenues, including amortization of motion                                                                         
   pictures and other films of $1,490,440                                                                                  
   and $707,522, and $1,823,759, respectively                     13,330,798            11,564,466              11,939,031   
                                                                ------------          ------------            ------------ 
                                                                   7,060,336             6,791,402               7,586,979   
                                                                                                              
Selling, general and administrative expenses                       6,219,307             7,026,944               6,747,382        
                                                                ------------          ------------            ------------
                                                                                                                               
  Income (loss) from operations                                      841,029              (235,542)                839,597          

  -----------------------------                                 ------------          ------------            ------------     
                                                                                                                               
Other income and expenses                                                                                                      
-------------------------                                                                                               
    Interest expense                                                (348,980)             (340,864)               (396,170) 
    Royalty income                                                   127,206               128,091                    -     
    Gain on sale of subsidiaries                                        -                     -                    171,795   
    Gain on settlement of litigation                                    -                  113,000                 196,400   
    Miscellaneous (expense) income                                    (3,870)               12,315                   6,623   
    Minority interest                                                (18,220)                 -                       - 
                                                                ------------          ------------            ------------     
                                                                    (243,864)              (87,458)                (21,352)       
                                                                ------------          ------------            ------------ 
  Income (loss) before provision for income taxes                    597,165              (323,000)                818,245
  -----------------------------------------------                                                                         
                                                                                                                   292,570
Provision (benefit) for income taxes                                 247,484              (115,842)           ------------
                                                                ------------         -------------                        
  Net income (loss)                                             $    349,681          $   (207,158)           $    525,675 
  -----------------                                             ============          ============            ============ 
                                                                                                                           
    Basic earnings (loss) per common share                      $        .09          $       (.06)           $        .17         
    Diluted earnings (loss) per common share                             .09                  (.06)                    .17
                                                                                                                          
Weighted average number of shares outstanding                                                                             
    Basic                                                          3,661,994             3,503,565               3,014,437
    Diluted                                                        3,812,213             3,553,565               3,163,675
</TABLE> 
 
                See Notes to Consolidated Financial Statements

                                      F-3
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------------
<TABLE> 
<CAPTION> 
                                                 Series A                                                 Additional
                                              Preferred Stock                  Common Stock                 Paid-in 
                                       Shares                  Amt.      Shares               Amt.          Capital
                                       ----------------------------      -------------------------      --------------
<S>                                    <C>                 <C>           <C>               <C>          <C> 
Balance, May 31, 1995                                                    2,344,884         $   284        $3,376,276
Shares issued:                                  
 as compensation for services                   
   rendered by consultants                                                  55,666               6           289,657 
 in connection with the conversion              
   of a $1,000,000 note payable                                            730,568              73         1,095,793
 in connection with the "IDC"                   
   settlement of litigation                                                (75,000)             (8)         (224,992)
 Upon exercise of warrants                                                 306,916              31           460,493 
 Upon exercise of options                                                   45,000               5           181,871
Amortization of unearned                        
   compensation                                                         
Net income                                      
                                                                         ----------     ----------      ---------------
Balance, May 31, 1996                                                    3,408,034             341         5,179,098
                                                
Shares issued:                                  
 as compensation for services rendered          
   by consultants                                                          100,000              10           243,790
 as compensation for directors and employees                                12,400               1            13,949
 Stock dividend pursuant to a private placement                             17,734               2            53,477
Upon exercise of options                                                    20,000               2            52,448
Amortization of unearned compensation           
Net loss                                        
                                                                         ----------     ----------     -------------- 
Balance, May 31, 1997                                                     3,558,168            206         1,374,572
                                                
Shares issued:                                  
  as compensation for services                  
   rendered by consultants                                                  206,000             20           282,979
  as compensation for directors                 
   and employees                                                              5,000              1             6,849
  in connection with conversion of              
    notes payable and accrued                   
    interest of $714,037                                                    476,025             47           713,990
  upon issuance of Series A Preferred           
   stock (less offering cost of                 
   $11,500)                             2,175            2,163,500       
Subscription receivable on Series A             
   Preferred stock ($645,000 held in            
   escrow cash)                        (1,320)          (1,317,000)
Dividends on Series A Preferred stock                       11,479
Unamortized compensation - restricted           
   stock                                        
Net income                                      
                                        --------        ------------    ----------     ----------     --------------  
Balance, May 30, 1998                        855        $    857,979    $4,254,193     $      424     $    6,546,580
                                       

<CAPTION> 
                                                Retained           Unearned     
                                                Earnings           Compensation         Total
                                               -----------         ------------     ----------
<S>                                            <C>                 <C>               <C>     
Balance, May 31, 1995                          $1,109,534          $  (118,750)      $4,367,294
Shares issued:                                  
 as compensation for services                   
   rendered by consultants                                                              289,663
 in connection with the conversion              
   of a $1,000,000 note payable                                                       1,095,866
 in connection with the "IDC"                   
   settlement of litigation                                                            (225,000)
 Upon exercise of warrants                                                              460,524
 Upon exercise of options                                                               181,876
Amortization of unearned                        
   compensation                                                         75,000           75,000
Net income                                        525,675                               525,675
                                               -----------         ------------     ----------
                                                 
Balance, May 31, 1996                            1,635,209             (43,750)       6,770,898
                                                
Shares issued:                                  
 as compensation for services rendered          
   by consultants                                                                       243,800
 as compensation for directors and employees                                             13,950 
 Stock dividend pursuant to a private placement    (53,479)
Upon exercise of options                                                 43,750
Amortization of unearned compensation             (207,158)                            (207,158)
Net loss                                        
                                               -----------         ------------     ----------
Balance, May 31, 1997                            1,374,572                    0      6,917,690
                                                
Shares issued:                                  
  as compensation for services                  
   rendered by consultants                                                              282,999
  as compensation for directors                 
   and employees                                                                          6,850
  in connection with conversion of              
    notes payable and accrued                   
    interest of $714,037                                                                714.037
  upon issuance of Series A Preferred           
   stock (less offering cost of                  
   $11,500)                                                                           2,163,500
Subscription receivable on Series A             
   Preferred stock ($645,000 held in            
   escrow cash)                                                                      (1,317,000)
Dividends on Series A Preferred stock              (11,479)  
Unamortized compensation - restricted           
   stock                                                                (62,500)        (62,500)
Net income                                         349,681                              349,681
                                               -----------         ------------      ----------
Balance, May 30, 1998                           $1,712,774            $ (62,500)     $9,055,257
                                               ===========         ============      ==========
</TABLE> 

                                      F-4
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

<TABLE> 
<CAPTION> 
                                                                     1998                  1997                1996        
                                                                  ------------         -----------         ------------    
<S>                                                               <C>                  <C>                 <C>                 
CASH FLOWS FROM OPERATING ACTIVITIES:                                                                          
   Net income (loss)                                              $    349,681         $  (207,158)        $    525,675
                                                                  ------------         -----------         ------------
   Adjustments to reconcile net income (loss) to                                                                       
      net cash provided by operating activities:                                                                       
  Depreciation and amortization                                     1,875,666            1,051,493            2,152,026
      Bad debt expense                                                177,203              331,000                 -
  Loss on abandonment of equipment                                       -                    -                  16,389             

  Gain on sale of equipment                                              -                  (2,927)                - 
  Gain on sale of subsidiaries                                           -                    -               (171,795) 
  Gain on settlement of litigation                                       -                (113,000)           (196,400)  
  Amortization of unearned compensation                                  -                  43,750              75,000  
  Amortization of goodwill                                               -                    -                 12,666  
  Common stock issued for consulting services                         220,499                 -                289,663  
  Common stock issued for compensation                                  6,850               27,700               -      
      Minority interest                                                18,220                 -                  -      
   (Increase) decrease in assets:                                                                                        
      Accounts receivable                                          (1,188,427)          (1,201,852)           (483,777)            
      Inventory                                                       (42,462)             362,023            (567,989) 
      Prepaid expenses and other current assets                       (37,291)              60,733             (49,321) 
      Other assets                                                     37,395              136,746            (208,912) 
      Recoverable income tax                                          287,000             (287,000)               -      
      Deferred income taxes                                           (82,850)             (87,150)               -            
   Increase (decrease) in liabilities:                                                                             
      Accounts payable and accrued expenses                           206,500              832,683            (212,054)  
      Income taxes payable                                            (37,018)              86,694             196,257  
      Deferred income taxes payable                                    23,600               (6,300)            (50,643) 
                                                                -------------          -----------         -----------  
  Total adjustments                                                 1,464,885            1,234,593             801,110     
  -----------------                                             -------------          -----------         -----------    
                                                                                                                                 
  Net cash provided by operating activities                         1,814,566            1,027,435             1,326,785 
  -----------------------------------------                     -------------          -----------           ----------- 
</TABLE> 
                 See Notes to Consolidated Financial Statements

                                      F-5
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
INCREASE (DECREASE) IN CASH
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------
<TABLE> 
<CAPTION> 
                                                                         1998             1997             1996  
                                                                      ----------       ----------       ----------  
<S>                                                                   <C>              <C>              <C> 
CASH FLOWS FROM INVESTING ACTIVITIES:                                                                   
    Proceeds from sale of equipment                                         -              11,000             - 
    Investments in motion pictures and other films                    (2,279,676)      (1,402,883)      (1,803,999)
    Purchase of property and equipment                                  (105,590)        (147,726)        (301,793)
    Cash transferred in connection with sale of                                                                    
        subsidiaries                                                        -                -             (52,906)             
                                                                      ----------       ----------       ----------  
  Net cash used in investing activities                               (2,385,266)      (1,539,609)      (2,158,698)           
  -------------------------------------                                ---------      -----------       ---------- 
                                                                                                                   
                                                                                                                   
CASH FLOWS FROM FINANCING ACTIVITIES:                                                                              
    Proceeds from the issuance of Series A                                                                         
        convertible preferred stock                                      846,500             -               -     
    Proceeds from issuance of common stock                                  -              26,250         642,399  
    Net proceeds (payments) from line of credit                         (366,975)         391,186         506,061  
    Increase in notes payable                                            500,000             -            122,447  
    Principal payments on notes payable                                     -             (30,501)       (38,133)  
    Principal payments on capital lease obligations                     (281,554)        (177,708)      (107,247)  
                                                                    ------------      ------------     ---------
  Net cash provided by financing activities                              697,971           209,227     1,125,527
  -----------------------------------------                         ------------      ------------     ---------
                                                                                                                
Net increase (decrease) in cash                                          127,271          (302,947)      293,614       
                                                                                                                 
Cash, beginning of year                                                   57,724           360,671        67,057 
                                                                    ------------      ------------     ---------
CASH, END OF YEAR                                                   $    184,995      $     57,724     $ 360,671  
                                                                    ============      ============     =========         
                                                                                                     
Supplemental disclosures of cash flow information:                                                   
                                                                                                     
    Cash paid during the year for:                                  $    278,248      $    253,517     $ 235,066 
        Interest                                                    ============      ============     ========= 
                                                                                                                 
        Income taxes                                                $     29,637      $    290,556     $ 147,478
                                                                    ============      ============     =========
</TABLE> 
                 See Notes to Consolidated Financial Statements

                                      F-6
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
INCREASE (DECREASE) IN CASH
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

Supplemental schedule of non-cash investing and financing activities:

   During the year ended May 30, 1998, notes payable and accrued interest
   totaling $714,037 were converted into 476,025 restricted shares of the
   Company's common stock.

   During the year ended May 31, 1997, accounts payable with a value of $230,000
   was converted into 90,000 shares of the Company's common stock.

   During the year ended May 31, 1997, under the terms of a prior year private
   placement, the company issued a stock dividend valued at $52,450 (17,734
   shares of common stock) to such applicable stockholders.

   During the year ended May 31, 1997, the Company settled a pending litigation
   by agreeing to pay a fine of $200,200. Since the Company was indemnified, the
   related indebtedness was reduced by $200,200.

   During the year ended May 31, 1996, the Company sold three of its
   subsidiaries for an aggregate price of $1,076,947. As payment, the buyer
   assumed the Company's debt and accrued interest of $1,076,947. The
   subsidiaries' net assets over net liabilities (excluding cash transferred of
   $52,906) in connection with the sale amounted to $852,246 resulting in a gain
   of $171,795.

   During the year ended May 31, 1996, machinery and equipment of approximately
   $159,000, was returned to vendor and the related capital lease obligation for
   $159,252 was canceled.

   During the year ended May 31, 1996, in connection with a litigation
   settlement, the Company received back its common stock valued at $225,000
   reflected as a reduction in stockholders' equity (see Note 3 ).

   During the year ended May 31, 1996, note payable plus accrued interest for
   $1,095,866 was converted into 730,568 shares of the Company's common stock
   for the year ended May 31, 1996.

   Capital lease obligations of $412,495, $584,554, and $150,564, were incurred
   during the years 1998, 1997 and 1996, respectively, when the Company entered
   into capitalized leases for office equipment and machinery and equipment.


                 See Notes to Consolidated Financial Statements

                                      F-7
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

The Company produces and distributes, predominantly in the United States, motion
pictures and other entertaining products (including magazines, videos and
novelties) and related ancillary products to wholesalers and retailers oriented
to the adult entertainment market.

Name Change and Merger

In November 1996 Metro Global Media, Inc. (the "Company") merged into an
inactive subsidiary (Metro Sub, Inc.) under the laws of the state of Delaware
and simultaneously changed its name back to Metro Global Media, Inc.  This
transaction was accounted in a manner similar to that used in pooling of
interest accounting and had no effect on authorized, issued, and outstanding
shares of the Company or to the financial statements presented herein.

Year-end

Beginning May 31, 1997, the Company changed its fiscal year end to a 4-4-5 week
format which results in the Company's year end to be on the last Saturday in May
of each year.

Principles of Consolidation

The consolidated financial statements include the accounts of Metro Global
Media, Inc. ("Metro Global") and its majority-owned and controlled subsidiaries
(collectively the "Company").  All intercompany balances and transactions have
been eliminated in consolidation.

Recognition of Revenues

Revenue is recognized at the time the Company sells motion pictures and other
products to customers. Substantially all products returned to the Company can
either be exchanged for similar products or returned by the Company to its
vendors.

Fees collected from motion pictures licensed as television program material are
recognized as revenue when the license period begins and the licensee is able to
exercise rights under the agreement.

Use of Estimates

The preparation of financial statements in conformity with generally accepted
accounting principals requires the use of estimates based on management
knowledge and experience.  Due to their prospective nature, actual results could
differ from those estimates.

                                      F-8
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Inventory

Inventory is valued at the lower of cost (first-in, first-out method) or market
and consists principally of motion picture films, magazines and novelty items
held for resale.

Property and Equipment

The cost of property and equipment, including leasehold improvements, is charged
to operations over the estimated useful lives of the respective assets using
depreciation computed by the straight-line method ranging from 5 to 10 years.
Amortization of assets held under capital leases is included in depreciation
expense.  Maintenance and minor repairs and replacements are charged directly to
operations.  Major renewals and improvements are capitalized.  Costs and
accumulated depreciation applicable to assets sold are removed from the accounts
and any gain or loss on disposal is charged or credited to income.

Motion Picture and Other Films

Motion picture films, including video cassettes, video libraries, video rights,
and CD-ROMs are reflected at the lower of amortized cost or net realizable
value.  The cost of motion picture films is charged to operations using the
individual film forecast computation method, which amortizes film costs in the
same ratio as current gross revenues to anticipated total gross revenues.
Estimated future revenues are periodically reviewed and, revisions may be made
to amortization rates or write-downs made to the film's net realizable value as
a result of significant changes in future revenue estimates.  Net realizable
value is the estimated selling price in the ordinary course of business, less
estimated costs to complete and exploit in a manner consistent with realization
of that income.  More than 75% of film costs are expected to be amortized over
three years commencing upon the release of the respective motion picture films.

Deferred Income Taxes

The Company follows Statements of Financial Accounting Standards No. 109,
"Accounting for Income Taxes".  This statement requires a liability approach for
measuring deferred taxes based on temporary differences between the financial
statement and tax bases of assets and liabilities existing at each balance sheet
date using enacted tax rates for years which taxes are expected to be paid or
recovered.

Earnings Per Share

During the year ended May 30, 1998, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings per Share", which replaces primary and
fully diluted earnings per share with basic and diluted earnings per share.
Under the new requirements the dilutive effect of certain common stock
equivalents is excluded from the computation of basic earnings per share.
Diluted earnings per share is calculated similarly to fully diluted earnings per
share as required under APB 15. All prior period earnings per share data
presented have been restated to conform to the provisions of this statement.

                                      F-9
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Basic earnings per share is computed by dividing net income available to common
stockholders (net income less preferred stock dividends) divided by the weighted
average number of shares outstanding during the year.  Diluted earnings per
share is consistent with basic earnings per share while giving effect to all
dilutive potential common shares that would have been outstanding if the
dilutive potential common shares had been issued, while adding back to income
any preferred dividend or interest expense on convertible securities.

2. ACQUISITIONS/DISPOSITIONS

Amazing Direct

In March, 1998, the Company acquired an 80% interest in Amazing Direct, a Nevada
Corporation by purchasing 400 shares of its outstanding stock at $2.00 per
share.  Amazing Direct, a mail order company, has rights to a licensing
agreement to distribute certain products under the Hustler name.  For the period
ended May 30, 1998, Amazing Direct incurred a loss of approximately $98,000 of
which  the Company absorbed approximately $19,600 attributed to the minority
interest.  The loss was attributed to startup expenses such as printing costs
associated with mail order brochures.

Maxstone Media

In August, 1997, Rocket Media Group, LLC, a wholly owned subsidiary of Metro,
Inc. entered into a joint venture with Salmill Enterprises, Inc. for the purpose
of magazine publishing.  Under the terms of the agreement, Rocket contributed a
sub-license agreement for the rights to certain titles, names and materials and
Salmill contributed its publishing and circulation expertise into a newly formed
entity Maxstone Media, LLC.  The Company recorded its capital contributions at
zero and included Maxstone Media's results from operations in the consolidated
financial statements.  Minority interest amounted to $18,220 at May 30, 1998.

Arcus Media Group, Inc.

During the year ended May 31, 1995 the Company formed Arcus Media Group, Inc.
("Arcus"), a wholly owned subsidiary, to develop and distribute computer
software products oriented to the adult entertainment market.

                                      F-10
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------


In November, 1994, Arcus acquired certain assets, including equipment and key
technical personnel of Innovative Data Concepts ("IDC") for 160,000 restricted
shares of the Company's common stock, having a fair value of $480,000.  Costs
allocated to the purchase of employment contracts of $419,000 were expensed
during the year ended May 31, 1995.  In May, 1995, Arcus filed suit against IDC
and its principals alleging fraud in connection with the transaction and
requesting recission and damages.  On May 31, 1996 the suit filed by Arcus
against IDC and its principals was settled.  As a result of the settlement, the
Company received from IDC 75,000 shares of its restricted common stock valued at
$225,000, of the 160,000 shares originally transferred by Arcus to IDC as part
of the November 10, 1994 Asset Purchase Agreement which was reflected as a
reduction in stockholders' equity.  The 75,000 common shares were retired on
effective May 31, 1996. As a result of the settlement of the suit the Company
wrote-off  its machinery and equipment by $28,600, and a gain on settlement of
litigation was recognized for $196,400 in the financial statements for the year
ended May 31, 1996.  Effective May 31, 1997 Arcus was dissolved.

3. PROPERTY AND EQUIPMENT

Property and equipment consist of the following:
<TABLE>
                                                                    1998        1997
                                                                  ----------  ----------
<S>                                                               <C>         <C>       
   Machinery and equipment                                        $1,756,828  $1,611,773
                                                                     448,129     442,661
   Furniture and fixtures                                            699,520     615,477
   Office equipment                                                               15,574
   Automobiles                                                       256,087     193,653
   Leasehold improvements                                         ----------  ----------
                                                                   3,160,564   2,879,138 
   Less accumulated depreciation                                                        
    and amortization                                               1,681,138 1,303,939  
                                                                  ---------- ---------- 
                                                                                        
                                                                  $1,479,426  $1,575,199
                                                                  ==========  ========== 
                                    
</TABLE>
4.  MOTION PICTURES AND OTHER FILMS

Motion pictures and other films consist of the following:
<TABLE>
<CAPTION> 
                                                                    1998        1997
                                                                -----------  ----------
<S>                                                             <C>          <C>
  Motion picture films produced and released                    $ 6,900,008  $5,551,301
  Rights acquired to release motion pictures and other films      2,153,454   1,727,654
  CD-Rom                                                            414,565     313,807
  Motion picture films in process                                 1,250,575     846,164
                                                                -----------  ----------
                                                                 10,718,602   8,438,926
  Less accumulated amortization                                   6,575,623   5,085,183
                                                                -----------  ----------
                                                                $ 4,142,979  $3,353,743
                                                                ===========  ========== 
                                                               
</TABLE>

                                      F-11
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

5. LONG-TERM DEBT

During the year ended May 30, 1998 certain notes payable due to related parties
with principal amount of $533,639 plus accrued interest of $180,398 were
converted into 476,025 shares of the Company's common stock.

  Capital Lease Obligations

<TABLE>
<CAPTION> 
                                                                            1998      1997
                                                                         --------  -------- 
<S>                                                                      <C>       <C>
  The Company leases office equipment ($456,798 less 
  accumulated depreciation of $210,772 at May 30, 1998 
  and $404,052, less accumulated depreciation of $143,308 
  at  May 31, 1997) and, machinery and equipment ($507,187
  less accumulated depreciation of $118,296 at May 30, 1998 
  and $377,305, less accumulated depreciation of $53,715 at
  May 31, 1997) and, furniture and fixtures ($185,339 less 
  accumulated depreciation of $94,953 at May 30, 1998 and 
  $185,339, less accumulated depreciation of $68,476 at 
  May 31, 1997) under noncancellable capital leases.  The 
  leases, which expire at various times through 2003 bearing 
  interest at annual rates ranging from 10.895% to 20.783% 
  provide for aggregate monthly payments averaging $35,400.  
  All leases are secured by the respective assets acquired.
                                                                         $715,494  $584,553
  Less current portion                                                    363,956   222,962
                                                                         --------  -------- 
                                                                         $351,538  $361,591 
                                                                         ========  ======== 
</TABLE> 
Annual payments under capital lease obligations are due as follows:
<TABLE>
<CAPTION> 
Years ended                                                               Amount  
-----------                                                              -------- 
<S>                                                                      <C>      
   1999                                                                  $427,738 
   2000                                                                   247,055 
   2001                                                                    96,247 
   2002                                                                    44,304 
   2003                                                                    18,025 
                                                                         -------- 
   Less deferred interest                                                 833,369 
                                                                          117,875 
                                                                         -------- 
                                                                                   
                                                                         $715,494 
                                                                         ========  
                                            
</TABLE>

                                      F-12
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

6. SHORT-TERM BORROWINGS

Pursuant to a line of credit agreement with a finance company, the Company's
subsidiary, Metro, Inc. may borrow up to 75% of assigned accounts receivable
less than 90 days old, up to a maximum of $1,500,000.  The balance due under the
line of credit bears interest at the prime rate plus 5% per annum. In addition,
Metro pays the finance company a management fee equal to 3/4 of 1% of sales
submitted for inclusion in the net security value of the accounts receivable,
but not more than $7,500 per month.  The outstanding balance under the line is
secured by the accounts receivable of Metro, and the guarantees of the Company
and certain officer/shareholders.  As of May 30, 1998, short-term borrowings
under the line of credit totaled $530,272.

During the year ended May 30, 1998, the Company issued two separate 12%
convertible debentures totaling $500,000 due March 23, 1999.  These debentures
are convertible into common stock at $2.25 per share

7.  INCOME TAXES

The provision (benefit) for income taxes consists of the following:
<TABLE>
<CAPTION> 
                                   1998        1997       1996
                                 --------   ---------   -------- 
<S>                             <C>         <C>         <C>
Current provision (benefit)      
    Federal                       $275,000  $ (59,704)  $262,001  
    State and local                 31,734     37,312     41,217 
                                  --------  ---------   --------  
                                   306,734    (22,392)   303,218 
                                  ========  ---------   --------  
Deferred provision (benefit)                
    Federal                        (46,700)   (58,100)    (3,037)    
    State and local                (12,550)   (35,350)    (7,611) 
                                  --------  ---------   --------  
                                   (59,250)   (93,450)   (10,648) 
                                  --------  ---------   --------   
       Total                      $247,484  $(115,842)  $292,570
       -----                      ========  =========   ======== 

 
 
</TABLE>
The following is a reconciliation of the statutory federal income tax rate to
the actual effective income tax rate:
<TABLE>
<CAPTION> 
                                                       1998     1997    1996
                                                      -----    ------   ----- 
<S>                                                   <C>     <C>       <C>
  Statutory federal income tax rate                    34.0%   (34.0)%    34.0 
  State income taxes, net of federal benefit            3.5%     7.0 %   3.2 %
  Net change attributable to temporary differences     (2.8)%    0.0 %   (1.5)%
  Net change attributable to permanent differences      6.7%    (8.9)%     .3% 
                                                      -----    ------   ----- 
                                                       41.4%   (35.9)%   36.0% 
                                                      =====   =======   =====  
                                                                       
</TABLE>

Deferred income taxes result from temporary differences in the financial bases
and tax bases of assets and liabilities.  The significant components of the
Company's deferred income tax assets and liabilities as follow:

                                      F-13
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

7.   INCOME TAXES (CONTINUED)

<TABLE>
<CAPTION> 
                                                  1998         1997
                                               ----------   ----------  
                                                  Asset        Asset    
                                               (Liability)  (Liability)
                                               ----------   ----------  
<S>                                            <C>          <C>   
  Excess depreciation                           $(197,490)   $(157,650)
  Unearned management compensation                121,950      121,950
  Allowance for doubtful account                   72,042        8,943 
  Inventory capitalization                        164,158      127,844 
      State net operating loss carryforward        12,300       16,700 
  Other expenses                                   16,240       12,163 
                                                ---------    --------- 
   Net deferred assets                          $ 189,200    $ 129,950 
                                                =========    ========= 
                                                          
</TABLE>

The Company's state net operating loss carryforward of approximately $122,000
expires in year 2005.

8.  SHAREHOLDERS' EQUITY

Series A Convertible Preferred Stock

During 1998, the Company entered into an Offshore Securities Subscription
Agreement for convertible Preferred Shares pursuant to regulation S of the U.S.
Securities Act of 1933.  Under the terms of the agreement, the Company is to
issue 2,175 shares of 1998 Series A Convertible Preferred Stock ("Series A
Shares") at a price of $1,000 per share with a 5% cumulative dividend payable in
common stock at conversion.  At May 30, 1998 the Company received proceeds of
$846,500, net of offering costs representing 855 shares.  Substantially all of
the proceeds for the remaining 1320 shares were subse  quently received.

The Series A Shares are convertible at a rate of 100 shares plus accrued
dividends per week at 80% of the 15 day average closing bid price.  These Shares
are subject to a 24 month mandatory conversion feature.  Management is presently
obtaining fair values of the embedded beneficial conversion feature and warrants
which is expected to be reallocated out of the proceeds after May 30, 1998.
Such values will be recognized as dividends and amortized over the mandatory
conversion period of two years beginning in June of 1998.

In addition to the Series A Shares the Company  issued 400,000 warrants to
purchase the Company's common stock at $1.50 per share commencing April 20, 1998
exercisable over 5 years.

Consultant Stock Compensation Plan

The Company's Consultant Stock Compensation Plan (the "Plan") allows the Company
to compensate consultants and certain other persons who have provided service to
the Company through the award of 500,000 shares of the Company's common stock.

                                      F-14
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

8.  SHAREHOLDERS' EQUITY (CONTINUED)

During the years ended May 30, 1998 the Company issued 206,000 shares of common
stock valued at $282,999 of which $62,500 will be earned through May, 1999.
During the year ended May 31, 1997 the Company issued 100,000 shares of common
stock valued at $243,800.  As of May 30, 1998, 77,000 shares are available under
this plan.

Equity Incentive Plan

During the year ended May 31, 1997 the Company adopted an Equity Incentive Plan
(the "Plan") which allows the Company to compensate key employees and directors
who have provided service to the Company through the award of 500,000 shares of
the Company's common stock, including qualified and non-qualified stock options.

During the year ended May 31, 1997 options to purchase 200,000 shares were
awarded to officers and key employees under the Plan.  The grants under the Plan
provide for the options to vest 1/5 annually, on the anniversary date of the
grant.  The vested options are exercisable through March 2007 at $2.00 per
share.  Due to the termination of employment 100,000 shares have been returned
to the plan.

During the year ended May 30, 1998, 5,000 shares of common stock valued at
$6,850 were awarded under the plan.  There are 395,000 shares available under
this plan as of May 30, 1998.

Employee Stock Purchase Plan

During the year ended May 31, 1997 the Company adopted an Employee Stock
Purchase Plan.  This plan allows employees of the Company to purchase up to
600,000 shares of the Company's common stock at a 15% discount to the market
price of the stock on the commencement date or closing date of the plan year,
whichever is lower.

During the year ended May 30, 1998 no shares were awarded  under this plan.

Private Placement

The company sold 55,000 common shares (45,000 and 10,000 during the fiscal years
ended May 31, 1995 and 1994, respectively) at a price of $6.00 per share to a
limited number of investors, pursuant to a Private Placement Memorandum dated
May 6, 1994.  Pursuant to the offering, original participants received a stock
dividend at .15 shares for each share held as of the second anniversary of the
private placement valued at $52,450 which resulted in the Company issuing 17,734
additional shares in October, 1996.

                                      F-15
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

8.  SHAREHOLDERS' EQUITY (CONTINUED)

Debt Conversion

During the year ended May 30, 1998, the Company converted a note payable to
Metro Plus Company, a company owned by a shareholder, with a principal balance
plus accrued interest totaling $577,501 into 385,000 shares of common stock.
Additionally, the Company converted a notes payable to a share  holder with a
principal balance and accrued interest totaling $136,536 into 91,025 shares of
common stock.

Stock Options

Pursuant to an employment agreement, a former Executive was granted options to
purchase 200,000 shares of the Company's common stock at $1.50 per share on
January 1, 1993.  Compensation of $300,000 was charged to operations from
January 1, 1993 to January 1, 1997.  As of January 1, 1997 the term to exercise
the options was extended to December 31, 2006.

All options remain outstanding.

9. COMMITMENTS AND CONTINGENCIES

Operating Leases

The Company is obligated under long-term operating leases which require minimum
annual rentals as follows:
<TABLE>
<CAPTION> 
 
                                Office and            Machinery
                                Warehouse                and
  Year          Total           Premises   Vehicles  Equipment
  ----       ----------        ----------  --------  --------- 
<S>          <C>               <C>         <C>       <C> 
  1999       $  691,637       $  503,086  $ 69,267   $119,284
  2000          383,973          350,121    16,176     17,676
  2001          314,351          297,425               16,926
  2002          311,405          297,425               13,980
  2003          279,289          279,289
             ----------       ----------   -------   --------
  Total      $1,980,655       $1,727,346   $85,443   $167,866
             ==========       ==========   =======   ========   
                               
</TABLE>

The lease on the Rhode Island warehouse and office facilities (Note 10) has a
renewal option for two successive additional terms of five years (through April,
2008 and April, 2013, respectively), each based on the current annual rent plus
an amount based on the consumer price index one month prior to the date of
renewal.  The lease requires monthly rentals of $20,433.  On June 1, 1997, the
Company was granted a rent reduction of $81,733 which is being amortized over
the remaining term  of the lease.

                                      F-16
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

9. COMMITMENTS AND CONTINGENCIES (CONTINUED)

The three leases on the California buildings have a renewal option for one
additional term of five years providing for cost of living adjustments ranging
from 4% to 8% beginning on July 1, 1999 and July 1, 2001.

Rent expense under office and warehouse operating leases totaled $412,122,
$364,173 and $424,813 during the years 1998, 1997 and 1996, respectively.

Uninsured Cash

The Company maintains its cash and cash equivalents in various banks.  Accounts
at each bank are guaranteed by the Federal Deposit Insurance Corporation (FDIC)
up to $100,000.  Uninsured cash and cash equivalents approximated $152,959 and
$-0- at May 30, 1998 and May 31, 1997, respectively.


Other Matters

The Company is a defendant in three suits relating to matters arising in the
ordinary course of business. The amount of liability, if any, from the claims
cannot be estimated, but management and outside counsel is of the opinion that
the outcome of the claims will not have a material impact on the Com  pany's
financial position.  Nevertheless, due to uncertainties in the settlement
process, it is at least reasonably possible that management's view and outside
counsel's view of the outcome will change in the near term.

During the years 1998 and 1997, one vendor provided substantially all printing
services (magazines, video boxes and promotional material) to the Company.
Management of the Company believes that other suppliers could provide similar
services at comparable terms.

10.  RELATED PARTY TRANSACTIONS
--------------------------------

The Company has significant tenant, borrower and customer relationships with
companies owned and managed by officers/shareholders of the Company (see Notes
5, 8 and 9).  Significant related party transactions for the years 1998, 1997
and 1996 are summarized below:

Capital Video Corporation ("CVC") operates approximately 34 video and magazine
retail stores in the New England and New York areas and accounted for
approximately 47%, 39%, and 32% of the company's sales for the years 1998, May
31, 1997 and 1996, respectively.  The Company's accounts receivables include
$2,477,041 and $1,711,443 due from CVC at May 30, 1998 and 1997.  The Company
has obtained the personal guarantee of the principal shareholder of CVC.  No
allowance for doubtful related party receivables and no related party bad debts
expense has been recorded in the accompanying 1998, 1997 and 1996 consolidated
financial statements.  During the year ended May 30, 1998, the Company billed
CVC $120,000 for services rendered for distribution and sales analysis costs
incurred by the Company.  During fiscal 1998 the Company received from CVC
$84,592 in royalty income pursuant to a franchise agreement for the operation of
the Airborne for Men/TM/ stores owned by CVC.

                                      F-17
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

10.  RELATED PARTY TRANSACTIONS (CONTINUED)
 
The Company leases its Rhode Island warehouse and office facilities from Castle
Properties, L.L.C., an affiliate, for its Rhode Island operations.  A portion of
the facility rented from Castle Properties, L.L.C. is sublet to CVC on a month-
to-month basis.  Sublease income during the years 1998, 1997 and 1996 totaled
$48,000, $49,000, and $104,000 respectively.  During the year ended May 30,
1998, Castle Properties granted the Company a four month moratorium amounting to
$81,733 which is being amortized over the remaining lease term.  The net rent
expense to Castle Properties, L.L.C. for the years ended May 30, 1998, 1997 and
1996 was $177,478, $196,200, and $141,200, respectively.

Effective January 31, 1996, Airborne for Men, Ltd. sold to Capital Video
Corporation the stock of its wholly owned subsidiary A.F.M. Limited and
effective November 30, 1995, Airborne for Men, Ltd. sold to CVC the stock of its
wholly owned subsidiaries, Eastern Sales, Inc., a Rhode Island corporation and
Aircoldco, Inc. (formerly known as Airborne East, Inc.), a Rhode Island
corporation.  The Company's total gain for the sale of the three Airborne stores
amounted to $171,795 for the year ended May 31, 1996.

11.  ACCOUNTING FOR STOCK BASED COMPENSATION

The Company applies APB Opinion 25 and related interpretations in accounting for
its stock option transactions.  Accordingly, no compensation cost has been
recognized for the years May 30, 1998, May 31, 1997 and 1996 (see Notes 8 and
9).

In October, 1997, the Financial Accounting Standards Board issued Statement
(SFAS) No. 123, Accounting for Stock Based Compensation, which becomes effective
for transactions entered into in fiscal years beginning after December 15, 1995.
This statement permits an entity to apply the fair value based method to stock
options awarded during 1995 and thereafter in order to measure the compensation
cost at the grant date and recognize it over its vesting period.  This statement
also allows an entity to continue to measure compensation costs for these plans
pursuant to APB Opinion 25.  Entities electing to remain with the accounting
treatment under APB Opinion 25 must make proforma disclosures in net income and
earnings per share to include the effects of all awards granted in fiscal years
beginning after December 31, 1994, as if the fair value based method of
accounting pursuant to SFAS No. 123 had been applied.

The Company has stock option plans which reserves shares of common stock for
issuance to executives, employees, and directors.  The Company has adopted the
disclosure only provisions of Statement of Financial Accounting No. 123,
"Accounting for Stock Based Compensation".  Accordingly, compensa  tion expense
continues to be recognized under APB Opinion 25 for such plans.  Had
compensation cost for the Company's stock option plans been determined based on
the fair value at the grant date for awards during the year ended May 30, 1998
consistent with the provisions of SFAS No. 123, the Company's net income (loss)
and earning (loss) per share would have been reduced to the pro forma amounts
indicated below:

                                      F-18
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

 
                                                              1998       1997
                                                              ----       ----
 
 Net income (loss) - as reported                            $349,681  $(207,158)
 Net income (loss) - pro forma                              $292,681  $(311,558)
 Basic earnings (loss) per share - as reported                   .09       (.06)
 Basic earnings (loss) per share - pro forma                     .08       (.09)
 Diluted earnings (loss) per share - as reported                 .09       (.06)
 Diluted earnings (loss) per share - as pro forma                .08       (.09)

The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants during May 30, 1998: dividend yield 0.00%, expected
volatility 58.08%, risk free interest rate of 7.50%, and expected lives of 10
years.

The pro forma effect of applying SFAS 123 may not representative of the effects
on reported net income and earnings per share for future years since options
vest over several years.

12.  FAIR VALUES OF FINANCIAL INSTRUMENTS
-----------------------------------------

Statement of Financial Accounting Standards (SFAS) No. 107, "Disclosures about
Fair Value of Financial Instruments", requires that the Company disclose
estimated fair values for its financial instruments.  Fair value estimates are
made at a specific point in time, based on relevant market information and
information about the financial instrument.  Because no market exists for a
significant portion of the Company's financial instruments, fair values are
based on judgments regarding future expected loss experience, current economic
conditions, risk characteristics of various financial instruments and other
factors.  These estimates are subjective in nature and involve uncertainties and
matters of significant judgment and therefore cannot be determined with
precision.

Management of the Company estimates that all financial instruments of the
Company, except long-term liabilities (notes payable) and a certain trade
accounts receivable included in other assets, have a fair value equal to the
carrying value.  Regarding the fair value of the long-term liabilities and
certain trade account receivables, it has been determined that fair value cannot
be reasonably estimated since the unique nature, interest rates, repayment
terms, restrictions and all related conditions pertaining to these instruments
do not provide information that would yield a basis for a sound fair value in
accordance with guidelines in SFAS 107.

                                      F-19
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------
13. SUBSEQUENT EVENT (UNAUDITED)

Acquisition - Fanzine

On July 31, 1998, the Company acquired 100% of the stock of Fanzine
International, Inc. ("Fanzine") for a preliminary purchase price of $7,500,000.
Fanzine, which began operations on August 1, 1997, publishes event driven,
mainstream magazines translated into seven languages and distributed world
wide.  The acquisition price consists of $4,000,000 cash, and 1,000,000
restricted shares of the Company's common stock with put option rights at $8.00
per share to be exercised by the selling shareholder's during the second year on
a quarterly basis, if certain minimum earnings, as defined, are met.  However,
during Fanzines' first year of operations, the Company has the right to call the
shares at the greater of $6.00 per share or 75% of the market price.  The
acquisition agreement, also, provides for a reduction in purchase price if
Fanzine's results of operations do not meet certain minimum earnings.

Management is presently obtaining an independent valuation to finalize the
preliminary estimated purchase price of $7,500,000.  The Company's right to
redeem its shares during the first year and the selling shareholders' right to
put the shares to the Company in the second year could result in an estimated
increase in purchase price ranging from $2,500,000 to $4,500,000.  These
adjustments to the purchase price could have a material impact on the pro-forma
information, as presented below, and to the future consolidated results.

The acquisition will be accounted for as a purchase.  The excess of the purchase
price over the fair market values of net assets acquired, which include, among
others, licences, trademarks, and distribution rights, will be allocated
principally to goodwill and amortized over fifteen years.

The cash portion of $4,000,000 is being financed by a long-term convertible
debenture.  Management anticipates financing the additional consideration to be
paid in the near future, (if any), with Fanzine's cash flow resulting from
profitable operations.

As the acquired company (Fanzine) financial statements only include eleven
months of operations from inception through June 30, 1998, the following
selected unaudited pro-forma information is being provided to present a summary
of the continued results of the Company and Fanzine as if the acquisition had
occurred on August 1, 1997:

Pro-Forma information (Unaudited)
 (In thousands, except per share data)
<TABLE>
<CAPTION>
 
                           YEAR ENDED MAY 30, 1998 (ONLY)
                           ------------------------------
<S>                                                          <C>
               Net sales                                     $30,137
               Net Income                                      1,140
               Earnings Per Share:
                   Basic                                         .25
                   Diluted                                       .20
 
</TABLE>

                                      F-20
<PAGE>
 
METRO GLOBAL MEDIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED MAY 30, 1998, MAY 31, 1997 AND 1996
--------------------------------------------------------------------------------

13. SUBSEQUENT EVENT (UNAUDITED) (CONTINUED)

The pro forma results include amortization of the intangibles and interest
expense on debt issued to finance the purchase.  The pro forma results are not
necessarily indicative of what actually would have occurred if the acquisition
had been completed as of the beginning of the fiscal period presented, nor are
they necessarily indicative of future consolidated results.

Employment Agreement

In connection with the Fanzine acquisition on July 31, 1998, each of the four
selling shareholders entered into separate five year employment agreements, with
an option to renew for an additional three years and with automatic annual
renewals.

The employment agreements entitle each selling stockholder to receive deferred
compensation amount equal to six times the Company's pre-tax net earnings (as
defined) multiplied by a rate of 8.164% for the one stockholder and 13.612 for
each other stockholder.  The applicable pre-tax earnings are to be derived from
the greater of the Company's pre-tax earnings in year of termination or the
verage   pre-tax earnings since inception of the agreement.  Fanzine's proforma
unaudited applicable pre tax earnings for the eleven months ended June 30, 1998
approximated $4,665,000.

                                      F-21