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                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

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

                                   FORM 10-K

  (Mark one)

[X]Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
   Act of 1934 (No fee required)

  For the fiscal year ended April 30, 1999, or

[_]Transition report pursuant to Section 13 or 15(d) of the Securities
   Exchange Act of 1934 (No fee required)

  For the transition period from        to

  Commission file number 0-24346

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

                              VIDEO UPDATE, INC.
            (Exact name of registrant as specified in its charter)

<TABLE>
<S>                                              <C>
                    Delaware                                       41-1461110
          (State or other jurisdiction                          (I.R.S. employer
       of incorporation or organization)                       identification No.)

            3100 World Trade Center                                  55101
             30 East Seventh Street                                (Zip Code)
              St. Paul, Minnesota
    (Address of principal executive offices)
</TABLE>

                                (651) 312-2222
             (Registrant's telephone number, including area code)

       Securities registered pursuant to Section 12(b) of the Act: None

          Securities registered pursuant to Section 12(g) of the Act:
                     Class A Common Stock, $.01 Par Value
                               (Title of class)

  Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.

                                Yes X    No

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

  Aggregate market value of registrant's voting stock held by non-affiliates
as of July 29, 1999: Class A Common Stock, $.01 par value: $18,484,758 based
on a closing price of $0.6875 per share.

  Number of shares outstanding of each of the registrant's classes of common
stock, as of July 29, 1999: Class A Common Stock, $.01 par value: 29,278,457
shares.

               Disclosure Regarding Forward Looking Statements:

  Note: The discussions in this Form 10-K contain forward looking statements
that are subject to risks and uncertainties. The actual results of Video
Update, Inc. and subsidiaries (the "Company") could differ significantly from
those set forth herein. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in "Business" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" as well as those discussed elsewhere in this Form 10-K. Statements
contained in this Form 10-K that are not historical facts are forward looking
statements that are subject to the safe harbor created by the Private
Securities Litigation Reform Act of 1995. A number of important factors could
cause the Company's actual results for fiscal 2000 and beyond to differ
materially from those expressed or implied in any forward looking statements
made by, or on behalf of, the Company.

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<PAGE>

                                    PART I

Item 1. Business

General

  Video Update, Inc. ("Video Update" or the "Company") owns and operates video
specialty stores throughout North America. As of April 30, 1999, the Company
owned and operated 652 stores located in 31 states and five provinces in
Canada and franchised 55 additional video specialty stores predominantly in
the United States. As of April 30, 1999, 485, or approximately 92%, of the
Company's stores in the United States, and 124, or approximately 98% of the
Company's Canadian stores, were superstores, defined as retail video stores
that carry more than 7,500 rental units. The Company believes that, as of the
end of its most recent fiscal year, it is the third largest video specialty
retailer in the United States and the third largest video specialty retailer
in Canada based on the number of superstores it operates. Video Update stores
in the United States and Canada offer on average approximately 11,500 and
9,300 rental units, respectively, including multiple copies of new and popular
movie releases and video games, in a visually appealing and customer friendly
layout.

  The Company franchised its first store in January 1983 and opened its first
Company-owned store in September 1989. By July 1994, when the Company
completed its initial public offering, the Company had grown to 15 Company-
owned stores and 30 franchised stores and had developed a cost-effective
superstore format that distinguished the Company from other video retailers by
providing it with the flexibility to expand into desirable sites in both small
and large markets without compromising profitability, or decreasing the number
of viable markets into which it could expand. During fiscal 1998, the Company
rapidly grew in size from 343 to 681 Company-owned stores. During this period,
the Company acquired 267 video stores in its acquisition of Moovies, Inc.,
("Moovies") opened 84 new video superstores and closed 13 stores, including
stores closed related to acquisitions. During fiscal 1999, the Company opened
16 new video superstores and closed 45 stores (see Notes to the Consolidated
Financial Statements: Note 3 "Moovies, Inc. Acquisition" and Note 4 "Provision
for Store Closings and Other Charges" for discussions on 41 planned store
closings as of April 30, 1998). Same store sales during fiscal 1999 increased
by approximately 2%. As a result of the Moovies acquisition, new superstore
openings and increases in same store sales, the Company's revenues increased
from approximately $156,154,000 in fiscal 1998 to approximately $254,096,000
in fiscal 1999.

 The Home Video Industry

  The home video retail industry has experienced significant growth over the
last several years. According to industry reports, gross rental revenues for
the home video industry in the United States have grown from approximately
$2.6 billion for rentals in 1985 to approximately $8.0 billion for rentals in
1998. Industry reports also show that over 83% of the approximately 99 million
American households owning televisions also owned a VCR and that nearly one
quarter of all Americans make a trip each week to their video store. Industry
reports project that U.S. video rentals will grow to $9.7 billion in 2002 and
that VCR penetration of U.S. television households will exceed 87%. In 1998 a
record number of approximately 18.8 million VCR's were sold in the United
States. Convenience, limited out-of-pocket expense and reliability are all
factors that make video rentals the preferred medium of entertainment for
millions of customers.

  According to industry reports, the home video market remains the largest
single source of revenue to movie studios, accounting for approximately 50% of
movie studios' total revenues. Of the many movies produced by major studios
and released in the United States each year, relatively few are profitable for
the studios based on box office revenue alone. In addition to purchasing box
office hits, video specialty stores typically purchase movies on video that
were not as successful at the box office because customers will often rent a
video that they might not view at a theater. The Company believes that the
consumer is more likely to view movies that were not box office hits on a
rented video than on any other medium because video specialty stores provide
an inviting opportunity to browse and make an impulse choice among a very
broad selection of movie titles at a relatively low price. These purchases by
the video stores provide the major movie studios with a reliable source of
revenue for the majority of their movies. In addition, many of the major
studios have entered into revenue-sharing

                                       1
<PAGE>

arrangements with a few of the larger national chains, such as Video Update.
The Company expects that such revenue-sharing arrangements will allow
retailers to offer a greater quantity of titles to meet consumer demand,
enhancing the interdependent relationship between the studios and the larger
national chains.

  The Company believes that the home video industry remains highly fragmented.
The industry has been characterized by significant consolidation and store
closings, with larger regional and national chains of superstores acquiring
smaller chains. In addition, as the regional and national chains grow through
acquisition and new store openings, they gain market share and single store
operators are forced to close. Larger superstore chains easily fill the void
of fewer stores by providing a wider breadth and depth of videos for rent or
sale, superior locations, and cost effective advertising programs along with
promotions to drive consumer traffic. The Company believes this consolidation
trend will continue based on recognition by store operators because of the
competitive advantages that larger organizations enjoy. These advantages
include access to working capital, marketing efficiencies, revenue sharing and
direct purchasing programs with movie studios, other economies of scale and
the enhanced ability to obtain quality retail locations.

  The video retail industry historically includes both rentals and sales of
VHS movie cassettes. The consumer market for video movies has primarily been a
rental market and the Company's core business. Movie studios determine the
suggested retail prices of videos and through their pricing decisions,
influence the relative levels of video rentals versus video sales. Videos
released at relatively high prices, typically $60 or more, are generally low
to middle dollar grossing theatrical box office performers, (one million to
$40 million dollars) or direct-to-video productions with no theatrical
release. These releases make up the majority of new product and are purchased
by video retailers, then made available exclusively through video rentals.
Exceptions to the high price rule exist primarily in the genres of children
and family product where the mass appeal acceptance of content make it
attractive for mass merchants to purchase this product, therefore enticing the
movie studios to release it at a lower price (i.e. "A Bugs Life" and "The
Rugrats Movie"). Videos released at relatively low prices, typically $15 to
$30, are generally high grossing theatrical box office performers (over $40
million dollars). These releases are purchased by video retailers for both
sale and rental and may be purchased by consumers at a variety of retail
stores including video retailers, mass merchants, electronic superstores,
grocery and convenience stores. Low priced releases are attractive rentals to
the video retailer because of the relatively few number of rentals required to
recover their cost and provide a favorable return despite the extra sales
competition from other retail channels. Exceptions to the low price rule exist
when content is rated PG-13 or R and mass merchants notify the studios that
they will not purchase the title. This exception is more frequent since a
majority of high grossing theatrical releases are often of the comedy, drama,
action and horror genres that include content of a mature adult theme, making
them unacceptable for sale in the mass merchant environment (i.e. "There's
Something About Mary" and "Saving Private Ryan"). These exceptions are very
favorable to video retailers since the high box office performers initially
are only available for rent.

  The Company has recently negotiated direct relationships with several
studios to maximize its rental title depth, while reducing its initial
inventory investment. Revenue sharing partnerships have been established with
several major studios to achieve this objective. Revenue sharing lowers the
initial cost of high priced rental product and shares the revenue of each new
release rented over an approximate six-month period. This process compensates
the studios with a comparable cost per new release copy but only as the
Company generates revenues to offset its initial investment. Low priced rental
and sale products are purchased outright and are not part of the revenue
sharing process. In addition, the Company believes that studios not
participating in revenue sharing programs have reduced initial costs of high
priced new releases to remain competitive and ensure representation on new
release shelves. The Company believes that direct revenue sharing programs are
exclusive to the Company and other major national chains, providing it with a
distinct purchasing advantage over small chains and single storeowners. The
Company believes that small chains and single storeowners do not have
information reporting systems or distribution facilities necessary to
economically participate in direct studio relationships.

  The Company believes that its direct relationships with movie studios have
also strengthened its "movies for sale" category. The ability to purchase low
price "for sale" titles direct from the studios at a reduced cost, has allowed
the Company to competitively price product with the mass merchants and
electronic superstores who

                                       2
<PAGE>

have dominated the sell-through market. The Company believes our increased
"movies for sale" program will increase revenue during the 1999 holiday season
when most movie sales are made for gift giving. In addition, revenue sharing
programs that provide extra copy depth on most new release rentals have added
significant opportunities for the sale of "previously viewed" movies.
Previously viewed movies offer customers the opportunity to purchase their
favorite rental movie at a reduced price and often before it is available at
other stores for sale. Typically, previously viewed movies are an authorized
part of revenue sharing after a specified "no sale" period. Selling previously
viewed movies also assists the Company in recouping the initial investment
made in each revenue sharing agreement. Previously viewed movies had provided
additional revenue in the past, but the Company expects that the added depth
of product purchased through revenue sharing programs will add additional
revenues.

  The relatively new technology of DVD movies and a growing interest in video
game technology has presented new opportunities for revenue growth. The
Company expects to expand the presentation of DVD rental sections to over 50%
of the stores by the 1999 holiday quarter. The Company also expects to add a
"DVD's for sale" section to top performing DVD rental locations. The video
game industry is experiencing significant growth and the Company expects that
its stores will increase title depth of best renting video games to support
this trend. Top performing game rental stores are also expected to add a
"games for sale" and "game accessories" section to maximize revenue potential.
The Company intends to support the introduction of the new "Sega Dreamcast"
128 bit game format with rentals of both game hardware and software in
September 1999. The Company also expects the current game industry leading
manufacturers of "Sony Playstation" and "Nintendo 64" (64 bit game formats) to
reduce the cost of their hardware game units to boost consumer interest in
their product through the 1999 holiday season. Both Sony and Nintendo plan to
introduce 128+ bit game hardware and software in the year 2000. The new game
hardware technologies are exciting and provide graphics equal to, or superior
to, arcade games. The Company strongly believes that these new product
introductions will strengthen consumer interest and provide revenue growth
opportunities.

  Historically, new technologies have led to the creation of additional
distribution channels for movie studios. Movie studios seek to maximize their
revenues by releasing movies in sequential release date "windows" to various
movie distribution channels. These distribution channels currently include, in
release date order, movie theaters, video specialty stores, pay-per-view,
basic cable television, and foreign, network and syndicated television. The
Company believes that this method of sequential release has allowed movie
studios to increase their total revenue with relatively little adverse effect
on the revenue derived from previously established channels and that movie
studios will continue the practice of sequential release as new distribution
channels become available. According to industry experts, many movie studios
have recently agreed to extend the length of the exclusive window on many new
release videos for video specialty stores from the prior practice of 30 days
to between 60 and 90 days and longer. According to industry experts, this
window increased an average of five days from 1997 to 1998. The Company
believes that the length of time between the movie theater release date and
the release date to video specialty stores is getting shorter. The Company
believes that studios are also starting to bypass the movie theaters by
releasing high quality and popular movie sequels directly to video specialty
stores.

Operating Strategy

  The Company's management has substantial experience in the video retailing
industry. The Company has developed a cost-effective superstore format that
distinguishes the Company from other video retailers by providing it with the
flexibility to expand into desirable sites in both small and large markets
without compromising profitability or decreasing the number of viable markets
into which it can expand. Management's depth of experience in and knowledge of
the industry are reflected in the Company's operating strategy, the key
elements of which include the following:

  Provide Extensive Selection of Videocassette Movies and Games. At April 30,
1999, 485, or approximately 92%, of the Company's stores in the United States
and 124, or approximately 98%, of the Company's Canadian stores were
superstores. Superstores are video rental stores that have more than 7,500
rental units. The Company

                                       3
<PAGE>

believes that an extensive selection of rentals is a key determinant that
consumers consider in choosing to visit and patronize a particular video
store. The Company tailors the movies and games available for rent in a given
store according to the market served by that store. Additionally, catalog
videocassette movies (those in release for more than one year) are displayed
in a library style (spine-out method) allowing for significantly more
videocassettes per square footage of rental space. As a result, in part
because of its direct revenue sharing relationships with movie studios, the
Company believes that it is able to provide an extensive selection, yet retain
greater flexibility than many of its competitors in terms of store size in
which it can operate.

  Effectively Manage Inventories. The Company maintains an integrated point of
sale ("POS") system that provides it with immediate access to and feedback on
records related to, among other things, videocassette movie rentals,
individual title performance, category rental performance, shrinkage and
overdue rentals. The Company endeavors to convert the POS systems of acquired
stores to that of the Company's as quickly as is practicable. The Company
utilizes its POS system to manage its inventory turns, purchase new inventory,
and balance customer demand and rental trends, all of which the Company
believes maximizes each store's profitability.

  Aggressive Marketing. The Company uses aggressive marketing programs to
attract new customers and increase the frequency of rentals by current
customers. The Company's long-time popular "Two-for-$.99 Tuesday" rental
promotion is used throughout its system and has been effective in building
customer loyalty and increasing revenue on a day of the week that historically
has not been a significant rental volume day. In fiscal 1999, the Company
introduced a "new" 7-day rental promotion that has helped bring in new
customers by offering extended viewing periods on slower turning new releases.
Seven-day rentals are available on a majority of the videos in our new release
section. The 7-day rental new releases are determined by copy turns after
approximately a 60-day window of one-day rentals. Another successful program
is the 47-cent catalog rental. This catalog promotion creates multiple
transactions in select stores and is used periodically to promote interest in
catalog movie rentals. "Bundle of Savings" is a holiday package designed to
enhance holiday quarter (November to January) sales. The bundle includes candy
and beverage concessions, new releases, gift certificates and a coupon booklet
with value savings on rentals and products for sale. Gift certificates are
sold year-round with a significant push in the third fiscal quarter.

  Geographic Concentration. The Company has locations in 31 states and five
provinces in Canada. For fiscal year 2000, the Company intends to focus on
maximizing the operating efficiencies of these locations and on completing the
build out of new stores in locations for which the Company has signed lease
commitments, rather than on aggressively expanding with new superstores in
additional metropolitan areas where it does not presently have locations. The
Company expects that the geographic concentration of its existing stores
together with acquired stores will allow the Company to more easily monitor
store operations through its regional management offices and to achieve
operating efficiencies in inventory management, marketing, distribution,
training and store supervision. Because the Company operates multiple stores,
it is able to receive relatively large aggregate cooperative advertising
credits from its distributors and direct suppliers. The Company receives
cooperative advertising credits for each store it operates, and by operating
multiple stores in a single geographic market, it can more effectively use
cooperative advertising credits to maximize the impact of its advertising.

  Consistency of Image and Operations. The Company strives to create a
national presence and name recognition. To achieve this objective and to most
efficiently and effectively operate its stores, the Company attempts to
maintain consistency among its Company-owned and franchised stores. This
consistency of operations includes signage, store layout, marketing,
management information systems and customer service. The Company attempts to
fully integrate acquired stores into its overall format as quickly as is
practicable. Such integration typically involves the prompt installation of
the management information systems and interior signage, supplementing the
existing base stock of titles, processing acquired videocassettes, training
existing management and sales personnel, and completing limited build-out of
the facilities. Subject to permit requirements and other such regulatory
controls, the Company installs exterior signage as soon as practicable. To
expedite the integration of acquired businesses, the Company has developed a
uniform approach that management believes minimizes the time necessary to
fully assimilate an acquired store's operations into those of the Company.

                                       4
<PAGE>

Business Strategy

  During fiscal 1998, the Company grew in size from 343 to 681 Company-owned
stores, including the acquisition of 267 stores from Moovies, Inc. in March
1998. As of the end of fiscal 1999, the Company owned and operated 652 stores,
including 55 franchised stores. As a result of acquisitions and the previous
rapid growth rate, for fiscal 2000 the Company intends to focus on maximizing
the operating efficiencies of the acquired locations as well as its existing
locations. The key elements of the Company's business strategy include the
following:

  Capitalize on revenue-sharing. Revenue-sharing will permit the Company to
cost-effectively stock more copies of new releases than previously. The
Company has initiated marketing programs designed to communicate to consumers
in its trade areas, and especially to members who have exhibited declining
rental frequency, that it is now stocking numerous copies of new releases,
thereby minimizing the likelihood that consumers will not be able to rent
desired new titles. Initial data indicates that implementation of revenue-
sharing and corresponding copy depth improves the likelihood of a consumer
finding an in-stock copy of a desired new release from 35% to over 85%.

  Close underperforming stores. The Company has identified approximately 70
underperforming stores that it plans to close during the next 12 months (see
Note 4 of the Notes to Consolidated Financial Statements for more information
on the planned closings).

  Increase prices. The Company is instituting rental price increases of new
releases in line with moves by major competitors. The Company believes that
the new pricing structure still provides an excellent value to consumers
considering the increased copy depth and extended day rental programs.

  Leverage studio marketing dollars. The sale and rental of home videos
currently provides studios with approximately 50% of their revenues generated
by motion picture entertainment. Following the implementation of revenue-
sharing, studios have a further incentive to encourage video rentals. As a
result, studios are now spending more advertising dollars to promote their
videos by directing customers to visit their local video stores for specific
titles, and are rewarding advertising co-op and market development funds to
chains with revenue-sharing agreements.

  Targeted Superstore Development. During fiscal 1999, the Company opened 16
new video superstores and closed 45 stores, including stores closed related to
acquisitions and the business restructuring plan announced in fiscal 1998. The
Company intends to open a limited number of superstores (currently estimated
to be no more than 10 new superstores) in fiscal 2000 in its existing markets
and selected new markets where attractive opportunities are available. The
Company believes that the selection of locations for its superstores has been
and will continue to be important to the success of its operations. Important
criteria for selection of a new superstore location include density of local
residential population, traffic count on roads immediately adjacent to the
superstore location, visibility of the superstore to passing motorists, easy
accessibility and ample parking. The Company estimates that each new
superstore currently requires up to 24 months of operations in order to ramp-
up to its expected level of mature operations.

  Targeted Acquisitions. The Company believes that acquiring chains of stores
is often the most cost-effective means of entering a new market, particularly
when the stores are in desirable locations. The Company also believes that the
video rental industry has experienced a recent trend toward consolidation
driven by the recognition by store operators of the competitive advantages
that larger organizations enjoy in terms of access to working capital,
marketing efficiencies and other economies of scale and the enhanced ability
to obtain quality retail locations. This trend has created an opportunity for
the Company to grow further through acquisitions. The Company believes that it
will continue to be presented with attractive acquisition opportunities. The
Company's ability to resume an acquisition growth strategy is dependent upon
its ability to generate cash flow from operations and to raise additional
capital.

  Franchise Operations. Franchised superstores operate under substantially the
same hours and methods of operation as Company-owned stores. The Company
currently intends to franchise stores primarily in areas where the Company
does not expect to pursue new superstore development or acquisitions.

                                       5
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Store Operations and Locations

  Each Video Update store operates under substantially the same plan of
operation. Company-owned stores are open 365 days a year with daily hours
generally from 10:00 a.m. to 11:00 p.m. Sunday through Thursday and from 10:00
a.m. to 12:00 midnight Friday and Saturday. The Company's stores use a self-
service system, whereby customers select products from the shelves and proceed
to the checkout counter. Video Update stores in the United States and Canada
average approximately 6,000 and 4,800 square feet in size, respectively.

  The Company seeks to locate its stores in geographic areas that will enable
it to achieve operating efficiencies in inventory management, advertising,
marketing, distribution, training and store supervision. The following table
sets forth the locations of existing Company-owned and franchised stores as of
April 30, 1999:

<TABLE>
<CAPTION>
                                                Number of   Number of    Total
                                              Company-Owned Franchised Number of
                                                 Stores       Stores    Stores
                                              ------------- ---------- ---------
   <S>                                        <C>           <C>        <C>
   Alaska....................................        3         --           3
   Arizona...................................       43         --          43
   Colorado..................................       12         --          12
   Connecticut...............................        3         --           3
   Georgia...................................       36         --          36
   Illinois..................................       25         --          25
   Indiana...................................       25         --          25
   Iowa......................................       21         --          21
   Kentucky..................................      --           20         20
   Michigan..................................       15         --          15
   Minnesota.................................       56           9         65
   Missouri..................................       14         --          14
   Nebraska..................................        4         --           4
   Nevada....................................        7         --           7
   New Hampshire.............................      --            8          8
   New Jersey................................        6         --           6
   New Mexico................................        1         --           1
   New York..................................       11         --          11
   North Carolina............................       35         --          35
   Ohio......................................       30         --          30
   Oklahoma..................................        7         --           7
   Oregon....................................        1         --           1
   Pennsylvania..............................       31           1         32
   South Carolina............................       33         --          33
   South Dakota..............................        5         --           5
   Tennessee.................................        2         --           2
   Texas.....................................       23         --          23
   Utah......................................        3         --           3
   Virginia..................................       27          13         40
   Washington................................       40         --          40
   Wisconsin.................................        6           1          7
   Alberta...................................       60         --          60
   British Columbia..........................       59           3         62
   Manitoba..................................        5         --           5
   Ontario...................................        2         --           2
   Yukon.....................................        1         --           1
                                                   ---         ---        ---
     Total...................................      652          55        707
                                                   ===         ===        ===
</TABLE>


                                       6
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Management Information Systems

  The Company believes the accurate and efficient management of purchasing,
inventory and sales records has been important to the Company's success. The
Company maintains information, updated daily, regarding revenue, current and
historical sales and rental activity, demographics of store membership and
videocassette rental patterns. This information can be organized by store, by
region or for all operations.

  The Company maintains a national POS system and a corporate information
system. All rental and sales transactions are recorded by the POS system when
scanned at the time of customer checkout. Nightly, the POS system transmits
each store's data from operations into the corporate information system. The
systems track all rental and sales products from the videocassette
distribution center to each store using scanned bar code information. The
systems also maintains the detailed rental history of each customer and title.
This information produces the reports used by the Company, including those
used in making purchasing decisions on new releases. All of the Company's
stores use the Company's POS system when opened or converted to the Video
Update concept, in the case of an acquired store.

Products

  Videocassette Rental. The core of the Company's revenue is driven by the
rental of videocassettes. New release one-day video prices generally range
from $2.49-$3.49. New release seven-day prices range from $3.49-$3.99 and
catalog movies rent for $1.49. The Company consistently completes market-
pricing evaluations to maximize transaction revenue. Aggressive price
competition from regional or national competitor chains may reduce new release
prices to $1.99 in some markets and reduce catalog videocassettes to as low as
47 cents. The Company believes that its rental prices are competitive with
those of other video stores, and its videocassettes are available for one-day
and multiple-day rentals to satisfy the shopping habits of all rental
consumers.

  The Company's stores generally carry approximately 11,500 and 9,300 videos
for rent in its United States and Canadian stores, respectively, representing
approximately 8,700 and 6,800 titles, respectively. Movie titles are
classified into at least 23 categories, such as "Action," "Drama," "Family,"
and "Children" and are displayed alphabetically within those categories. These
categories are also easily identified by our in-store mask graphic elements.
Each category mask graphic depicts a theatrical expression or element that
bonds the graphic to the category. These graphic elements are used in
promotional and advertising elements and create a unique brand identity for
the Company's stores.

  Video Games. In addition to the videocassette rentals, stores also rent
video games for use with "Sony Playstation" and "Nintendo 64". A new line,
"Sega Dreamcast," will be introduced in September 1999. A "game store" within
the store itself is being developed as a test to further develop and maximize
the growing game market. The concept is expected to include an expanded
selection of games for rent and sale, game decks, game accessories, and a used
"Buy, Sell and Trade" program.

  Additional Products. DVD for rental and sell-through is expected to be
represented in over 50% of our stores by the end of 1999. Candy, popcorn and
beverage concessions are sold internationally and prominently displayed by the
service counter with impulse messaging. Concession add-on sales are assisting
the Company to increase our average dollars per customer transaction. Test
programs on magazines and related accessories items are ongoing. Once the test
proves effective, the programs are then rolled out on a national level backed
with advertising.

Franchise Operations

  The Company currently intends to franchise superstores in areas where it
does not expect to pursue new superstore development or acquisitions.

  The standard Company franchise agreement generally requires the franchisee
to pay the Company a continuing monthly royalty fee equal to five percent of
the franchisee's gross monthly rental revenue, as

                                       7
<PAGE>

calculated under the terms of the franchise agreement. The franchisee is also
generally obligated to pay a continuing monthly royalty fee of one percent of
gross monthly product revenues derived specifically from the sale of certain
video products. The monthly royalty fees are calculated and due from the date
that the franchised superstore opens for business. In addition to the royalty
payments, franchisees generally are also required to pay a monthly advertising
fee equal to one percent of the franchisee's gross monthly revenue for the
preceding month.

  Under the Company's current franchising program, the Company will grant to a
franchise owner the right to develop one or a specified number of Video Update
superstores at an approved location or future locations (within specific
geographic areas) pursuant to the terms of a franchise agreement. The
exclusivity accorded to a franchisee is individually negotiated but generally
does not extend beyond a radius of one mile from the franchised location.
Prior to the actual store opening, the Company provides advice to the
franchisee on promotions, store displays and inventory control as well as a
comprehensive five day training course.

  The Company monitors franchisees' compliance with ongoing obligations on the
basis of monthly revenue reports and inventory reports. The franchise
agreement generally also grants the Company the right to audit the
franchisee's books, business records, sales reports, financial statements, and
tax returns at any time. The franchise agreement allows the Company to
terminate the franchise under certain conditions, including without
limitation, failure to comply with the Company's operating guidelines, failure
to obtain and maintain the necessary retail licenses and permits, operation of
a competitive venture, and understatement of gross monthly revenues for any
two operating periods by more than two percent. To date, the Company has
experienced no material problems it is aware of relating to the understatement
of revenues by franchisees.

Marketing and Advertising

  The Company promotes new titles and promotions primarily through the use of
radio, TV and direct mail. Radio campaigns are enhanced by on-air, store
location or cross-promotions. A loyalty/reward direct mail campaign is used to
solidify our customer base. During the holiday quarter (November to January)
TV advertising enhances the business for both rental and sell-through.
Cooperative movie advertising made available by studios or suppliers to
promote certain videocassettes generally funds the cost of these campaigns.
The in-house magazine, Entertainment Magazine, is published monthly. The
magazine identifies the upcoming new releases, new games, sell-through titles
and current marketing programs. This newly enhanced glossy magazine ties in
the new store graphic elements, reinforcing the Company's identity. The in-
store trailer tape played on several monitors reinforces the Company's
quarterly promotions between professionally produced movie trailers.

Suppliers

  The Company acquires its inventory of videocassettes and video games and
accessories from several videocassette studios and distribution divisions of
Ingram Entertainment Inc. ("Ingram") and Video One Canada Ltd. ("Video One").

  The videocassette inventory in each Company-owned and franchised store
consists of catalog titles and new release titles. To develop its inventory of
titles for store openings, the Company transfers videocassettes from existing
stores and purchases videocassettes from suppliers.

  The Company currently purchases new release rental videocassettes at an
average cost of approximately $45. The Company believes that, if its
relationship with Ingram or Video One were terminated, the Company could
obtain videocassettes direct from most suppliers at prices and terms
comparable to those available from such entities.

  Suppliers generally provide the Company with a comprehensive monthly listing
of all new video releases. In addition, movie studios generally provide the
Company with several copies of a new release video for preview by the Company.
The Company's movie selection committee uses listings of new releases, video
previews,

                                       8
<PAGE>

knowledge of the popularity of past video releases and the Company's
computerized information on the past performance of titles rented by the
Company to select the titles and number of copies of each title to be acquired
for rental in each of its stores. The Company is permitted to return unopened
or defective videocassettes to its suppliers in certain circumstances. The
Company purchases video game software from a variety of distributors, based on
price and availability.

  In addition to traditional inventory purchasing, in fiscal 1999, the Company
entered into direct license revenue-sharing agreements with several major
motion picture studios. Under the terms of the agreements, the Company will
share the greater of an agreed-upon percentage of the rental revenue or dollar
amount per rental transaction, which percentage declines over a period of
weeks following the release of the title for video rental. Some agreements
include a nominal up front fee for units purchased or a specified guarantee
amount. The Company is aggressively pursuing additional direct licensing
revenue-sharing agreements with other studios, although no assurances can be
given that such agreements will be obtained.

  The Company believes that such revenue-sharing agreements will be a cost-
effective source for larger orders of an individual title, particularly new
release titles. Such agreements will enable the Company to order larger
quantities, two to five times the normal order, of copies of a particular
title to satisfy customer demand than could be cost-effective if the copies
were purchased for rental. To obtain the full benefits of such revenue sharing
agreements, the Company must correctly identify the new release and other
titles that it should offer on this basis. No assurances can be given that the
Company will be able to use such revenue sharing agreements to obtain the
intended results.

  The Company also is a party to an agreement with Rentrak Corporation (the
"Rentrak Agreement"), a distributor of prerecorded videocassettes and other
media, which agreement superseded in all substantial respects a previous
agreement between Rentrak and recently acquired Moovies, Inc. The Rentrak
Agreement includes a requirement that the Company obtain a minimum annual
dollar amount of new release titles from Rentrak. The minimum dollar amount is
subject to increase or decrease depending on the Company's gross revenues from
video rental/sales and the number of major studios participating in Rentrak.
In addition, under the Rentrak Agreement the Company is allowed to choose
which stores offer a title from Rentrak, but if a store obtains a copy of a
new release title from Rentrak, it must obtain all copies of that title from
Rentrak.

  In August 1998, the Company filed suit in federal court in Delaware against
Rentrak, alleging that the Rentrak Agreement is in conflict with federal
antitrust law, given Rentrak's position in the market and its exercise of
monopoly power. Although the Company's claim is not pursuant to or arising
from the Rentrak Agreement, a resolution of the action may affect some or all
of the provisions of the agreement as well as similar agreements in the video
industry or may leave the agreement unaffected. The Company has not ordered
any titles from Rentrak under the agreement or otherwise. Further, the court
in the action may determine that some or all of any monies paid to Rentrak
under the Rentrak Agreement are subject to offset or recoupment (see "Item 3-
Legal Proceedings").

Inventory

  New release videocassettes are ordered by the Company and delivered directly
to stores where they are offered for rental or sale on the studio release date
for the title. Previously viewed inventory for existing and new stores is
received, processed and stored in the Company's approximately 34,000 square
foot central distribution facility located in St. Paul, Minnesota. New release
and previously viewed videocassettes and games are processed for rental
according to uniform companywide standards. Each videocassette is removed from
its original carton and placed in a standard Video Update rental case with a
magnetic security device. Bar codes are then affixed to each videocassette and
video game. For previously viewed videocassettes, the artwork from the
original carton is cut out and inserted into clear pockets on the standard
Video Update rental case for shelf display. For new release videocassettes,
the original carton is displayed separately in front of the standard Video
Update rental case containing the videocassette.

                                       9
<PAGE>

Competition

  The video rental industry is highly competitive. The Company competes with
other video retail stores, including Blockbuster, Inc., a subsidiary of
Viacom, Inc. ("Blockbuster") and other superstores, and with supermarkets,
pharmacies, convenience stores, bookstores, mass merchants, mail order
operations, vending machines and other retailers, as well as with
noncommercial sources such as libraries. In addition to competing with other
video retailers, the Company competes with other leisure-time activities,
especially entertainment activities such as movie theaters, sporting events,
network television and cable television.

  The Company also competes with other distribution channels for studio
movies, including pay-per-view television on basic cable service, which
currently offer only a limited number of channels and monthly movie
selections. Recently developed digital compression technology combined with
fiber optics and other technology will eventually permit cable companies,
direct broadcast satellite companies and other telecommunications companies to
transmit a much greater number of movies to homes at scheduled intervals
throughout the day. Ultimately, these technologies could lead to the
availability of movies on demand to the consumer. Certain cable and other
telecommunications companies have tested and are continuing to test movie-on-
demand services in some markets.

  The Company and its larger competitors, including Blockbuster, have entered
into direct revenue-sharing arrangements with several major motion picture
studios. Such arrangements could allow these competitors to order and stock a
greater number of new release and other titles, thus increasing competition in
those areas in which each of the Company and its competitors have retail
locations and diminishing the potential benefits of similar revenue sharing
arrangements entered into by the Company, which could have a material adverse
effect on operations. In addition, certain of the Company's larger, better
capitalized competitors may seek to acquire some of the same video specialty
stores that the Company seeks to acquire. Such competition for acquisitions
would likely increase acquisition prices and related costs and result in fewer
attractive acquisition opportunities, which could have a material adverse
effect on the Company's growth.

  The Company's franchise operations compete with numerous franchise
operations in many industries that have significantly greater financial and
human resources and more experience in selling franchises than does the
Company. Potential franchisees may believe that these franchisers offer
greater opportunities for success than the Company.

Service Marks

  The Company has a federal registration for its service mark "Video
Update(R)" and logos that include its service mark. The Company also holds
registrations in Canada for its service marks and logos. The Company considers
its service marks to be important to its business and intends to actively
protect them.

Government Regulation

  The Company is subject to various federal, state and local laws, including
the Federal Videotape Privacy Protection Act and similar state laws that
govern the disclosure and destruction of video rental records. The Company
also must comply with various regulations affecting its business, including
state and local licensing, zoning, land use, construction and environmental
regulations.

  The Company has not made, nor does it anticipate making, any material
capital expenditures in order to comply with environmental regulations. No
assurance can be given, however, that new environmental regulations will not
be adopted that will require the Company to make material capital expenditures
for compliance.

  The Company also is subject to the Federal Trade Commission's Trade
Regulation Rule entitled "Disclosure Requirements and Prohibitions Concerning
Franchising and Business Opportunity Ventures" (the "FTC Franchise Rule") and
state laws and regulations that govern the offer and sale of franchises. To
offer and sell franchises, the Company is required by the FTC Franchise Rule
to furnish each prospective franchisee a

                                      10
<PAGE>

current franchise offering circular prior to the sale of a franchise. In
addition, a number of states require a franchisor to comply with registration
or filing requirements prior to offering a franchise in the state and to
provide a prospective franchisee with a current franchise offering circular
complying with the state's laws, prior to the sale of the franchise. Although
no assurance can be given, the Company intends to maintain a franchise
offering circular that complies with all applicable federal and state
franchise sales laws. However, if the Company is unable to comply with the
franchise sales laws and regulations of any state that regulates the offer and
sales of franchises, the Company will be unable to offer and sell franchises
in such state.

  The Company is required to update its franchise offering circular to reflect
material changes, under applicable law, regarding its franchise offering and
to comply with changes in disclosure requirements. The occurrence of any such
material changes may, from time to time, require the Company to stop offering
and selling franchises until its franchise offering circular is updated. No
assurance can be given that the Company's franchising program will not be
adversely affected by its failure to register or file in certain states
consistent with its expansion plans, or because compliance with applicable law
necessitates that the Company cease offering and selling franchises in certain
states until its franchise offering circular is updated, or because of its
inability to comply with existing or future franchise laws.

  The Company also is subject to a number of state laws and regulations that
regulate certain substantive aspects of the franchisor-franchisee
relationship, including those governing the termination or nonrenewal of a
franchise agreement (such as requirements that "good cause" exist as a basis
for such termination and that a franchisee be given advance notice of, and a
right to cure, a default prior to termination), requirements that the
franchisor deal with its franchisees in good faith, prohibitions against
interference with the right of free association among franchisees and those
regulating discrimination among franchisees in charges, royalties or fees.

  Compliance with federal and state franchise laws is costly and time
consuming, and no assurance can be given that the Company will not encounter
difficulties or delays in this area or that it will not require significant
capital for franchising activities.

Employees

  As of April 30, 1999, the Company employed 6,671 persons, including 6,487 in
Company-owned stores and 184 in the Company's corporate, administrative and
warehousing operations. Of the employees, approximately 986 were full-time and
5,685 were part-time. The typical required staffing for a Video Update store
is 9 to 11 employees, including a store manager. Store managers are supervised
by district managers who in turn are supervised by regional managers. Regional
managers report directly to the Company's Vice Presidents of Store Operations
who in turn report to the Executive Vice President of Store Operations or the
Chief Operations Officer. The Company believes that its employee relations are
satisfactory.

  The Company has an incentive bonus plan under which store managers are
eligible for monthly bonuses. The performance of each manager is evaluated on
a variety of criteria, including store revenue, payroll, cash overages and
shortages and inventory control.

Item 2. Properties

  The Company leases substantially all of the sites (including buildings and
improvements) where its Company-owned video stores are located. The occupancy
expense for these sites for the years ended April 30, 1997, 1998 and 1999 was
approximately $20,777,000, $39,156,000 and $65,434,000, respectively. These
leases generally have a term of three to ten years and provide options to
renew for periods ranging from three to five additional years. The Company is
generally responsible for real estate taxes, insurance and utilities under all
leases (see Note 9 of the Notes to Consolidated Financial Statements "Lease
Agreements"). The Company expects that most future video superstores will also
occupy leased premises. The Company owns three locations

                                      11
<PAGE>

for Company-owned superstores, one of which is subject to a mortgage, (see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources").

  The Company's franchisees enter into leases individually for their
respective superstore locations. These leases are on terms substantially
similar to the terms for Company-owned superstore leases. Generally, the
Company does not guarantee and is not a party to such leases.

  The Company's corporate headquarters are located at 3100 World Trade Center,
30 East Seventh Street, St. Paul, Minnesota 55101 and consist of approximately
38,000 square feet of office space. The Company's central distribution
facility is located at a different location in St. Paul, Minnesota and
consists of approximately 34,000 square feet. The Company's headquarters and
distribution facilities are leased pursuant to agreements that expire on
October 31, 2001 and August 31, 2001, respectively. In addition, the Company
maintains other locations for the offices of district and regional managers
and for limited storage purposes. The Company expects that suitable additional
space will be available in the Twin Cities area, when needed, on commercially
reasonable terms.

Item 3. Legal Proceedings

  In connection with the acquisition of the assets of Videoland, Inc.
("Videoland") in November 1995, the Company issued 239,163 shares of its Class
A Common Stock (the "Videoland Shares") to the sellers of the assets of
Videoland (the "Videoland Sellers"). With respect to the Videoland Shares, the
Company agreed to make a deficiency payment in October 1996 to the Videoland
Sellers if the gross proceeds received by such sellers from the sale of the
Videoland Shares during the six months from March 1996 through September 1996
are not equal to the number of shares of Videoland Shares sold multiplied by
$12.00. The Videoland Sellers were subject to certain "lockup" or sale
restrictions as a condition to any deficiency payment. The Company initiated
an action in federal district court in Minnesota for a declaratory judgment
that the Videoland Sellers are not entitled to any deficiency payment in light
of the failure by such sellers to comply with the lockup or sale restrictions.
In January 1998, the court entered a judgment against Video Update in the
amount of $1,220,403 plus interest from October 1996, and attorney's fees. The
Eighth Circuit recently denied the Company's appeal. The Company is exploring
further avenues of relief. The foregoing description is qualified in its
entirety by reference to the full text of the complaint and papers on file in
the action (Case No. 3-96 735).

  In May 1998, Rousnam Video, Inc., a Michigan corporation and Hani (Al)
Monsour (collectively "Monsour") filed a lawsuit in state court (Macomb
County, Michigan) claiming amounts due pursuant to post-closing adjustments
contemplated in connection with an Asset Purchase Agreement among Monsour and
Moovies, Inc. dated as of March 14, 1997, and the alleged default on a
Promissory Note among Monsour and Moovies, Inc. in the amount of $2,000,000
which is currently reflected in notes payable. The trial court has ruled in
favor of the plaintiffs on a motion for summary judgment, and a judgment for
$2,370,195 has been entered against the Company. The Company believes it has
meritorious grounds for its appeal which is currently pending, although
assurances cannot be given as to the outcome of such action. The foregoing
description is qualified in its entirety by reference to the full text of the
complaint and papers on file in the action (Case No. 98-1998-CK).

  In May 1998, four stockholders filed suit in the US District Court for the
Central District of California. The plaintiff stockholders allege that Mr.
Potter and the Company made false and misleading statements or omitted
material information about the Company and the video industry during the
period April 1995 to September 1996, the date of its subsequent public
offering. Plaintiffs are seeking "at least the sum of $967,967," plus
interest, additional damages and attorneys' fees. The Company and Mr. Potter
believe that the claims are unsubstantiated, without merit and they intend to
defend the matter vigorously. A motion to dismiss the First Amended Complaint
was granted, but the court allowed Plaintiffs to re-file. At present, the
Second Amended Complaint has been filed. The Company is in the process of
discovery, which is not scheduled to close until December 1999. The foregoing
description is qualified in its entirety by reference to the full text of the
complaint and papers on file in the action (Case No. SACV 98-415 GLT-ANx).


                                      12
<PAGE>

  In August 1998, the Company filed suit in federal court in Oregon against
Rentrak Corporation, an Oregon Corporation. The Company alleges that Rentrak
has violated the federal antitrust law, given Rentrak's position in the market
and its exercise of monopoly power. Rentrak has counter-claimed for amounts it
alleges were owed by Moovies, Inc. prior to the acquisition of Moovies, Inc.
by the Company; the Company has denied that any sums are due. Discovery in the
matter is now scheduled to be completed in December 1999. The Company intends
to pursue its claims aggressively, although assurances cannot be given as to
the outcome of this matter. The foregoing description is qualified in its
entirety by reference to the full text of the complaint and papers on file in
the action (Case No. CV 98-1013-HA).

  On June 20, 1999, Allen Industries, Inc., a North Carolina corporation,
filed a lawsuit against the Company claiming approximately $3 million in
unpaid invoices arising out of the conversion of various Moovies stores. The
Company has asserted that Allen Industries breached its contract and performed
defective work. The Company believes that the claims of Allen Industries are
unsubstantiated and without merit. The Company intends to defend the matter
vigorously. The foregoing description is qualified in its entirety by
reference to the full text of the complaint and papers on file in the action
(Case No. 1:99CV640).

  On April 12, 1999, Sight and Sound Distributors, Inc., a Delaware
corporation, filed a lawsuit in state court (St. Louis County, Missouri)
alleging that the Company owes approximately $7.7 million for goods and
services purchased from Sight & Sound. The Company filed its answer denying
liability and alleging entitlements to off-sets. The Company is in the process
of discovery. A required settlement conference has been scheduled for December
20, 1999. The foregoing description is qualified in its entirety by reference
to the full text of the complaint and papers on file in the action (Case No.
99CC-001222).

  In addition to the above, the Company is involved in various legal
proceedings arising during the normal course of conducting business.
Management believes that the resolution of these proceedings will not have any
material adverse impact on the Company's financial statements.

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

  The Company held its Annual Meeting of Stockholders (the "Meeting") on April
26, 1999, at the offices of the Company, 3100 World Trade Center, 30 East
Seventh Street, St. Paul, Minnesota to consider and vote upon the following
proposals, each of which is more particularly described in the Company's Proxy
Statement filed with the Commission on March 31, 1999.

  1. The election of six (6) members of the Company's Board of Directors (the
"Board of Directors Proposal"); and

  2. The ratification of the selection of Deloitte & Touche LLP as independent
auditors for the Company for the fiscal year ending April 30, 1999 (the
"Auditors Proposal").

  The results of the voting for each of the foregoing proposals at the Meeting
were as follows:

  1.The Board of Directors Proposal:

   Daniel A. Potter

   23,231,393 VOTES FOR
   797,281 WITHELD AUTHORITY

   John M. Bedard

   23,249,345 VOTES FOR
   779,329 WITHELD AUTHORITY

                                      13
<PAGE>

   Daniel C. Howard

   23,250,270 VOTES FOR
   778,404 WITHELD AUTHORITY

   Paul M. Kelnberger

   23,249,570 VOTES FOR
   779,104 WITHELD AUTHORITY

   Bernard R. Patriacca

   23,249,770 VOTES FOR
   778,904 WITHELD AUTHORITY

   Theodore J. Coburn

   23,250,170 VOTES FOR
   778,504 WITHELD AUTHORITY

  Accordingly, each of the above-referenced six persons was elected as a member
of the Board of Directors.

  2.The Auditors Proposal:

   23,860,016 VOTES FOR
   109,933 VOTES AGAINST 58,725 ABSTAINING

  Accordingly, approval was given for this proposal.

                                       14
<PAGE>

                                    PART II

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

  From May 1, 1995 until May 7, 1995, the Company's Class A Common Stock was
traded on the NASDAQ Small Cap Market. From May 8, 1995 to date, the Company's
Class A Common Stock has traded on the NASDAQ National Market System under the
symbol "VUPDA." The Company's Class A Common Stock began trading on NASDAQ on
July 20, 1994. On April 30, 1999, the closing price for the Class A Common
Stock as reported by NASDAQ was $0.7188 per share.

  The Company has been notified by the NASDAQ National Market that its Class A
Common Stock is subject to delisting based on the Company's failure to meet
certain maintenance criteria including minimum bid price requirements. The
Company has provided information to NASDAQ as it makes its decision in this
matter. For continued listing, the Company will have to demonstrate to the
satisfaction of NASDAQ that it can regain compliance with these particular
deficiencies and maintain long term compliance with all applicable maintenance
criteria. The Company presented its plan for continued compliance, which
includes provisions for a possible reverse stock split of the Company's Class
A Common Stock. The NASDAQ decision on delisting will be rendered after
consideration of the entire record presented by the Company. Their decision
may be entered and effected immediately. No assurances can be given that there
will be a favorable NASDAQ ruling, nor that the Company will be in compliance
with other NASDAQ National Listing requirements or that its Class A Common
Stock will continue to be listed on NASDAQ National Market. In the event of
any delisting, the Company expects that its Class A Common Stock would
immediately be eligible to trade on NASDAQ's OTCBB ("Over-the-Counter Bulletin
Board").

  For the period indicated, the following table sets forth the range of high
and low sale prices for the Class A Common Stock as reported on the NASDAQ
National Market System.

                             Class A Common Stock

<TABLE>
<CAPTION>
                                                                 High     Low
                                                               -------- --------
     <S>                                                       <C>      <C>
     Fiscal 1998
     Quarter ended July 31, 1997.............................. $5 5/16  $3 3/8
     Quarter ended October 31, 1997...........................  3 7/8    2 5/8
     Quarter ended January 31, 1998...........................  3 1/4    1 11/16
     Quarter ended April 30, 1998.............................  3 5/8    2 1/16
     Fiscal 1999
     Quarter ended July 31, 1998..............................  2 31/32  1 3/32
     Quarter ended October 31, 1998...........................  1 3/8      5/8
     Quarter ended January 31, 1999...........................  1 31/32    1/2
     Quarter ended April 30, 1999.............................  1 11/16   17/32
</TABLE>

  As of April 30, 1999, there were 341 stockholders of record of the Company's
Class A Common Stock.

  During the fiscal year ended April 30, 1999, the Company did not pay any
dividends on its Common Stock and management does not anticipate the payment
of any dividends to its stockholders in the foreseeable future. The Company
currently intends to reinvest earnings, if any, in the development and
expansion of its business. The declaration of dividends in the future will be
at the discretion of the Board of Directors and will depend upon the earnings,
capital requirements and financial position of the Company, general economic
conditions and other pertinent factors, including covenants relating to bank
indebtedness.

                                      15
<PAGE>

Item 6. Selected Consolidated Financial Data

<TABLE>
<CAPTION>
                                           Fiscal Year Ended April 30,
                          ------------------------------------------------------------------
                           1994      1995      1996(1)       1997      1998(2)     1999(3)
                          -------  ---------  ----------  ----------  ----------  ----------
                                (Dollars in thousands, except per share amounts)
<S>                       <C>      <C>        <C>         <C>         <C>         <C>
Statement of Operations
 Data:
Revenues................  $ 4,989  $   9,051  $   50,504  $   91,799  $  156,154  $  254,096
Income (loss) from
 continuing
 operations.............  $   301  $     213  $    1,628  $    4,620  $  (14,480) $ (110,371)
Income (loss) per share
 from continuing
 operations, diluted....  $  0.33  $    0.10  $     0.15  $     0.28  $    (0.71) $    (3.77)
Weighted average
 shares(4)..............  904,000  2,226,000  10,663,000  16,262,000  20,412,000  29,278,000
Operating Data:
Increase in same store
 sales(5)...............       26%        21%         16%          5%          2%          2%
Number of stores open at
 end of period:
  Company-owned.........       15         33         204         343         681         652
  Franchised............       31         22          25          30          72          55
                          -------  ---------  ----------  ----------  ----------  ----------
                               46         55         229         373         753         707
                          =======  =========  ==========  ==========  ==========  ==========
Number of Company-owned
 stores:
  Opened during the
   period...............        2          4          35          65          84          16
  Acquired during the
   period...............      --          14         136          74         267         --
  Closed during the
   period...............      --         --          --          --           13          45
Balance Sheet Data:
Total assets............  $ 3,489  $  19,450  $   79,518  $  133,607  $  278,431  $  207,208
Notes payable...........  $ 1,568  $   1,278  $    4,859  $   20,564  $  104,488  $  116,014
Total liabilities.......  $ 2,614  $   4,279  $   18,018  $   42,615  $  169,132  $  210,303
Stockholders' equity....  $   875  $  15,171  $   61,500  $   90,992  $  109,299  $   (3,095)
</TABLE>
--------
(1) During the fourth quarter of fiscal 1996, the Company adopted a new method
    of amortizing videocassette rental inventory. The effect of the change for
    recognizing salvage value of base stock and the effect of the application
    of the new method of amortizing videocassette copies in excess of the base
    stock to May 1, 1995 had the impact, in total, of increasing amortization
    expense by $2,773,000 and decreasing net income by $1,604,000, or $.15 per
    share, in fiscal 1996. See Note 2 of the Notes to Consolidated Financial
    Statements.
(2) During the fourth quarter of fiscal 1998, the Company took significant
    one-time charges of approximately $17 million. Exclusive of the one-time
    charges, the net loss would have been $2,701,000 or $0.11 per share.
(3) During the fourth quarter of fiscal 1999, the Company took significant
    one-time charges of approximately $16 million (see Note 4 of the Notes to
    the Consolidated Financial Statements) related to additional store
    closings and $51 million (see Note 2 of the Notes to Consolidated
    Financial Statements) related to a change in amortization method for Video
    and Game Rental Inventory. Exclusive of the one-time charges, the net loss
    would have been $43,607,000 or $1.49 per share.
(4) See Note 1 of the Notes to Consolidated Financial Statements for
    calculation of weighted average shares for fiscal 1997, 1998 and 1999.
(5) The stores included in same store sales are Company-owned stores that have
    been owned and operated by the Company for more than 12 months.

                                      16
<PAGE>

Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

  The following discussion of the financial condition and results of
operations should be read in conjunction with the Company's audited
consolidated financial statements and notes thereto appearing elsewhere
herein.

Overview

  The Company franchised its first store in January 1983 and opened its first
company-owned store in September 1989. By July 1994, when the Company
completed its initial public offering, the Company had grown to 15 Company-
owned stores and 30 franchised stores. Subsequently, the Company accelerated
its growth and as of April 30, 1999, operates 652 Company-owned stores in 31
states and five provinces in Canada, and has 55 franchised stores
predominantly in the United States.

  In March 1998, The Company acquired Moovies, Inc., and its 267 video retail
stores. As a result of the acquisition, the results of operations for the year
ended April 30, 1999 were reduced by an increase in amortization of goodwill
of approximately $2,118,000 (see "Significant Future Charges to Earnings
Arising from Amortization of Goodwill" following "Liquidity and Capital
Resources" in Item 7 hereof). The Company anticipates that future acquisitions
could involve the recording of additional significant amounts of goodwill and
deferred charges on its balance sheet.

  In December 1998, the Company's Board of Directors approved a resolution
changing the Company's fiscal year-end from April 30 to January 31, effective
January 31, 2000.

  The Company generates revenues primarily from the rental of videocassettes
and video games, from the sale of products, and from service fees from its
franchisees. As reflected in the chart below, rental revenues at Video Update
stores have accounted for the substantial majority of the Company's revenues.
The Company expects that this trend will continue.

<TABLE>
<CAPTION>
                                                        Fiscal Year Ended April
                                                                  30,
                                                       -------------------------
                                                        1997     1998     1999
                                                       ------- -------- --------
                                                            (In thousands)
   <S>                                                 <C>     <C>      <C>
   Revenues:
     Rental revenue................................... $83,489 $138,279 $221,238
     Product sales....................................   7,743   17,075   31,915
     Service fees.....................................     567      800      943
                                                       ------- -------- --------
       Total revenues................................. $91,799 $156,154 $254,096
                                                       ======= ======== ========
</TABLE>

  Overall revenues, including same store sales, did not meet management's
expectations for fiscal 1999, due in significant part to certain factors,
including: (i) Moovies locations not performing to management's expectations
for the year, being due in large part to a drop in customer traffic as Moovies
locations were converted to the Video Update format; and (ii) the timing
advantage afforded by direct studio revenue sharing arrangements obtained by
some of the Company's largest competitors, including Blockbuster.

  Management is continuing several actions intended to enhance prospects for
profitable revenue growth for fiscal 2000. The Company successfully converted
all Moovies stores by November 30, 1998. During the 12 months ending April 30,
1999, the Company opened 16 new stores, closed 45 under-performing stores and
performed significant conversions on several other stores. During the fourth
quarter of 1999, the Company began and completed an extensive analysis of each
store's performance and adopted a business restructuring plan to close
approximately 70 of its stores. The Company is now obtaining inventory under
several revenue sharing arrangements with motion picture studios and is
pursuing additional direct revenue sharing arrangements with other studios.

                                      17
<PAGE>

Operating Results

  The table below sets forth the percentage of revenues represented by certain
items included in the Company's statement of operations for the periods
indicated.

<TABLE>
<CAPTION>
                                               Fiscal Year Ended April 30,
                                              --------------------------------
                                                1997       1998        1999
                                              ---------  ---------   ---------
   <S>                                        <C>        <C>         <C>
   Revenues:
     Rental revenue..........................      91.0%      88.6%       87.1%
     Product sales...........................       8.4       10.9        12.6
     Service fees............................       0.6        0.5         0.3
                                              ---------  ---------   ---------
       Total revenues........................     100.0      100.0       100.0
                                              ---------  ---------   ---------
   Costs and expenses:
     Store operating expenses................      76.5       83.2        91.4
     Selling, general and administrative.....       8.6       16.2        10.3
     Cost of product sales...................       4.0        6.3         8.0
     Store closing charge....................       --         3.2         5.8
     Inventory valuation charge..............       --         --         19.9
     Amortization of goodwill................       1.8        1.5         1.8
                                              ---------  ---------   ---------
       Total costs and expenses..............      90.9      110.4       137.2
                                              ---------  ---------   ---------
   Operating income (loss)...................       9.1      (10.4)      (37.2)
   Other income (expense)
     Interest expense........................      (0.9)      (2.8)       (5.4)
     Other income............................       0.5        0.0         0.3
                                              ---------  ---------   ---------
       Total other expense...................      (0.4)      (2.8)       (5.1)
                                              ---------  ---------   ---------
   Income (loss) before income taxes.........       8.7      (13.2)      (42.3)
   Income tax expense (benefit)..............       3.7       (3.9)        1.1
                                              ---------  ---------   ---------
   Net income (loss).........................       5.0%      (9.3)%     (43.4)%
                                              =========  =========   =========
</TABLE>

Fiscal 1999 Compared to Fiscal 1998

  Rental revenue. Rental revenue was approximately $221,238,000 and
$138,279,000, or 87.1% and 88.6% of total revenues for fiscal 1999 and 1998,
respectively. The increase in rental revenue of $82,959,000 was derived
primarily from the 267 video stores acquired from Moovies in March 1998 and a
2% increase in same store revenues at the Video Update locations. Rental
revenues did not meet management's expectations for the 12 months ended April
30, 1999, primarily due to the conversion of the Moovies locations in several
significant markets, which was completed during the third fiscal quarter, as
well as the simultaneous impact during the period of revenue sharing
arrangements and copy title depth obtained by competitors in markets where the
Company's stores are located. Management expects that future results will be
positively impacted by the operation of all of the now fully converted Moovies
locations. In addition, the Company is now obtaining additional videocassette
product under several direct revenue sharing arrangements with motion picture
studios, allowing it to better compete with larger competitors at a time when
all of its Company-owned locations are now operating under the Video Update
name and operating system.

  Product sales. Product sales were approximately $31,915,000 and $17,075,000,
or 12.6% and 10.9% of total revenues for fiscal 1999 and 1998, respectively.
The increase in product sales of $14,840,000 was primarily a result of product
sales by the Moovies video stores acquired in March 1998 and from the sale of
videocassettes of the movie "Titanic." The increase as a percentage of total
revenues was primarily due to a difference in product mix and high Titanic
video sales.

                                      18
<PAGE>

  Service fees. Service fees were approximately $943,000 and $800,000, or 0.3%
and 0.5% of total revenues for fiscal 1999 and 1998, respectively. Continuing
service fees and royalties from franchisees account for 95% of total service
fees from fiscal 1999 and 1998. The increase in service fees of $143,000 was
primarily a result of franchises acquired with the Moovies acquisition in
March 1998.

  Store operating expenses. Store operating expenses consist primarily of
compensation and related expenses, occupancy expenses, and the cost of rental
tapes and video games. Operating expenses were approximately $232,287,000 and
$129,920,000, or 91.4% and 83.2% of total revenues for fiscal 1999 and 1998,
respectively. Store operating expenses do not include a one-time charge to
change the amortization policy for rental inventory (see Note 2 "Change in
Amortization Method for Video and Game Rental Inventory" to the Consolidated
Financial Statements). The increase in store operating expenses of
$102,367,000 was primarily the result of the Moovies video stores acquired in
March 1998. The increase in store operating expenses as a percentage of total
revenues was primarily due to: (i) a sales shortfall arising from the timing
advantage of revenue sharing arrangements and copy title depth obtained by
competitors in the markets where the Company's stores were located; (ii)
revenues of a significant number of acquired Moovies locations not performing
to management's expectations; and (iii) corresponding higher costs of new
video stores prior to revenue reaching maturity during the first two years of
operations. Store operating expenses consist of the following (in 000's):

<TABLE>
<CAPTION>
                           Twelve Months Ended April 30,   Percent of Revenue
                          ------------------------------- ----------------------
                            1997       1998       1999     1997    1998    1999
                          --------- ---------- ---------- ------  ------  ------
<S>                       <C>       <C>        <C>        <C>     <C>     <C>
Cost of rental revenue..  $  20,317 $   38,689 $   76,044   22.1%   24.8%   29.9%
Occupancy expenses......     22,355     41,596     71,436   24.4%   26.6%   28.1%
Compensation and related
 benefits...............     20,278     38,424     60,055   22.1%   24.6%   23.6%
Furniture, fixtures, and
 equipment expenses.....      3,960      6,313     13,777    4.3%    4.1%    5.5%
Other store operating
 expenses...............      3,295      4,898     10,975    3.6%    3.1%    4.3%
                          --------- ---------- ---------- ------  ------  ------
  Total store operating
   expenses.............  $  70,205 $  129,920 $  232,287   76.5%   83.2%   91.4%
                          ========= ========== ========== ======  ======  ======
</TABLE>

  Cost of rental revenue was approximately $76,044,000 and $38,689,000, or
29.9% and 24.8% of total revenues for fiscal 1999 and 1998, respectively. Cost
of rental revenue reflects the amortization of videocassettes and video games,
revenue sharing expenses, and fees paid to videocassette and video game
suppliers. The increase of $37,355,000 was primarily attributable to the
addition of new release videocassette inventory for new, existing, and the
acquired Moovies locations. Cost of rental revenue as a percentage of revenues
for future periods may vary based on the Company's purchase of videocassette
inventory and revenue sharing arrangements. These costs are subject to change
based on the Company's rate of expansion, studio pricing, minimum buy
requirements, studio release schedules and market demand.

  Occupancy expenses were approximately $71,436,000 and $41,596,000, or 28.1%
and 26.6% of total revenues for fiscal 1999 and 1998, respectively. The
increase of approximately $29,840,000 was primarily due to the Moovies
locations acquired in March 1998. The increase as a percentage of total
revenues was primarily due to revenues of a significant number of acquired
Moovies locations not performing to management's expectations.

  Compensation and related benefits were approximately $60,055,000 and
$38,424,000, or 23.6% and 24.6% of total revenues for fiscal 1999 and 1998,
respectively. The increase of approximately $21,631,000 was primarily due to
the Moovies locations acquired in March 1998.

  Selling, general and administrative. Selling, general and administrative
expenses were approximately $26,179,000 and $25,223,000, or 10.3% and 16.2% of
total revenues for fiscal 1999 and 1998, respectively. During the fourth
quarter of fiscal 1998, the Company recorded the following: (i) a $3,546,000
non-cash, non-tax deductible charge to compensation expense related to the
release of 1,170,000 shares of Class B common stock from escrow (see Note 12
"Stockholders' Equity" of the Notes to Consolidated Financial Statements);
(ii) a $7,161,000 charge consisting of a $3,236,000 non-cash charge relating
to the restated employment agreements

                                      19
<PAGE>

for the Company's Chief Executive Officer and its President, representing
amounts to be applied to their existing stock option related loan obligations,
and $3,925,000 to be used by the executives primarily to pay income taxes
arising from the stock option related transaction; and (iii) $700,000 for
previously capitalized bank fees related to the Company's previous Revolving
Credit Facility which was repaid prior to its maturity. After giving
consideration to these items, expenses were $26,179,000 and $13,816,000, or
10.3% and 8.8% of total revenues for fiscal 1999 and 1998, respectively. The
increase of $12,363,000 was primarily due to (i) additional finance and
information systems personnel and related expenses to support the Company's
growth; (ii) outside legal and accounting fees; (iii) upgraded computer and
phone systems; and (iv) bank service fees related to additional locations. The
increase in selling, general and administrative expenses as a percent of total
revenue was primarily due to (i) higher than expected costs incurred to
integrate the Moovies locations; and (ii) sales shortfalls at Moovies
locations as they were converted to the Video Update format.

  Cost of product sales. Cost of product sales was approximately $20,257,000
and $9,809,000, or 8.0% and 6.3% of total revenues for fiscal 1999 and 1998,
respectively. The cost of product sales as a percentage of total product sales
revenue was approximately 63.5% and 57.4% for fiscal 1999 and 1998,
respectively. The increase in the cost of product sales as a percentage of
product sales was primarily due to the sale of the "Titanic" video which was
sold at a low margin due to industry competition.

  Store Closing Charge. During the fourth quarter of 1999, the Company began
and completed an extensive analysis of its base store performance and adopted
a business restructuring plan to close approximately 70 under- performing
stores. This analysis resulted in the Company recording a pretax charge of
approximately $16,135,000 to cover lease termination charges, closing costs
and asset write-downs for those stores. During the fourth quarter of fiscal
1998, the Company recorded a store closing reserve of approximately $5,082,000
of which approximately $1,337,000 was reversed in fiscal 1999 due to
successful negotiation of lease terminations (see Note 4 of the Notes to
Consolidated Financial Statements).

  Amortization of goodwill. Amortization of goodwill was approximately
$4,471,000 and $2,353,000 for fiscal 1999 and 1998, respectively. The increase
was primarily attributable to the acquisition of Moovies in March 1998.

  Interest expense. Interest expense was approximately $13,695,000 and
$4,292,000 or 5.4% and 2.8% of total revenues for fiscal 1999 and 1998,
respectively. The increase of $9,403,000 was primarily attributable to
interest on increased borrowings under the Company's Senior Facility (as
defined below).

  Other income (expense). Other income (expense) was approximately $677,000
and $(71,000) for fiscal 1999 and 1998, respectively.

Fiscal 1998 Compared to Fiscal 1997

  Rental revenue. Rental revenue was approximately $138,279,000 and
$83,489,000, or 88.6% and 91.0% of total revenues for fiscal 1998 and 1997,
respectively. The increase in rental revenues of $54,790,000 was derived
primarily from the 267 video stores acquired during the period, from the
opening of 71 company-owned stores, net of closings, during fiscal 1998, and
from a 2% increase in same store revenues.

  Product sales. Product sales were approximately $17,075,000 and $7,743,000,
or 10.9% and 8.4% of total revenues for fiscal 1998 and 1997, respectively.
The increase in product sales of $9,332,000 was a result of product sales by
the video stores acquired during the period, the opening of 71 Company-owned
video stores, net of closings, and an increase in sales of inventory and
fixtures to franchisees. The increase as a percentage of total revenues was
primarily due to: (i) an increased demand for the purchase of video games,
especially in Canada; (ii) the introduction of confection items in selected
markets; and (iii) increased sales of holiday videocassettes.

                                      20
<PAGE>

  Service fees. Service fees were approximately $800,000 and $567,000, or .5%
and .6% of total revenues of fiscal 1998 and 1997, respectively. Continuing
service fees and royalties from franchisees account for 95% of total service
fees from fiscal 1998 and 1997. The decrease in service fees as a percentage
of total revenues was due to a significant increase in the number of Company-
owned stores without a corresponding increase in the number of franchise
stores, until 42 franchise stores were acquired in the March 1998 Moovies
transaction.

  Store operating expenses. Store operating expenses consist primarily of
compensation and related expenses, occupancy expenses, and the cost of rental
videos and games. Operating expenses were approximately $129,920,000 and
$70,205,000, or 83.2% and 76.5% of total revenues for fiscal 1998 and 1997,
respectively. The increase in store operating expenses of $59,715,000 was
primarily the result of video stores acquired during the period and the
opening of 71 Company-owned video stores, net of closings, during fiscal 1998.
The increase in store operating expenses as a percentage of total revenues was
primarily due to revenues of new stores not meeting management's expectations
due primarily (management believes) to new release titles not generating
consumer interest or rental traffic and corresponding higher costs associated
with the opening of new video stores prior to revenue reaching maturity during
the first two years of operations.

  Compensation and related expenses were approximately $38,424,000 and
$20,278,000, or 24.6% and 22.1% of total revenues for fiscal 1998 and 1997,
respectively. The increase of $18,146,000 was primarily the result of the
video stores acquired during the period and the opening of 71 Company-owned
video stores, net of closings, during fiscal 1998.

  Occupancy expenses were approximately $41,596,000 and $22,355,000, or 26.6%
and 24.4% of total revenues for fiscal 1998 and 1997, respectively. The
increase of $19,241,000 was primarily the result of the video stores acquired
during the period and the opening of 71 Company-owned video stores, net of
closings, during fiscal 1998.

  Cost of rental revenue were approximately $38,689,000 and $20,317,000, or
24.8% and 22.1% of total revenues for fiscal 1998 and 1997, respectively. Cost
of rental revenue reflects the amortization of videocassettes and video games,
revenue sharing expenses, and fees paid to videocassette and video game
suppliers. The increase of $18,372,000 was primarily the result of video
stores acquired during the period and the opening of 71 Company-owned video
stores net of closings during fiscal 1998.

  Selling, general and administrative. Selling, general and administrative
expenses were approximately $25,223,000 and $7,883,000, or 16.2% and 8.6% of
total revenues for fiscal 1998 and 1997, respectively. The increase of
$17,340,000 was primarily due to the following significant charges the Company
recorded during the fourth quarter of 1998: (i) a $3,546,000 non-cash, non-tax
deductible charge to compensation expense related to the release of 1,170,000
shares of Class B common stock from escrow (see Note 12 "Stockholders' Equity"
of the Notes to Consolidated Financial Statements); (ii) a $7,161,000 charge
consisting of a $3,236,000 non-cash charge relating to the restated employment
agreements for the Company's Chief Executive Officer and its President,
representing amounts to be applied to their existing stock option related loan
obligations and $3,925,000 to be used by the executives primarily to pay
income taxes arising from the stock option related transaction; and (iii)
$700,000 for previously capitalized bank fees related to the Company's
previous Revolving Credit Facility which was repaid prior to its maturity.

  Cost of product sales. Cost of product sales was approximately $9,809,000
and $3,705,000, or 6.3% and 4.0% of total revenues for fiscal 1998 and 1997,
respectively. The cost of product sales as a percentage of total product sales
revenue was approximately 57.4% and 47.8% for fiscal 1998 and 1997,
respectively. The increase in the cost of product sales as a percentage of
total product sales was primarily the result of a different mix of products
sold in video stores acquired which generally provided smaller margins and
lower rebates from concession vendors.

  Amortization of goodwill. Amortization of goodwill was approximately
$2,353,000 and $1,613,000, or 1.5% and 1.8% of total revenues for fiscal 1998
and 1997, respectively. The increase of $740,000 was primarily

                                      21
<PAGE>

attributable to the increase in goodwill associated with the Company's
continuing acquisitions of video stores in the 1998 fiscal year and prior
periods and the related amortization thereof.

  Interest expense. Interest expense was approximately $4,292,000 and
$892,000, or 2.8% and 0.9% of total revenues for fiscal 1998 and 1997,
respectively. The increase of $3,400,000 was primarily attributable to
interest on borrowings under the Company's bank line of credit.

  Other income (expense). Other income (expense) was approximately $(71,000)
and $461,000, or (0.0)% and 0.5% of total revenues for fiscal 1998 and 1997,
respectively. The expense increase of $532,000 was primarily attributable to
Moovies acquisition expenses and lower interest income.

Liquidity and Capital Resources

  The Company has funded its operations through cash from operations, the
proceeds of prior equity and debt offerings, borrowings under bank facilities,
trade credit and equipment leases. The Company's principal capital
requirements are for the purchase of rental inventory, payments related to
approximately 70 store closings, payments related to aged accounts payable,
payments of interest and principal related to the Senior Facility (as herein
defined) and the Ingram Note (as herein defined).

  At April 30, 1999, the Company had cash and cash equivalents of
approximately $1,235,000. The Company uses an unclassified balance sheet in
its financial statements, and as a result, does not classify its assets or
liabilities as current or non-current. If the Company were to use a classified
balance sheet, a portion of videocassette rental inventories would be
classified as non-current because they are not assets that are reasonably
expected to be completely realized in cash or sold in one year. The
acquisition cost of these inventories, however, would be reflected in current
liabilities. The Company believes that classification of videocassette rental
inventories as non-current assets would be misleading because it would not
indicate the level of assets expected to be converted into cash in the next
year as a result of rentals or sales of these videocassettes.

  For the year ended April 30, 1999, net cash provided by operating activities
was approximately $60,555,000. Net cash used in investing activities was
approximately $71,263,000, consisting primarily of approximately $12,962,000
for new and remodeled stores as well as the conversion of the Moovies stores,
and approximately $63,060,000 for the purchase of video and game rental
inventory for existing, new stores, and additional Moovies rental inventory.
Net cash generated from financing activities was approximately $11,264,000.

  In March 1998 the Company completed the acquisition of Moovies, Inc. The
Company issued approximately 9.3 million shares of Class A Common Stock in
exchange for Moovies common stock. The transaction was treated as a tax-free
exchange for federal income tax purposes and recorded under the purchase
method of accounting.

  Simultaneous with the closing of the Moovies transaction, the Company
announced that a syndicate led by Banque Paribas had extended it a $120
million senior credit facility (the "Senior Facility"). This Senior Facility
replaced the Company's previous line of credit. The Senior Facility consisted
of the following: (i) two term loans totaling $95 million; (ii) a $15 million
capital expenditure line; and, (iii) a $10 million revolving line. The Company
borrowed the $95 million of the two term loans in conjunction with the closing
of the merger and the proceeds were used to: (i) refinance approximately
$35,000,000 of outstanding indebtedness including accrued interest under the
Company's previous line of credit; (ii) refinance approximately $50,000,000 of
indebtedness of Moovies under Moovies' previous credit agreement; and (iii)
pay transaction fees and expenses relating to the Merger of approximately
$10,000,000, (including legal fees, accounting fees, and registration fees).
The capital expenditure line was primarily available to fund the conversion of
the acquired Moovies stores and integration costs, the opening of new stores
and selected acquisitions.

  During the second quarter of fiscal 1999, the Company and the bank syndicate
amended the terms of the Senior Facility to, among other things: (i) reduce
the Senior Facility from $120 million to $115 million; (ii) revise

                                      22
<PAGE>

certain financial covenants; (iii) modify the terms of the capital expenditure
line to allow usage for working capital needs; (iv) increase the overall
interest rate by 0.5%; (v) add consent fees of $600,000 payable August 12,
1998 and $575,000 payable on August 12, 1999; and (vi) reprice warrants held
by the bank syndicate to a more current market price. During the third quarter
of fiscal 1999, the Company and the bank syndicate amended the terms of the
Senior Facility to, among other things; (i) permit a sale-leaseback
transaction; (ii) defer the January 31, 1999 principal payments to March 12,
1999; and (iii) increase the overall interest rate by 0.25%. During the fourth
quarter of fiscal 1999, the Company and the bank syndicate amended the terms
of the Senior Facility to, among other things; (i) defer the March 12, 1999
principal payments to May 31, 1999; (ii) revise certain financial covenants;
and (iii) add a consent fee of $57,500 due on April 30, 1999 and May 15, 1999.
As of April 30, 1999, the Company had $15 million outstanding under the
capital expenditure line and $5 million outstanding under the revolving line
both of which are available to fund working capital needs. As of April 30,
1999 the Company had no further borrowing capacity available under its Senior
Facility.

  Effective May 28, 1999, the Company and the bank syndicate amended the terms
of the Senior Facility to, among other things; (i) increase the overall Senior
Facility with a new tranche of C Term loans in the aggregate amount of $10.5
million maturing June 2006, and bearing 12% interest; (ii) revise certain
financial covenants; (iii) revise and defer certain principal payments; (iv)
increase the overall interest rate by 0.75%; and (v) reflect the issuance of
7,481,250 warrants at $0.8719 per share expiring June 2006. The Company is
using proceeds of the new C Term loans for, among other things, the purchase
of rental inventory, payments related to expected store closings, trade
payables, and debt service. The Company believes that its relationship with
the Senior Facility lenders is satisfactory and that it would be able to
obtain any necessary waivers, amendments or modifications to the Senior
Facility if the Company's operating performance causes it to fall short of
certain financial covenants in the Senior Facility, although no assurances can
be given. If the Company is unable to maintain such a level of operations, it
will be required to reduce its overall expenditures and expansion plans to
comply with the covenants and requirements of the Senior Facility.
Additionally, any failure by the Company to maintain its level of operations
within the covenants and requirements of the Senior Facility could cause the
Company to be in default thereunder, allowing the lenders to take legal action
against the Company, including but not limited to, the immediate acceleration
of payment of borrowed funds, which could materially and adversely affect the
Company's operations. The immediate acceleration of debt thereunder or the
lack of further borrowing capacity, in whole or in part, would have a material
adverse effect on the Company's operations and financial condition.

  Amounts borrowed under the Senior Facility bear interest at variable rates
based on the "base rate" (i.e., the higher of the federal funds rate, plus 1/2
of 1% or the prime commercial lending rate) or the inter-bank Eurodollar rate
(approximately 7.75% and 4.99% per annum, respectively as of April 30, 1999)
plus an applicable margin rate that could range from .5% to 4.50%. Amounts
currently outstanding at April 30, 1999 had a weighted average rate of 9.33%.

  The Senior Facility includes negative, affirmative and financial covenants
including, but not limited to, minimum free cash flow, consolidated
indebtedness to consolidated free cash flow, maximum leverage, minimum fixed
charge coverage, a prohibition or restriction on capital expenditures, debt
and guarantees, liens and encumbrances on any property, mergers,
consolidations, investments, advances, divestitures, change of business or
conduct of business, joint ventures, partnerships, the creation of new
subsidiaries, dividends, distributions, repurchases or redemptions of
outstanding stock (including options or warrants), the voluntary prepayment,
repurchase redemption or defeasance of debt, and the acquisition, sale or
transfer, lease or sale-leaseback of assets. The Senior Facility is secured by
substantially all of the Company's assets as well as by pledges of its stock
in its subsidiaries, which subsidiaries also have provided guarantees of the
Company's obligations.

  Also in May 1999, the Company issued Ingram Entertainment Inc., a supplier
of rental inventory ("Ingram"), a $14,000,000 subordinated promissory note in
respect of outstanding trade payable amounts from the Company. The note (the
"Ingram Note") bears interest at a rate of 12% per annum with principal and
interest payable monthly over three years. Simultaneous with the issuance of
the Ingram Note, the Company issued

                                      23
<PAGE>

Ingram warrants to purchase 1,000,000 shares of Class A Common Stock, at the
then market price of $0.81 per share, which warrants expire May 2004.

  In November 1998, the Company entered into a sale/leaseback arrangement with
respect to certain of its furniture, fixtures, equipment and signage used in
selected retail locations. Under the arrangement the Company obtained
approximately $5 million.

  During fiscal 2000, the Company is proceeding with actions intended to
enhance prospects for revenue growth and profitability including the closing
of approximately 70 identified under-performing locations; and the continued
pursuit of additional direct revenue sharing arrangements with motion picture
studios. The Company continues to evaluate opportunities to reduce costs and
improve revenues. The Company has maintained a longstanding and satisfactory
relationship with its primary product vendors and has negotiated extended
payment terms with several of these vendors. The loss of its primary product
vendors could have a material adverse effect on the Company. The Company will
continue to focus on reducing the aged accounts payable with payments, the
extension of terms, and negotiated settlements. If the Company is unable to
reduce the aged accounts payable to the satisfaction of the trade creditors,
it could have a material adverse effect on the Company. Assuming the Company
is able to maintain a satisfactory relationship with its selected vendors, its
bank lenders, and its trade creditors, the Company expects that cash from
operations, trade credits, equipment leases, available revenue sharing
arrangements, and available borrowings under the Senior Facility will be
sufficient to fund future inventory purchases and other working capital needs
for the next twelve months, although no assurances can be given that the
Company will not require additional sources of financing as a result of
disappointing operating results, or unanticipated cash needs or opportunities.
Moreover, no assurances can be given that such additional funds will be
available on satisfactory terms, if at all. If the Company is unable to obtain
such additional financing, the Company may be required to reduce its overall
expenditures and the Company's ability to maintain or expand its current level
of operations could be materially and adversely affected.

  Each of Messrs. Potter and Bedard have issued notes to the Company (the
"Recourse Notes") in connection with stock option exercises, for approximately
$2,080,147 and $1,155,637, respectively, including accrued interest through
April 30, 1998. In fiscal 1999, the Recourse Notes accrued additional interest
of $147,097 and $81,721 for a total Recourse Note balance of $2,227,244 and
$1,237,358 for Messrs. Potter and Bedard, respectively. The Recourse Notes
were issued by the executives upon their exercise in August 1995 of 420,000
options granted to them under the Stock Option Plans in May 1995 at an
exercise price of $4.3125, the fair market value of the stock on the date the
options were granted. The Recourse Notes represent the total exercise price of
such options plus amounts advanced by the Company to such executives to
satisfy then anticipated tax liabilities. The Recourse Notes, which provide
for full recourse against the respective officer's personal assets and Company
stockholdings, are evidenced by promissory notes bearing accrued interest at a
rate of 8% per annum with payment of principal and interest due on October 4,
1999. In the event that the obligors sell shares of the Company's stock, the
net proceeds thereof will be applied to payment, in part or in full, of the
Recourse Notes.

  In connection with the restated employment agreements for Mr. Potter and Mr.
Bedard, the Board has approved an accrual of bonuses that will be directed
primarily to satisfying obligations arising from the Recourse Notes. For
fiscal year 1998, bonus payments aggregating $816,580 were awarded as
reimbursement of previous payments of principal and interest on the Recourse
Notes and accompanying tax liability to the recipients. In addition, the Board
has approved the subsequent payment of additional aggregate bonuses of
approximately $6,345,000 to be used primarily to satisfy the Recourse Notes,
as well as the anticipated income tax liabilities to the executives subject to
any required approvals. In fiscal 1999, the Company accrued an additional
bonus of $458,000 to be used to satisfy the fiscal 1999 accrued interest
related to the Recourse Notes as well as the anticipated income tax
liabilities to the executives subject to any required approvals. If such
bonuses are not effected, the Recourse Notes will remain outstanding.

  The Company generally does not offer lines of credit or guarantees for the
obligations of its franchisees, although on occasion, the Company has made
short-term loans to current franchisees. The Company intends to

                                      24
<PAGE>

evaluate the possibility of providing loans or limited guarantees for certain
franchisee obligations, which in the aggregate are not expected to be material
to the Company's financial condition.

  Substantially all Company-owned stores are in leased premises, except for
three stores that are located on premises owned by the Company. The Company
expects that most future stores will occupy leased premises.

  This Annual Report on Form 10-K contains a number of forward looking
statements. Any statements contained herein (including without limitation
statements to the effect that the Company or its management "believes,"
"expects," "anticipates," "plans" and similar expressions) that are not
statements of historical fact should be considered forward looking statements.
There are a number of important factors that could cause the Company's results
to differ materially from those indicated by such forward looking statements.
These factors include, without limitation, the following:

 Cash Requirements

  As a result of the one-time charges recorded by the Company and its
operating results for the prior quarters, the Company was not in compliance
with certain of the financial covenants of its Senior Facility. Although the
Company has obtained previous waivers, no assurances can be given that future
waivers or amendments will be obtained if the Company is unable to maintain a
level of operations necessary to meet the covenants and requirements of the
Senior Facility. If the Company is unable to maintain such a level of
operations, it will be required to reduce its overall expenditures and
expansion plans to comply with the covenants and requirements of the Senior
Facility. Additionally, any failure by the Company to maintain its level of
operations within the covenants and requirements of the Senior Facility could
cause the Company to be in default thereunder, allowing the lenders to take
legal action against the Company, including, but not limited to, the immediate
acceleration of payment of borrowed funds, which could materially and
adversely affect the Company's operations. The immediate acceleration of debt
thereunder or the lack of further borrowing capacity, in whole or in part,
would have a material adverse effect on the Company's operations and financial
condition.

  During fiscal 2000, the Company is proceeding with actions intended to
enhance prospects for revenue growth and profitability including the closing
of approximately 70 under-performing locations; and the continued pursuit of
additional direct revenue sharing arrangements with motion picture studios,
which arrangements allow the Company to provide additional copies of rental
titles. The Company continues to evaluate opportunities to reduce costs and
improve revenues. The Company has maintained a longstanding and satisfactory
relationship with its primary product vendors and has negotiated extended
payment terms with several of these vendors. The loss of its primary product
vendors could have a material adverse effect on the Company. The Company will
continue to focus on reducing the aged accounts payable with payments, the
extension of terms, and negotiated settlements. If the Company is unable to
reduce the aged accounts payable to the satisfaction of the trade creditors,
it could have a material adverse effect on the Company. The Company's
principal capital requirements are for the purchase of rental inventory,
payments related to approximately 70 store closings, payments related to aged
accounts payable, payments of interest and principal related to the
credit/term loan facility (the "Senior Facility") and the Ingram Entertainment
Inc. note, and potential acquisitions that fit its growth strategies. Assuming
the Company is able to maintain a satisfactory relationship with its selected
vendors, its bank lenders, and its trade creditors, the Company expects that
cash from operations, trade credits, equipment leases, available revenue
sharing arrangements, and available borrowings under the Senior Facility will
be sufficient to fund future inventory purchases and other working capital
needs for the next 12 months, although no assurances can be given that the
Company will not require additional sources of financing as a result of
disappointing operating results, or unanticipated cash needs or opportunities.
Moreover, no assurances can be given that such additional funds will be
available on satisfactory terms, if at all. If the Company is unable to obtain
such additional financing, the Company may be required to reduce its overall
expenditures and the Company's ability to maintain or expand its current level
of operations could be materially and adversely affected.

                                      25
<PAGE>

 Fluctuations in Quarterly Operating Results

  The Company has experienced in the past, and may continue to experience in
the future, fluctuations in its quarterly operating results. No assurance can
be given that the Company will have positive earnings in any quarter, or that
earnings in any particular quarter will not fall short of either a prior
fiscal quarter or investors' expectations. Factors such as the number of new
store openings (newer stores generally are less profitable than mature
stores), public acceptance and interest in new release titles, weather
(particularly on weekends and holidays), the mix of products rented and sold,
pricing actions of competitors, special or unusual events affecting retailers
in general, the level of advertising and promotional expenses, seasonality,
and one-time charges associated with acquisitions or other events could
contribute to quarterly variability in operating results. In addition, the
Company's expense levels are based in part on expectations of future sales
levels, and a shortfall in expected sales could therefore result in a
disproportionate decrease in net income.

 Significant Future Charges to Earnings Arising from Amortization of Goodwill

  At April 30, 1999, the Company had approximately $77,715,000 of goodwill on
its balance sheet that resulted primarily from the acquisition of video rental
stores, which will be amortized over 20 years. The Company expects that its
operating results for future quarters over the next 20 years will reflect
quarterly, non-cash charges of approximately $1,068,000 for amortization of
goodwill from these acquisitions. The Company also anticipates that future
acquisitions will involve the recording of a significant amount of goodwill on
its balance sheet, which will be amortized over varying periods of time of up
to 20 years.

 Competition

  The video rental industry is highly competitive. The Company competes with
other video retail stores, including Blockbuster and other superstores, and
with supermarkets, pharmacies, convenience stores, bookstores, mass merchants,
mail order operations, vending machines and other retailers, as well as with
noncommercial sources such as libraries. In addition to competing with other
video retailers, the Company competes with other leisure-time activities,
especially entertainment activities such as movie theaters, sporting events,
network television and cable television.

  The Company also competes with other distribution channels for studio
movies, including pay-per-view television on basic cable service, which
currently offer only a limited number of channels and monthly movie
selections. Recently developed digital compression technology combined with
fiber optics and other technology will eventually permit cable companies,
direct broadcast satellite companies and other telecommunications companies to
transmit a much greater number of movies to homes at scheduled intervals
throughout the day. Ultimately, these technologies could lead to the
availability of movies to the consumer on demand. Certain cable and other
telecommunications companies have tested and are continuing to test movie-on-
demand services in some markets.

  The Company and its larger competitors, including Blockbuster, have entered
into direct revenue-sharing arrangements with the major motion picture
studios. Such arrangements could allow these competitors to order and stock a
greater number of new release and other titles, thus increasing competition in
those areas in which each of the Company and its competitors have retail
locations and diminishing the potential benefits of similar revenue sharing
arrangements entered into by the Company, which could have a material adverse
effect on operations. In addition, certain of the Company's larger, better
capitalized competitors may seek to acquire some of the same video specialty
stores that the Company seeks to acquire. Such competition for acquisitions
would likely increase acquisition prices and related costs and result in fewer
attractive acquisition opportunities, which could have a material adverse
effect on the Company's growth.

  The Company's franchise operations compete with numerous franchise
operations in many industries that have significantly greater financial and
human resources and more experience in selling franchises than does the
Company. Potential franchisees may believe that these franchisers offer
greater opportunities for success than the Company.

                                      26
<PAGE>

 Expansion

  The Company currently intends to focus on maximizing the operating
efficiencies of existing locations and on opening a very limited number of new
stores in selected locations rather than aggressively expanding new
superstores in additional metropolitan areas where it does not presently have
locations. Expansion is, and is expected to remain, dependent on a number of
factors, including cash flow, the availability of bank and other financing
resources, the ability to hire, train, retain and assimilate competent
management and store-level employees, the ability to identify new markets in
which it can successfully compete, to locate suitable superstore sites and
negotiate acceptable lease terms and to adapt its purchasing, management
information and other systems to accommodate expanded operations. Expansion is
also dependent on the timely fulfillment by landlords and others of their
contractual obligations, the maintenance of construction schedules and the
speed at which local zoning and construction permits can be obtained. No
assurance can be given that the Company will be able to undertake any
substantial near-term expansion with new superstores or that such expansion,
if possible, will be profitable. Any expansion, including growth through
acquisitions, will place increasing pressure on the management controls of the
Company. No assurance can be given that the Company's new stores will achieve
sales or profitability comparable to its existing stores.

 Possible Adverse Effect of New Technologies on the Video Rental Business

  The Company also currently competes with pay-per-view cable television
systems. Recently developed digital compression technology combined with fiber
optics and other technology will eventually permit cable companies, direct
broadcast satellite companies and other telecommunications companies to
transmit a much greater selection of movies to homes at scheduled intervals
throughout the day. Ultimately, these technologies could lead to the
availability of movies-on-demand to the consumer. Certain cable and other
telecommunications companies have tested and are continuing to test movie on
demand services in some markets. Technological advances could have a material
adverse effect on the business of the Company.

 Changes in Studio Distribution and Pricing

  Changes in the manner in which movies are marketed by the studios that
produce them, primarily related to an earlier release of movie titles to
alternative distribution channels, could substantially decrease the demand for
video rentals, which could have a material adverse effect on the Company's
financial condition and results of operations. In addition, changes in the
movie studios' wholesale pricing structure for videos could result in a
competitive disadvantage for all video specialty stores, including those of
the Company.

 Supply Relationships

  In addition to traditional inventory purchasing, the Company has entered
into direct license revenue-sharing agreements with major motion picture
studios. Under the terms of the agreements, the Company can choose titles that
it wants and may obtain them directly from the studios, although the Company
remains able to obtain the titles through regular distribution channels on a
title by title basis. For each title obtained, the Company will share the
greater of an agreed-upon percentage of the rental revenue or dollar amount
per rental transaction, which percentage declines over a period of weeks
following the release of the title for video rental. The Company was obtaining
titles under these agreements during fiscal 1999 and is aggressively pursuing
additional direct licensing revenue-sharing agreements with other studios,
although no assurances can be given that such agreements will be obtained.

  The Company believes that such revenue-sharing agreements could be a cost-
effective source for larger orders of an individual title, particularly new
release titles. Such agreements enable The Company to order larger quantities,
two to five times the normal order, of copies of a particular title to satisfy
customer demand than could be cost-effective if the copies were purchased for
rental. To obtain the full benefits of such revenue sharing agreements, the
Company must correctly identify the new release and other titles that it
should offer in each location on this basis. No assurances can be given that
the Company will be able to use such revenue sharing agreements to obtain its
intended results.

                                      27
<PAGE>

 Consumer Acceptance of New Release Movie Titles

  The Company depends significantly on availability and consumer acceptance of
new release video titles available for rental. To the extent that available
new release titles fail to stimulate consumer interest and retail traffic,
operating results could be materially adversely affected.

 Management of Growth

  The Company's business, including sales, number of stores and number of
employees, has grown dramatically over the past several years. In addition,
the Company has consummated a number of significant acquisitions in the last
few years, and may make additional acquisitions in the future. This internal
growth, together with the acquisitions made, have resulted in integration
costs and placed significant demand on the Company's management and
operational systems. To manage its growth effectively, the Company will be
required to continue to upgrade its operational and financial systems, expand
its management team and increase and manage its employee base.

 Seasonality and Other Factors

  The Company's business is somewhat seasonal, with revenues in April, May,
September and October generally lower than in other months of the year. Future
operating results may be affected by many factors, including variations in the
number and timing of store openings and acquisitions, weather (particularly on
weekends and holidays), the public acceptance of new release titles available
for rental, competition, marketing programs, special or unusual events and
other factors that may affect retailers in general. Revenues may be reduced
temporarily if viewers prefer to watch such events rather than rent
videocassettes. Also, any concentration of new superstore openings and the
related pre-opening costs in any particular fiscal quarter could have a
material adverse effect on the Company's operating results for that quarter.

 Year 2000 Compliance

  The year 2000 ("Y2K") issue is the result of computer programs that were
written using two digits rather than four to define the applicable year. For
example, computer programs that have time-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. To the extent that
the Company's (and its vendors' and suppliers') software applications contain
source code that is unable to interpret appropriately the upcoming calendar
year 2000 and beyond, some level of modification or replacement of such
applications will be necessary to avoid system failures and the temporary
inability to process transactions or engage in other normal business
activities.

  The Company's information services group has been coordinating the Company's
internal Y2K compliance efforts and has identified all computer-based systems
and applications (including embedded systems) the Company uses in its
operations that might not be Y2K compliant. The Company is determining what
modifications or replacements will be necessary to achieve compliance;
implementing any necessary modifications and replacements; conducting tests
necessary to verify that the modified systems are operational; and
transitioning the compliant systems into the regular operations of the
Company. The Company estimates that these actions with respect to systems that
it believes would have a material effect on the business are approximately 80%
complete. The Company estimates that all critical systems and applications
will be Y2K ready by September 1999.

  The Company is also examining its relationship with certain key outside
vendors, suppliers, and others with whom the Company has significant business
relationships to determine, to the extent practical, the degree of such
outside parties' Y2K compliance. The Company has been contacting such outside
parties and attempting to seek assurances that such parties will be Y2K
compliant. The Company does not believe that its relationship with any single
third party is material to the Company's operations and, therefore, does not
believe that the failure of any single third party to be Y2K compliant would
have a material adverse effect on the Company. The Company believes that if
it, or any third party with whom the Company has a significant business
relationship, has a Y2K

                                      28
<PAGE>

related systems failure, the most significant impact would likely be the
inability, with respect to a store or group of stores, to conduct operations
due to a power failure, to deliver inventory in a timely fashion, to receive
certain products from vendors or to process electronically customer sales at
the store level. The Company does not anticipate that any such impact would be
material to the Company's liquidity or results of operations.

  The Company is establishing and implementing a contingency plan to provide
for viable alternatives to ensure that the Company's core business operations
are able to continue in the event of a Y2K related systems failure. The
Company expects to have a comprehensive contingency plan established by
October 1999. If the Company's systems are not sufficiently Y2K ready by the
end of calendar year 1999 or if the Company does not have an appropriate
contingency plan in place at that time, the Company's business, financial
condition and results of operations may be materially and adversely affected.
Such adverse effects may include, but may not be limited to, the ability to
manage store operations, collect revenues from customers, supply stores with
inventory, make payments to vendors and suppliers, remit wages to employees,
and conduct other essential business-related activities.

  Through April 30, 1999, the Company has expended approximately $1,386,600 to
address Y2K compliance issues. The Company estimates that it will incur an
additional $1,269,000 for a total of approximately $2,655,600 to address Y2K
issues, which includes the estimated costs of all modifications, testing and
consultant fees. Y2K costs will be funded through cash from operations and
available borrowings under the Senior Facility.

 Franchise Sales

  The sale of franchises is regulated by various state laws as well as by the
Federal Trade Commission (the "FTC"). The FTC requires that franchisors make
extensive disclosure to prospective franchisees but does not require
registration. A number of states require registration or disclosures in
connection with franchise offers and sales. In addition, several states have
"franchise relationship laws" or "business opportunity laws" that limit the
ability of franchisors to terminate franchise agreements or to withhold
consent to the renewal or transfer of these agreements. Although the
franchising operations are not materially adversely affected, to date, by such
existing regulations, the management of the Company cannot predict the effect
any future legislation or regulation may have on its business operations or
financial condition.

 Dependence on Key Personnel

  The Company's future success depends to a significant extent on the
continued contributions of Daniel A. Potter, the Company's Chairman and Chief
Executive Officer, and John M. Bedard, the Company's President. The loss of
the services of either of these officers could have a material adverse effect
on the Company. The Company's continued growth and profitability also depends
on its ability to attract, motivate, and retain other management personnel,
including qualified store managers. No assurance can be given that the Company
will be successful in attracting, motivating and retaining such personnel.

 Retention of Employees

  The success of the Company will depend in part upon the retention of key
employees. Competition for qualified personnel in the video rental industry is
very intense. Stock options, which generally become exercisable only over a
period of several years of employment, serve as an important incentive for
retaining key employees. Although the Company is engaged in ongoing efforts to
retain key employees, retaining such employees may be more difficult in the
future.

 Anti-takeover Effects; Shareholders' Rights Plan; Delaware Law and Certain
   Charter and Bylaw Provisions; Preferred Stock

  The Company's Board of Directors has the authority to issue up to five
million shares of Preferred Stock and to determine the price, rights,
preferences and privileges of those shares without any further vote or action

                                      29
<PAGE>

by the stockholders. The rights of the holders of Class A Common Stock will be
subject to, and may be adversely affected by, the rights of the holders of any
shares of Preferred Stock that may be issued in the future. The issuance of
Preferred Stock could have the effect of making it more difficult for a third
party to acquire a majority of the outstanding voting stock of the Company,
thereby delaying, deferring or preventing a change of control of the Company.
In addition, certain provisions in the Company's Certificate of Incorporation
and Bylaws containing restrictions on calling special meetings of stockholders
and restrictions on amendments to the Bylaws may discourage or make more
difficult any attempt by a person or group of persons to obtain control of the
Company.

  The Company is subject to the anti-takeover provisions of Section 203 of the
Delaware General Corporation Law. In general, the statute prohibits a publicly
held Delaware corporation from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder, unless the
business combination is approved in a prescribed manner. For purposes of
Section 203, a "business combination" includes a merger, asset sale or other
transaction resulting in a financial benefit to the interested stockholder,
and an "interested stockholder" is a person who, together with affiliates and
associates, owns (or within three years prior, did own) 15% or more of a
corporation's voting stock.

  In addition, options issued pursuant to the Company's stock option plans
generally will vest immediately upon a change in control as described in the
option grant letters.

  In April 1998, the Company's Board of Directors adopted a Rights Agreement
(the "Rights Agreement"). Under the Rights Agreement, a dividend of one right
("Right") to purchase a fraction of a share of newly created series of
preferred stock, was declared for each share of Class A Common Stock and each
Class B Warrant outstanding at the close of business on April 24, 1998. The
Rights, which expire on April 24, 2008, may be exercised only if certain
conditions are met, such as the acquisition (or the announcement of a tender
offer the consummation of which would result in the acquisition) of a
beneficial ownership of 15 percent or more of the Class A Common Stock by a
person or affiliated group. The Rights, if exercised, would cause substantial
dilution to a person or group of persons that attempts to acquire the Company
without the prior approval of the Board of Directors. The Board of Directors
may cause the Company to redeem the Rights for nominal consideration. The
Rights Agreement may discourage or make more difficult any attempt by a person
or group of persons to obtain control of the Company.

 Volatility of Stock Price

  The market price of the Company's Class A Common Stock has been, and may
continue to be, extremely volatile. In addition, prices of stocks of most
companies in the video store industry (including Video Update) have been
subject to a generally declining trend for approximately the past 36 months.
Factors such as new product announcements by the Company or its respective
competitors, new digital technologies such as near-video-on-demand and video-
on-demand, quarterly fluctuations in operating results, challenges associated
with integration of businesses, and general conditions in the data networking
market may have a significant impact on the market price of Video Update Class
A Common Stock. These conditions, as well as factors which generally affect
the market for stocks of retail companies, could cause the price of Video
Update Class A Common Stock to fluctuate substantially.

  The Company has been notified by the NASDAQ National Market that its Class A
Common Stock is subject to delisting based on the Company's failure to meet
certain maintenance criteria including minimum bid price requirements. The
Company has provided information to NASDAQ as it makes its decision in this
matter. For continued listing, the Company will have to demonstrate to the
satisfaction of NASDAQ that it can regain compliance with these particular
deficiencies and maintain long term compliance with all applicable maintenance
criteria. The Company presented its plan for continued compliance, which
includes provisions for a possible reverse stock split of the Company's Class
A Common Stock. The NASDAQ decision on delisting will be rendered after
consideration of the entire record presented by the Company. Their decision
may be entered and

                                      30
<PAGE>

effected immediately. No assurances can be given that there will be a
favorable NASDAQ ruling, nor that the Company will be in compliance with other
NASDAQ National Listing requirements or that its Class A Common Stock will
continue to be listed on NASDAQ National Market. In the event of any
delisting, the Company expects that its Class A Common Stock would immediately
be eligible to trade on NASDAQ's OTCBB ("Over-the-Counter Bulletin Board").

 Inflation

  To date, inflation has not had a material effect on the Company's business.
The Company anticipates that its business will be affected by general economic
trends. Although the Company has not operated during a period of high
inflation, it believes that it would generally be able to pass increased costs
resulting from inflation on to customers.

 Recently Issued Accounting Standards

  In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income" which was adopted by the Company beginning May 1, 1998. SFAS 130
requires the reporting of comprehensive income and its components in the
general-purpose financial statements. This Statement also requires that an
entity classify items of other comprehensive income by their nature in the
annual financial statement. The Company has disclosed this information in its
Consolidated Financial Statement of Shareholders' Equity.

  In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information" which
was adopted by Video Update in fiscal 1999. SFAS 131 redefines how operating
segments are determined and requires disclosure of certain financial and
descriptive information about a company's operating segments. The Company has
concluded that the current reportable segments are consistent with the
"management approach" methodology outlined in SFAS 131.

  In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" which is
effective for the Company in fiscal year 2001. SFAS No. 133 requires companies
to record derivatives on the balance sheet as assets or liabilities, measured
at fair value. Gains or losses resulting from changes in the values of those
derivatives would be accounted for depending on the use of the derivatives and
whether it qualifies for hedge accounting. Video Update is currently reviewing
the standard and its effect on the financial statements.

  In 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" which is effective for fiscal
years beginning after December 15, 1998. Management believes the adoption of
SOP 98-1 will not have a material effect on the Company's financial
statements.

  In 1998, the American Institute of Certified Public Accountants issued SOP
98-5, "Reporting on the Costs of Start-up Activities" which is effective for
fiscal years beginning after December 15, 1998. This SOP requires that
companies expense start-up costs and organizational costs as they are
incurred. Management believes the adoption of SOP 98-5 will not have a
material effect on the Company's financial statements.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

  The Company is subject to interest rate risk associated with its debt
instruments. The market risk inherent in the Company's debt instruments
represents the increased interest costs arising from adverse changes in
interest rates (primarily LIBOR and prime bank rates). The Company is party to
financial instruments with off-balance-sheet risk which are entered into in
the normal course of business to meet its financing needs and to manage its
exposure to fluctuations in market rates. These financial instruments include
swap agreements and interest rate caps. The instruments involve, to a varying
degree, elements of credit and market risk in addition to amounts recognized
in the financial statements. The Company does not hold or issue financial
instruments for trading purposes (see Note 16 of the Notes to Consolidated
Financial Statements).

                                      31
<PAGE>

  The Company operates internationally in Canada, and thus is subject to
potentially adverse movements in foreign exchange currency rate changes. The
Company does not enter into foreign exchange forward contracts to reduce its
exposure to foreign currency rate changes on inter-company foreign currency
denominated balance sheet positions. Historically, the effect of movements in
the exchange rates have been immaterial to the consolidated operating results
of the Company.

Item 8. Financial Statements and Supplementary Data

  The following financial statements are filed as part of this report.

<TABLE>
<CAPTION>
                                                                          Page
                                                                          ----
   <S>                                                                    <C>
   Reports of Independent Auditors.......................................  F2
   Consolidated Balance Sheets as of April 30, 1998 and 1999.............  F4
   Consolidated Statements of Operations for the years ended April 30,
    1997, 1998 and 1999..................................................  F5
   Consolidated Statements of Stockholders' Equity for the years ended
    April 30, 1997, 1998 and 1999........................................  F6
   Consolidated Statements of Cash Flows for the years ended April 30,
    1997, 1998 and 1999..................................................  F7
   Notes to Consolidated Financial Statements............................  F8
</TABLE>

Item 9. Changes in Registrant's Certifying Accountant

  Effective January 28, 1999, the Company retained Deloitte & Touche LLP as
its independent public accountants. On that same date, the Company terminated
the engagement of Ernst & Young LLP as its independent public accountants. The
engagement of Deloitte & Touche LLP was recommended by the audit committee of
the Company's Board of Directors and approved by the Board of Directors (the
"Board").

  The audit reports of Ernst & Young LLP on the Company's financial statements
for each of the past two fiscal years ended April 30, 1997 and 1998 did not
contain an adverse opinion or a disclaimer of opinion and were not qualified
or modified as to uncertainty, audit scope, or accounting principles.

  In connection with the audits of the Company's financial statements for each
of the two fiscal years ended April 30, 1997 and 1998, and in the subsequent
interim period, there were no disagreements between the Company and Ernst &
Young LLP on any matters of accounting principles or practices, financial
statement disclosure, or auditing scope and procedures which, if not resolved
to the satisfaction of Ernst & Young LLP, would have caused it to make
reference to the subject matter of the disagreement in connection with its
reports on the audited financial statements.

  In connection with the audits of the Company's financial statements for each
of the two fiscal years ended April 30, 1997 and 1998, and in the subsequent
interim period, there were no reportable events (as defined in Item 304 of
Regulation S-K) with Ernst & Young LLP. During such periods the Company has
not consulted Deloitte & Touche LLP regarding either (i) the application of
accounting principles to a specified transaction, either completed or
proposed, or the type of audit opinion that might be rendered on the Company's
financial statements or (ii) any matter that was either the subject of a
disagreement or a reportable event (each as defined in Item 304 of Regulation
S-K).

                                      32
<PAGE>

                                   PART III

Item 10. Directors and Executive Officers of the Registrant.

Background

  The Directors and executive officers of the Company, their positions held in
the Company, and their ages are as follows:

<TABLE>
<CAPTION>
                                       Age               Position
       Name                            ---               --------
   <S>                                 <C> <C>
   Daniel A. Potter...................  41 Chairman and Chief Executive Officer
   John M. Bedard.....................  41 President and Director
   Daniel C. Howard...................  38 Chief Operations Officer and Director
   Dale E. Lauwagie...................  40 Chief Financial Officer
   Richard Bedard.....................  45 Executive Vice President
   Michael G. Schifsky................  43 Senior Vice President
   Theodore Coburn....................  46 Director
   Paul M. Kelnberger.................  55 Director
   Bernard R. Patriacca...............  55 Director
</TABLE>

  Each director is elected for a period of one year at the Company's annual
meeting of stockholders and serves until his successor is duly elected by the
stockholders.

  The following is a brief summary of the background of each director,
executive officer, and significant employee of the Company:

  Daniel A. Potter, Chairman and Chief Executive Officer. Mr. Potter co-
founded the Company in 1983 and has served as the Company's Chairman and Chief
Executive Officer since its inception. Mr. Potter holds a B.A. degree from the
University of Minnesota and a J.D. degree from William Mitchell College of
Law. Mr. Potter is a member of the nominating committee.

  John M. Bedard, President and Director. Mr. Bedard co-founded the Company in
1983 with Mr. Potter and has served as the Company's President and as a
Director since its inception. Mr. Bedard, together with Mr. Potter, devised
and implemented the Company's real estate development program and operations.
Mr. Bedard is the brother of Richard Bedard, an Executive Vice President of
the Company.

  Daniel C. Howard, Chief Operations Officer and Director. Mr. Howard has
served as the Company's Chief Operations Officer since 1990, has coordinated
the Company's operations since 1983, and has served as a Director since August
1994. He holds a B.S. degree from the University of Minnesota School of
Management. Mr. Howard is a member of the executive compensation committee.

  Dale E. Lauwagie, Chief Financial Officer. Mr. Lauwagie has served as the
Company's Chief Financial Officer since November 1998. From February 1997 to
November 1998, Mr. Lauwagie served as Vice President of Finance for Mycogen
Corporation ("Mycogen"), a publicly held agricultural and biotechnology
company acquired by Dow Chemical Company in October 1998. From July 1994 to
January 1997, he served as controller of Mycogen. Mr. Lauwagie also served in
various finance related positions from 1986 to 1994 for Burlington Northern,
Inc., a publicly held company involved in railroads, oil and gas, real estate
and minerals. From 1981 to 1986 he was with KPMG Peat Marwick in Minneapolis,
Minnesota, attaining the level of Audit Supervisor. Mr. Lauwagie is a
certified public accountant and holds a B.S. degree in accounting from St.
Cloud State University, Minnesota, and an M.B.A. in finance from the
University of St. Thomas, Minnesota.

  Richard Bedard, Executive Vice President. Mr. Bedard has served as an
Executive Vice President of the Company since September 1995. From 1986 to
1995, he served as the Company's Vice President of Franchise Development. Mr.
Bedard is the brother of John M. Bedard, the Company's President and a
Director.


                                      33
<PAGE>

  Michael G. Schifsky, Senior Vice President. Mr. Schifsky has served as
Senior Vice President since 1998. Mr. Schifsky served as Vice President of
Store Development since rejoining the Company in 1990 until 1998. Mr. Schifsky
has also served as a District Manager of the Company from 1984 to 1988.

  Paul M. Kelnberger, Director. Mr. Kelnberger has served as a Director since
August 1994. Mr. Kelnberger has been a member of Johnson, West & Co., PLC
("Johnson, West & Co."), a certified public accounting firm with its principal
offices in St. Paul, Minnesota, since 1975. In addition, since November 1995
Mr. Kelnberger has served as a Director of Leuthold Funds, a publicly held
mutual fund. Johnson, West & Co. performed auditing services for the Company
prior to the fiscal year ended April 30, 1993. Since that time, Johnson West &
Co. has provided and continues to provide to the Company accounting services
in connection with the Company's acquisitions and sales and use tax planning.
Mr. Kelnberger is a certified public accountant and holds a Certificate of
Accounting from the Academy of Accountancy in Minneapolis, Minnesota. He
chairs the Board's audit committee and is a member of the executive
compensation committee. See "Certain Relationships and Related Transactions."

  Bernard R. Patriacca, Director. Mr. Patriacca has served as a Director since
April 1997. Since November 1997, he has served as the Vice President and
Controller of Summit Technology, Inc., a publicly held developer, manufacturer
and seller of opthalmic laser systems and related products designed to correct
vision disorders. Since 1994, he also has served as Vice President of Errands
Etc., Inc., a privately held homeowner's personal service company. From 1973
to 1991, Mr. Patriacca served in various capacities at Dunkin' Donuts
Incorporated, including Chief Financial Officer and Director. From 1991 to
1994, Mr. Patriacca held senior financial management positions at several
privately held consumer services companies. Mr. Patriacca is a certified
public accountant and holds Bachelor's and Master's degrees in finance and
accounting from Northeastern University. Mr. Patriacca is a member of the
audit committee and executive compensation committee.

  Theodore J. Coburn, Director. Theodore J. Coburn has been a director of the
Company since March 1998. Mr. Coburn served as a director of Moovies, Inc.
from June 1995 to March 1998. Since 1991, Mr. Coburn has been a partner and a
director of Brown, Coburn & Co., an investment banking firm. From 1986 until
1991, he was a Managing Director of Global Equity Transactions Group and a
member of the Board of Directors of Prudential Securities. From 1983 to 1986
Mr. Coburn served as Managing Director of Merrill Lynch Capital Markets. Mr.
Coburn serves as a director of Measurement Specialties, Inc., a publicly held
company and as a director of Ariel Corporation, a publicly held company. Mr.
Coburn also serves as a director of the Nicholas-Applegate Fund, Inc. He also
serves as a director of the Emerging Germany Fund. Mr. Coburn received his
B.S. from the University of Virginia in 1975 and an M.B.A. from Columbia
University Graduate School of Business in 1978 and holds master's degrees from
Harvard University Graduate School of Education and its Divinity School. Mr.
Coburn is a member of the nominating committee.

Section 16(a) Beneficial Ownership Reporting Compliance

  Section 16(a) ("Section 16(a)") of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), requires executive officers and directors, and
persons who beneficially own more than ten percent (10%) of the Company's
Common Stock, to file initial reports of ownership on Form 3 and reports of
changes in ownership on Form 4 with the Securities and Exchange Commission
(the "SEC") and any national securities exchange on which the Company's
securities are registered. Executive officers, directors and greater than ten
percent (10%) beneficial owners are required by SEC regulations to furnish the
Company with copies of all Section 16(a) forms they file.

  Based solely on a review of the copies of such forms furnished to the
Company and written representations from the executive officers and directors
that no other reports were required, the Company believes that during fiscal
1998, its executive officers, directors and greater than ten percent (10%)
beneficial owners complied with all applicable Section 16(a) filing
requirements, except that Mr. Schifsky filed an untimely report on Form 4 on
January 28, 1999 with respect to a purchase of shares, and F. Andrew Mitchell,
a former director of the Company, filed an untimely report on Form 4 on
February 1, 1999 with respect to a sale of shares.

                                      34
<PAGE>

Item 11. Executive Compensation.

Summary Compensation Table

  Set forth below is a Summary Compensation Table concerning the compensation
of the named executive officers for the last three completed fiscal years.

                          Summary Compensation Table

<TABLE>
<CAPTION>
                                                  Annual               Long Term
                                               Compensation           Compensation
                                     -------------------------------- ------------
                                                                         Awards
                                                                      ------------
                                                                       Securities
                         Fiscal Year                     Other Annual  Underlying   All Other
                            Ended     Salary    Bonus    Compensation Options/SARs Compensation
   Name and Principal     April 30    (1)($)    (2)($)      (3)($)       (4)(#)       (5)($)
      Position (A)           (B)       (C)       (D)         (E)          (G)          (I)
   ------------------    ----------- -------- ---------- ------------ ------------ ------------
<S>                      <C>         <C>      <C>        <C>          <C>          <C>
Daniel A. Potter........    1999     $360,000 $  294,195  $      --         --       $28,443
 Chairman and Chief         1998     $300,000 $4,603,665  $1,926,973        --       $26,195
 Executive Officer          1997     $300,000 $      --   $      --     300,000      $26,307

John M. Bedard..........    1999     $240,000 $  163,442  $      --         --       $23,168
 President and Director     1998     $200,000 $2,557,590  $1,557,019        --       $27,934
                            1997     $200,000 $      --   $      --     165,000      $17,952

Daniel C. Howard........    1999     $128,400 $      --   $      --         --       $13,841
 Chief Operations           1998     $ 87,890 $      --   $   62,278        --       $12,673
 Officer                    1997     $ 78,000 $      --   $      --      36,000      $ 8,113

Dale E. Lauwagie........    1999     $ 80,208 $      --   $      --      90,000      $ 8,183
 Chief Financial
 Officer(6)

Stephen L. Reynolds.....    1999     $102,083 $      --   $  313,200        --       $18,082
 Chief Financial            1998     $ 56,539 $      --   $   34,800     40,000      $14,259
 Officer(7)
</TABLE>
--------
(1) Amounts shown indicate cash compensation earned and received by executive
    officers; no amounts were earned but deferred at the election of those
    officers. Executive officers participate in the Company's group health
    insurance plan.
(2) Amounts shown in 1998 reflect the bonus amounts accrued by the Company in
    conjunction with Messrs. Potter and Bedard's restated employment
    agreements. Amounts totaling $524,945 and $291,635 were paid to Messrs.
    Potter and Bedard respectively in fiscal 1998 as reimbursement of previous
    payments of principal and interest on their recourse notes to the Company
    and accompanying tax liabilities. In 1999, the Company accrued bonus
    amounts for Messrs. Potter and Bedard intended to cover their respective
    obligations related to Recourse Notes. See Note 8 of Notes to Consolidated
    Financial Statements.
(3) Amounts for fiscal 1998 reflect the release of 635,755, 513,698 and 20,547
    shares of Class A Common Stock from escrow to Messrs. Potter, Bedard and
    Howard respectively, at the market price on the date of release. The
    amounts shown in fiscal 1998 and fiscal 1999 for Mr. Reynolds represent
    change of control payments as a result of the Moovies acquisition.
(4) Amounts shown reflect grants of options to purchase Class A Common Stock
    pursuant to the Company's Stock Option Plans. During fiscal years 1997
    through 1999, the Company made no awards of restricted stock and did not
    have a long-term incentive plan.
(5) Amounts shown reflect payment for automobile, insurance and other
    expenses. For Mr. Reynolds, the Company was providing housing for fiscal
    1999 and fiscal 1998.
(6) Mr. Lauwagie was appointed Chief Financial Officer of the Company on
    November 16, 1998. Mr. Lauwagie's base salary was set at $175,000. The
    amount of $80,208 represents salary earned through April 30, 1999.
(7) Mr. Reynolds was appointed Chief Financial Officer of the Company on
    January 6, 1998. Mr. Reynolds' base salary was set at $175,000. Mr.
    Reynolds' resigned as Chief Financial Officer of the Company on November
    13, 1998.

                                      35
<PAGE>

Option/SAR Grants in Fiscal Year 1999

  Set forth below is an Option/SAR Grants table concerning individual grants
of stock options and SARs made during the last completed fiscal year to each
of the named executive officers.

<TABLE>
<CAPTION>
                                                                                          Potential Realizable
                                                                                            Value At Assumed
                                                                                            Annual Rates of
                                                                                              Stock Price
                                                                                            Appreciation For
                                                 Individual Grants                           Option Term(1)
                          --------------------------------------------------------------- --------------------
                                                  Percent of Total
                                                    Options/SARs
                           Number of Securities      Granted to    Exercise of
                          Underlying Options/SARs   Employees in   Base Price  Expiration
                                Granted (#)        Fiscal Year(2)    ($/Sh)     Date(3)     5%($)     10%($)
        Name (A)                    (B)                 (C)            (D)        (E)        (F)       (G)
        --------          ----------------------- ---------------- ----------- ---------- --------- ----------
<S>                       <C>                     <C>              <C>         <C>        <C>       <C>
Daniel A. Potter........             --                 --              --           --         --         --
John M. Bedard..........             --                 --              --           --         --         --
Daniel C. Howard........             --                 --              --           --         --         --
Dale E. Lauwagie (4)....          90,000                5.2%         $1.063     11/23/08     60,166    152,473
Stephen L. Reynolds(5)..             --                 --              --           --         --         --
</TABLE>
                     Option/SAR Grants in Fiscal Year 1999
--------
(1) The dollar gains under these columns result from calculations assuming
    hypothetical growth rates as set by the Commission and are not intended to
    forecast future price appreciation of the Class A Common Stock.
(2) In fiscal 1999, options to purchase a total of 174,000 shares of the
    Company's Class A Common Stock were granted to employees of the Company,
    including executive officers.
(3) These options are subject to earlier termination upon certain events
    related to termination of employment.
(4) Mr. Lauwagie was appointed Chief Financial Officer of the Company on
    November 16, 1998.
(5) Mr. Reynolds resigned as Chief Financial Officer of the Company on
    November 13, 1998.

Aggregated Option/SAR Exercises And Fiscal Year-End Option/SAR Value Table

  Set forth below is a table concerning each exercise of stock options (or
tandem SAR's) and freestanding SARs during the last completed fiscal year by
each of the named executive officers and the fiscal year-end value of
unexercised options and SARs.

     Aggregated Option/SAR Exercises for Fiscal Year Ended April 30, 1999
                         and FY-End Option/SAR Values

<TABLE>
<CAPTION>
                                                        Number of
                                                        Securities          Value of
                                                        Underlying        Unexercised
                                                       Unexercised        In-The-Money
                                                       Options/SARs       Options/SARs
                             Shares                 at Fiscal Year-End at Fiscal Year-End
                          Acquired on     Value      (#) Exercisable/   ($) Exercisable/
                          Exercise (#) Realized ($)   Unexercisable     Unexercisable(1)
        Name (A)              (B)          (C)             (D)                (E)
        --------          ------------ ------------ ------------------ ------------------
<S>                       <C>          <C>          <C>                <C>
Daniel A. Potter........      --           --        200,000/100,000          --
John M. Bedard..........      --           --         110,000/55,000          --
Daniel C. Howard........      --           --          77,437/16,063          --
Dale E. Lauwagie(2).....      --           --               0/90,000          --
Stephen L. Reynolds(3)..      --           --               32,813/0          --
</TABLE>
--------
(1) In-the-money options are those options for which the fair market value of
    the underlying Common Stock is greater than the exercise price of the
    option. On April 30, 1999, the fair market value of the Company's Class A
    Common Stock underlying the options (as determined by the last sale price
    quoted on the NASDAQ National Market) was $0.719. None of the options
    listed under column D were in-the-money at Fiscal Year End.
(2) Mr. Lauwagie was appointed Chief Financial Officer of the Company on
    November 16, 1998.
(3) Mr. Reynolds resigned as Chief Financial Officer of the Company on
    November 13, 1998.

                                      36
<PAGE>

Compensation Committee Interlocks and Insider Participation

  Compensation decisions for the Company's Chief Executive Officer and
President are made by the Executive Compensation Committee, comprised of
Messrs. Kelnberger, Howard and Patriacca.

  None of the executive officers of the Company have served on the Board of
Directors or compensation committee of any other entity that has had any of
such entity's executive officers serve either on the Company's Board of
Directors or compensation committee.

  During fiscal 1999, the Company paid approximately $270,000 to Johnson, West
& Co. for accounting services in connection with the Company's acquisitions
and for tax return preparation services. Mr. Kelnberger is a member of
Johnson, West & Co.

Employment Contracts, Termination of Employment, Officer Loans and Change in
Control Arrangements

  In April 1998, the Company entered into restated employment agreements (the
"Employment Agreements") with Daniel A. Potter, its Chairman and Chief
Executive Officer and John Bedard, its President, each of whom also is a
director through April 2001. Mr. Potter and Mr. Bedard are to receive salaries
of $360,000 and $240,000, respectively. Such compensation may be increased and
bonuses may be awarded at the discretion of the Board of Directors of the
Company. Each of Messrs. Potter and Bedard have agreed to devote their full
time and best efforts to fulfill their duties and responsibilities to the
Company. Each of them will be entitled to participate in employee benefit
plans.

  Each of Messrs. Potter and Bedard have issued notes to the Company (the
"Recourse Notes") in connection with stock option exercises, for approximately
$2,080,147 and $1,155,637, respectively, including accrued interest through
April 30, 1998. In fiscal 1999, the Recourse Notes accrued additional interest
of $147,097 and $81,721 for a total Recourse Note balance of $2,227,244 and
$1,237,358 for Messrs. Potter and Bedard, respectively. The Recourse Notes
were issued by the executives upon their exercise in August 1995 of 420,000
options granted to them under the Stock Option Plans in May 1995 at an
exercise price of $4.3125, the fair market value of the stock on the date the
options were granted. The Recourse Notes represent the total exercise price of
such options plus amounts advanced by the Company to such executives to
satisfy then anticipated tax liabilities. The Recourse Notes, which provide
for full recourse against the respective officer's personal assets and Company
stockholdings, are evidenced by promissory notes bearing accrued interest at a
rate of 8% per annum with payment of principal and interest due on October 4,
1999. In the event that the obligors sell shares of the Company's stock, the
net proceeds thereof will be applied to payment, in part or in full, of the
Recourse Notes.

  In connection with the restated employment agreements for Mr. Potter and Mr.
Bedard, the Board has approved an accrual of bonuses that will be directed
primarily to satisfying obligations arising from the Recourse Notes. For
fiscal year 1998, bonus payments aggregating $816,580 were awarded as
reimbursement of previous payments of principal and interest on the Recourse
Notes and accompanying tax liability to the recipients. In addition, the Board
has approved the subsequent payment of additional aggregate bonuses of
approximately $6,345,000 to be used primarily to satisfy the Recourse Notes,
as well as the anticipated income tax liabilities to the executives subject to
any required approvals. In fiscal 1999, the Company accrued an additional
bonus of approximately $458,000 to be used to satisfy the fiscal 1999 accrued
interest related to the Recourse Notes as well as the anticipated income tax
liabilities of the executives subject to any required approvals. If such
bonuses are not effected, the Recourse Notes will remain outstanding.

  Under the Employment Agreements, the Company has a right to terminate each
of the agreements for "cause" as defined in the agreements or as a result of
the employee's disability. Except in the case of termination for cause, upon
early termination of the agreements of the Company, each of Messrs. Potter and
Bedard shall be entitled to receive their salary plus fringe benefits for 36
months from the date of termination. In addition, the Employment Agreements
provide that any amount owed by Messrs. Potter or Bedard to the Company will
be

                                      37
<PAGE>

forgiven (with any necessary payment to cover any resulting tax liability
incurred by such executive) if such executive leaves the Company while his
Recourse Note remains outstanding. In the event of a change of control of the
Company, Messrs. Potter and Bedard have the option to terminate their
employment subject to the provisions of the employment agreements and to
receive severance and fringe benefits for 36 months subject to the provisions
of their agreements. A "change in control" includes an acquisition of 15% of
the voting power of the securities of the Company by any person, certain
changes in the composition of the Board of Directors, and an approval by the
stockholders of the Company of a merger, consolidation, reorganization,
liquidation, dissolution or sale of all or substantially all of the assets of
the Company.

  Each of Messrs. Potter and Bedard has agreed not to disclose any
confidential information of the Company during the term of his employment or
to compete with the Company during the term of his employment or for a period
of three years following termination of his employment except in accordance
with the employment agreement.

  In January 1998, the Company entered into an employment agreement with
Daniel C. Howard, its Chief Operating Officer and a director and stockholder.
As compensation, Mr. Howard is to receive an annual base salary of $128,400,
plus bonuses and stock options as determined by the Board of Directors. The
agreement is for an initial term of two years, and is automatically renewed
for successive one-year terms, unless terminated by the Company or Mr. Howard.
Upon termination in accordance with the agreement, Mr. Howard is entitled to
receive severance pay of at least 12 months' base salary and at most 24
months' base salary, less certain amounts provided in the agreement. In the
event Mr. Howard's employment is terminated after a change in control,
Mr. Howard is entitled to receive an amount equal to two times his average
total annual compensation during the two years preceding the termination. A
"change in control" occurs when any person or entity acquires at least 51% of
the voting power of the securities of the Company, the stockholders of the
Company approve a plan of liquidation, or the Company engages in a merger,
sale of assets or other business combination that results in the security
holders of the Company holding less than a majority of the combined voting
power after the transaction. Mr. Howard has agreed not to disclose any
confidential information of the Company during his employment and thereafter,
and not to compete with the Company during his employment and for two years
thereafter, including soliciting customers and employees of the Company.

  In April 1999, the Company entered into employment agreements with Michael
G. Schifsky, Senior Vice President, and Richard Bedard, Executive Vice
President. As compensation, Mr. Schifsky and Mr. Bedard are to receive annual
base salaries of $119,700 and $98,600, respectively, plus bonuses and stock
options as determined by the Board of Directors. The agreements are
substantially similar to the employment agreement of Mr. Howard, as described
above.

  In connection with the acquisition of Moovies, Inc., the Company was
obligated to make certain "change of control" payments to F. Andrew Mitchell,
one of the Company's former directors, and to Stephen L. Reynolds, the
Company's former Chief Financial Officer, both of whom were formerly employed
by Moovies. Mr. Mitchell resigned as a director of the Company on January 25,
1999. Mr. Reynolds resigned as Chief Financial Officer on November 13, 1998.
During fiscal 1999, Messrs. Mitchell and Reynolds received $558,000 and
$313,200 respectively, the remaining amounts of the "change of control"
payments that were due.

  Mr. Potter's brother-in-law Robert Yager, formerly a director of the
Company, is employed as a Company vice president of franchise development. Mr.
John Bedard is the brother of Richard Bedard and Glenn Bedard, Company
executive vice presidents and Paul Bedard, a Company vice president. Each of
the non-executive employees receives an annual compensation ranging from
$69,800 to $98,700.

Compensation of Directors

  Members of the Board of Directors who are not employees of the Company
receive $1,000 for each meeting of the Board of Directors and for each
committee meeting of the Board of Directors attended by such director, in
addition to reimbursement of reasonable expenses incurred in attending such
meetings, and receive $2,000 for

                                      38
<PAGE>

each quarter of service as a director. Additionally, non-employee directors
receive options under the Formula Plan, as follows: (i) all non-employee
directors (currently Messrs. Patriacca, Kelnberger, and Coburn) each receive
options annually to purchase 1,500 shares of Class A Common Stock, which vest
in two equal annual installments on the first two anniversaries of the date of
grant and which are exercisable at a price equal to the fair market value of
the Class A Common Stock on the date of grant, provided that each of them is a
director on the date of the grant and each of them has attended at least 75%
of the meetings he or she was eligible to attend; and, (ii) any non-employee
directors appointed in the future will receive on the date of such
appointment, options to purchase 3,000 shares of Class A Common Stock, which
will vest in three equal annual installments on the first three anniversaries
of the date of grant and which will be exercisable at a price equal to the
fair market value of the Class A Common Stock on the date of grant.

Item 12. Security Ownership of Certain Beneficial Owners and Management

  The following table sets forth, as of July 29, 1999, the number and
approximate percentage of shares of Class A Common Stock beneficially owned
by: (i) all persons known by the Company to be the beneficial owner of more
than five percent (5%) of the outstanding Class A Common Stock; (ii) each
"named executive officer" (as defined in Item 402 to Regulation S-K under the
Securities Act of 1933, as amended) and director; and (iii) all directors and
executive officers of the Company individually and as a group.

<TABLE>
<CAPTION>
                                                        Number of
                                                         Class A
                                                          Shares    Percentage of
                                                       Beneficially Class A Shares
       Name and Address of Beneficial Owner(1)(2)        Owned(3)   Outstanding(3)
       ------------------------------------------      ------------ --------------
   <S>                                                 <C>          <C>
   Daniel A. Potter..................................   1,526,120         5.2%
    Chairman and Chief Executive Officer(4)
   John M. Bedard....................................   1,111,039         3.8%
    President and Director(5)
   Daniel C. Howard..................................     110,315           *%
    Chief Operating Officer and Director(6)
   Dale E. Lauwagie..................................      25,000           *%
    Chief Financial Officer(7)
   Richard Bedard....................................      75,000           *%
    Executive Vice President(8)
   Michael G. Schifsky...............................      95,100           *%
    Senior Vice President(9)
   Paul M. Kelnberger................................       6,750           *%
    Director(10)
   Theodore J. Coburn................................     117,250           *%
    Director(11)
   Bernard R. Patriacca..............................       2,750           *%
    Director(12)
   Wellington Management Company, LLP(13)............   2,560,800         8.8%
   All Directors and Executive officers as a group
    (9 persons)(2)(3)(4)(5)(6)(7)(8)(9)(10)(11)(12)..   3,069,324        10.5%
</TABLE>
--------
  * Less than one percent (1%) of the outstanding shares of Class A Common
    Stock.
 (1) The address of Messrs. Potter, John Bedard, Howard, Lauwagie, Richard
     Bedard, Schifsky, Kelnberger, Coburn and Patriacca is c/o Video Update,
     Inc. 3100 World Trade Center, 30 East Seventh Street, St. Paul, Minnesota
     55101. The address of Wellington Management Company, LLP is 75 State
     Street, Boston, MA 02109.
 (2) Does not include (a) Stephen L. Reynolds, who resigned from the position
     of Chief Financial Officer of the Company on November 13, 1998 or (b) F.
     Andrew Mitchell, who resigned from his position as a

                                      39
<PAGE>

    director of the Company on January 25, 1999. As of July 29, 1999, Does not
    include 1,048,000 shares beneficially owned by Farnam Street Partners,
    L.P., representing 3.6% of the Company's Common Stock, as reported in a
    Schedule 13G/A filed with the Commission on June 9, 1999.
 (3) For the purposes of this table, shares of Common Stock which, to the
     Company's knowledge, an individual or group has a right to acquire within
     sixty (60) days upon the exercise of options or warrants, are deemed
     outstanding for the purposes of computing the number and percentage of
     shares beneficially owned by such individual or group. Such shares are
     not deemed to be outstanding for the purpose of computing the percentage
     of shares beneficially owned by any other individual or group shown in
     the table. This table does not include an approximate aggregate amount of
     32,580 shares of Common Stock held by the executive officers of the
     Company through the Company's 401(k) plan.
 (4) Includes an aggregate of 200,000 shares of Common Stock issuable on
     exercise of various stock options. Includes an aggregate of 36,947 shares
     of Common Stock held in custodial accounts for Mr. Potter's children.
     Excludes an aggregate of 100,000 shares of Common Stock issuable upon the
     exercise of various stock options that have not yet vested. Does not
     include 26,250 shares of Common Stock owned by Mr. Potter's father, in
     which Mr. Potter disclaims beneficial ownership.
 (5) Includes an aggregate of 110,000 shares of Common Stock issuable on
     exercise of various stock options. Includes 39,515 shares of Common Stock
     held by Mr. Bedard's mother, but subject to a voting trust of which Mr.
     Bedard is a trustee. Excludes an aggregate of 55,000 shares of Common
     Stock issuable upon the exercise of stock options that have not yet
     vested.
 (6) Includes an aggregate of 77,437 shares of Common Stock issuable upon the
     exercise of various stock options. Excludes an aggregate of 16,063 shares
     of Common Stock issuable upon the exercise of various stock options that
     have not yet vested.
 (7) Excludes an aggregate of 90,000 shares of Common Stock issuable upon the
     exercise of stock options that have not vested.
 (8) Includes an aggregate of 63,000 shares of Common Stock issuable upon the
     exercise of various stock options that have vested. Excludes an aggregate
     of 54,000 shares of Common Stock issuable upon the exercise of stock
     options that have not vested.
 (9) Includes an aggregate of 90,100 shares of Common Stock issuable upon the
     exercise of various stock options that have vested. Excludes an aggregate
     of 41,900 shares of Common Stock issuable upon the exercise of stock
     options that have not vested.
(10) Includes an aggregate of 6,750 shares of Common Stock issuable upon the
     exercise of various stock options that have vested. Excludes an aggregate
     of 2,250 shares of Common Stock issuable upon the exercise of stock
     options that have not vested.
(11) Includes an aggregate of 117,250 shares of Common Stock issuable upon the
     exercise of various stock options and warrants that have vested. Excludes
     an aggregate of 3,500 shares of Common Stock issuable upon the exercise
     of stock options that have not vested.
(12) Includes an aggregate of 2,750 shares of Common Stock issuable upon the
     exercise of various stock options that have vested. Excludes an aggregate
     of 3,250 shares of Common Stock issuable upon the exercise of stock
     options that have not vested.
(13) Includes 1,310,000 shares of Common Stock of which the beneficial owner
     has shared voting power and 2,560,800 shares of Common Stock of which the
     beneficial owner has shared dispositive power. The information with
     respect to the beneficial owner has been taken from the beneficial
     owner's Schedule 13G/A filed with the Commission on February 10, 1999.

Item 13. Certain Relationships and Related Transactions

  Craig Belisle, the brother-in-law of John Bedard, the Company's President
and a Director, owned a majority interest in two franchise stores as of April
30, 1999. The amount of service fees earned from these franchisees was
approximately $87,230 for the year ended April 30, 1999. The amount due from
Mr. Belisle, as a franchisee, at April 30, 1999 approximated $15,100.

                                      40
<PAGE>

  During the years ended April 30, 1997, 1998 and 1999, the Company paid
approximately $271,000, $561,000 and $270,000, respectively, to Johnson, West
& Co., PLC ("Johnson, West & Co.") for accounting and tax services. Paul
Kelnberger, a Director of the Company, is a member of Johnson, West & Co.

  Constance Koppenhaver, the daughter of Mr. Kelnberger, owned an interest in
one franchise store as of April 30, 1999. The amount of service fees earned
from this franchise was approximately $15,420 for year ended April 30, 1999.
The amount due from Ms. Koppenhaver, as a franchisee, at April 30, 1999,
approximated $4,200.

  Robert Yager, formerly a director of the Company, is employed as a Company
vice president of franchise development and is the brother-in-law of Mr.
Potter. Richard Bedard and Glenn Bedard, Company executive vice presidents,
and Paul Bedard, a Company vice president, are each the brother of Mr. John
Bedard. In fiscal 1999, each of the non-executive employees received an annual
compensation ranging from $69,800 to $98,700.

  Brown, Coburn & Co. ("Brown, Coburn"), a privately held investment banking
firm of which Theodore J. Coburn, a director of the Company, is a principal,
received $15,000 for consulting services provided to the Company for the
fiscal year ended April 30, 1999. The Company intends to use Brown, Coburn's
services during fiscal 2000.

  In connection with the acquisition of Moovies, Inc., the Company was
obligated to make certain "change of control" payments to F. Andrew Mitchell,
one of the Company's former directors, and to Stephen L. Reynolds, the
Company's former Chief Financial Officer, both of whom were formerly employed
by Moovies. As of April 30, 1999, all change of control payments had been made
to Messrs. Mitchell and Reynolds, in the amount of $558,000 and $313,200
respectively.

  The Company believes that the above arrangements were on terms at least as
favorable as could be obtained from unaffiliated parties.

  Each of Messrs. Potter and Bedard have issued notes to the Company (the
"Recourse Notes") in connection with stock option exercises, for approximately
$2,080,147 and $1,155,637, respectively, including accrued interest through
April 30, 1998. In fiscal 1999, the Recourse Notes accrued additional interest
of $147,097 and $81,721 for a total Recourse Note balance of $2,227,244 and
$1,237,358 for Messrs. Potter and Bedard, respectively. The Recourse Notes
were issued by the executives upon their exercise in August 1995 of 420,000
options granted to them under the Stock Option Plans in May 1995 at an
exercise price of $4.3125, the fair market value of the stock on the date the
options were granted. The Recourse Notes represent the total exercise price of
such options plus amounts advanced by the Company to such executives to
satisfy then anticipated tax liabilities. The Recourse Notes, which provide
for full recourse against the respective officer's personal assets and Company
stockholdings, are evidenced by promissory notes bearing accrued interest at a
rate of 8% per annum with payment of principal and interest due on October 4,
1999. In the event that the obligors sell shares of the Company's stock, the
net proceeds thereof will be applied to payment, in part or in full, of the
Recourse Notes.

  In connection with the restated employment agreements for Mr. Potter and Mr.
Bedard, the Board has approved an accrual of bonuses that will be directed
primarily to satisfying obligations arising from the Recourse Notes. For
fiscal year 1998, bonus payments aggregating $816,580 were awarded as
reimbursement of previous payments of principal and interest on the Recourse
Notes and accompanying tax liability to the recipients. In addition, the Board
has approved the subsequent payment of additional aggregate bonuses of
approximately $6,345,000 to be used primarily to satisfy the Recourse Notes,
as well as the anticipated income tax liabilities to the executives subject to
any required approvals. In fiscal 1999, the Company accrued an additional
bonus of approximately $458,000 to be used to satisfy the fiscal 1999 accrued
interest related to the Recourse Notes as well as the anticipated income tax
liabilities of the executives subject to any required approvals. If such
bonuses are not effected, the Recourse Notes will remain outstanding.

                                      41
<PAGE>

                                    PART IV

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

  (a) The following documents are filed as part of this report:

  1.  Financial Statements

     All financial statements of the Company as set forth under Item 8 of this
report.

  2. Financial Statement Schedules

     No financial statement schedules have been included since they are either
not applicable or the      information is included elsewhere herein.

  3. Exhibits

  The following exhibits are filed herewith:

<TABLE>
<CAPTION>
 Exhibit
 Number                                  Description
 -------                                 -----------
 <C>     <C> <S>
   1      -- Form of Purchase Agreement by and between Video Update, Inc. (the
             "Company"), Piper Jaffray Inc. and The Robinson Humphrey Company,
             Inc. (filed as Exhibit 1 to the Company's Pre-Effective Amendment
             No. 2 to its Form S-3 Registration Statement filed with the
             Securities and Exchange Commission (the "Commission") on September
             27, 1996 and incorporated herein by reference) (replaced and
             superseded a corresponding exhibit previously filed with the
             Commission).

  2.1     -- Agreement and Plan of Merger dated as of July 9, 1997, as amended
             by Amendment to Agreement and Plan of Merger dated as of October
             27, 1997, by and among the Company, VUI Merger Corp. and Moovies,
             Inc. ("Moovies") (filed as Exhibit 2.1 to the Company's Form S-4
             Registration Statement filed with the Commission on January 23,
             1998 and incorporated herein by reference).

  2.2     -- Purchase Agreement by and among Video Update Canada Inc., Hill and
             Cassidy Retail Corp., Byron Hill, Patricia Hill and Mel Cassidy,
             dated as of April 1, 1997 (filed as Exhibit 2 to the Company's
             Current Report on Form 8-K filed with the Commission on April 7,
             1997 and incorporated herein by reference).

  2.3     -- Purchase Agreement by and among the Company, Cox Video
             Corporation, and Robert W. Cox, dated as of February 28, 1997
             (filed as Exhibit 2a to the Company's Current Report on Form 8-K
             filed with the Commission on April 4, 1997 and incorporated herein
             by reference).

  2.4     -- Purchase Agreement by and among the Company, Susan Janae Kingston,
             and Larry Peterman, dated as of March 17, 1997 (filed as Exhibit
             2b to the Company's Current Report on Form 8-K filed with the
             Commission on April 4, 1997 and incorporated herein by reference).

  2.5     -- Purchase Agreement by and among the Company, Video Warehouse,
             Inc., and Donald and Katherine Cianci, dated as of January 15,
             1997 (filed as Exhibit 2 to the Company's Current Report on Form
             8-K filed with the Commission on January 29, 1997 and incorporated
             herein by reference).

  2.6     -- Purchase Agreement by and among Video Update Canada Inc., Video
             View Ltd., and Gordon and Joanne Hillman, dated as of January 1,
             1997 (filed as Exhibit 2 to the Company's Current Report on Form
             8-K filed with the Commission on January 10, 1997 and incorporated
             herein by reference).

  2.7     -- Purchase Agreement by and between the Company, Videoland, Inc. and
             the Stockholder of Videoland, Inc., dated as of November 14, 1995
             (filed as Exhibit 2 to the Company's Current Report on Form 8-K/A
             filed with the Commission on January 26, 1996 and incorporated
             herein by reference).

</TABLE>


                                      42
<PAGE>

<TABLE>
<CAPTION>
 Exhibit
 Number                                  Description
 -------                                 -----------
 <C>     <C> <S>
  2.8     -- Purchase Agreement by and among the Company, 94 Video West, Inc.
             and Michael Bennett and Paul Levens, dated as of October 2, 1995
             (filed as Exhibit 2a to the Company's Current Report on Form 8-K
             filed with the Commission on October 13, 1995 and incorporated
             herein by reference).

  2.9     -- Purchase Agreement by and among the Company, Talerico Enterprises,
             Inc. ("TEI") and the stockholder of TEI, dated as of October 5,
             1995 (filed as Exhibit 2b to the Company's Current Report on Form
             8-K filed with the Commission on October 13, 1995 and incorporated
             herein by reference).

  2.10    -- Purchase Agreement by and between the Company, and the
             Stockholders of Indy Video, Inc., dated as of September 26, 1995
             (filed as Exhibit 2 to the Company's Current Report on Form 8-K
             filed with the Commission on September 27, 1995 and incorporated
             herein by reference).

  2.11    -- Stock Purchase and Sale Agreement by and among the Company,
             Wilderness Video Group Ltd., Richard Walton, the Walton Family
             Trust Alexsay Holdings Ltd., Barclays Bank of Canada, Allstate
             Life Insurance Company of Canada, and Ontario Municipal Employees
             Retirement Board, dated as of August 22, 1995 (filed as Exhibit 2a
             to the Company's Current Report on Form 8-K filed with the
             Commission on August 30, 1995 and incorporated herein by
             reference).

  2.12    -- Stock Purchase and Sale Agreement by and between the Company and
             Glenn Forth, dated August 23, 1995 (filed as Exhibit 2b to the
             Company's Current Report on Form 8-K filed with the Commission on
             August 30, 1995 and incorporated herein by reference).

  2.13    -- Stock Purchase and Sale Agreement by and between the Company and
             Seig Badke, dated August 23, 1995 (filed as Exhibit 2c to the
             Company's Current Report on Form 8-K filed with the Commission on
             August 30, 1995 and incorporated herein by reference).

  2.14    -- Stock Purchase and Sale Agreement by and among the Company, 443972
             B.C., Ltd., Dale Mounzer and Jim Collen dated August 22, 1995
             (filed as Exhibit 2d to the Company's Current Report on Form 8-K
             filed with the Commission on August 30, 1995 and incorporated
             herein by reference).

  2.15    -- Purchase Agreement by and between the Company and the Stockholders
             of AV Video, dated as of July 14, 1995 (filed as Exhibit 2 to the
             Company's Current Report on Form 8-K filed with the Commission on
             July 26, 1995 and incorporated herein by reference).

  2.16    -- Purchase Agreement by and between the Company and the Proprietors
             of Video Powerstore, dated as of June 2, 1995 (filed as Exhibit 2
             to the Company's Current Report on Form 8-K filed with the
             Commission on June 29, 1995 and incorporated herein by reference).

  2.17    -- Second Amendment to the Agreement and Plan of Merger by and among
             the Company, Schmidt & Schmidt Limited ("SSL"), and the
             Stockholders of SSL, dated February 28, 1995 (filed as Exhibit 2a
             to the Company's Form Quarterly Report on Form 10-QSB for the
             quarter ended January 31, 1995 filed with the Commission on March
             17, 1995 and incorporated herein by reference).

  2.18    -- Agreement and Plan of Merger by and among the Company, Jarzig
             Enterprises, Inc., and the Stockholders of Jarzig Enterprises,
             Inc., dated October 25, 1994 (filed as Exhibit 2b to the Company's
             Quarterly Report on Form 10-QSB for the quarter ended October 31,
             1994, filed with the Commission on December 15, 1994 and
             incorporated herein by reference).

  2.19    -- Agreement and Plan of Merger by and among the Company, Schmidt &
             Schmidt Limited, and the Stockholders of Schmidt & Schmidt
             Limited, dated September 16, 1994 (filed as Exhibit 2a to the
             Company's Current Report on Form 8-K filed with the Commission on
             October 3, 1994 and incorporated herein by reference).

</TABLE>


                                       43
<PAGE>

<TABLE>
<CAPTION>
 Exhibit
 Number                                  Description
 -------                                 -----------
 <C>     <C> <S>
   2.20   -- Agreement and Plan of Merger by and among the Company, Halgrimson
             Enterprises, Inc., and the Stockholders of Halgrimson Enterprises,
             Inc., dated September 16, 1994 (filed as Exhibit 2b to the
             Company's Current Report on Form 8-K filed with the Commission on
             October 3, 1994 and incorporated herein by reference).

   2.21   -- Agreement and Plan of Merger by and among the Company, Koonrod,
             Inc., and the Stockholders of Koonrod, Inc., dated September 2,
             1994 (filed as Exhibit 2 to the Company's Quarterly Report on Form
             10-QSB for the quarter ended July 31, 1994, filed with the
             Commission on September 10, 1994 and incorporated herein by
             reference).

   3.1    -- Restated Certificate of Incorporation (filed as Exhibit 3 to the
             Company's Current Report on Form 8-K filed with the Commission on
             January 20, 1997 and incorporated herein by reference).

   3.2    -- Bylaws of the Company, as amended on June 23, 1998 (filed as
             Exhibit 3 to the Company's Current Report on Form 8-K filed with
             the Commission July 7, 1998 and incorporated herein by reference).

   4.1    -- Form of Unit Purchase Option (filed as Exhibit 4a to the Company's
             Pre-Effective Amendment No. 1 to its Form SB-2 Registration
             Statement (No. 33-89018) originally filed with the Commission on
             March 31, 1995 and incorporated herein by reference).

   4.2    -- Specimen Class A Common Stock Certificate (filed as Exhibit 4a to
             the Company's Form SB-2 Registration Statement (No. 33-79292-C)
             declared effective by the Commission on July 20, 1994 and
             incorporated herein by reference).

   4.3    -- Specimen Class B Common Stock Certificate (filed as Exhibit 4b to
             the Company's Form SB-2 Registration Statement (No. 33-79292-C)
             declared effective by the Commission on July 20, 1994 and
             incorporated herein by reference).

   4.4    -- Form of Warrant Agreement, including Form of Class A and Class B
             Warrant Certificates (filed as Exhibit 4c to the Company's Form
             SB-2 Registration Statement (No. 33-79292-C) declared effective by
             the Commission on July 20, 1994 and incorporated herein by
             reference).

   4.5    -- Form of Unit Purchase Option of D.H. Blair Investment Banking
             Corp. (filed as Exhibit 4d to the Company's Form SB-2 Registration
             Statement (No. 33-79292-C) declared effective by the Commission on
             July 20, 1994 and incorporated herein by reference).

   4.6    -- Rights Agreement by and between the Company and American Stock
             Transfer and Trust Company (filed as Exhibit 4 to the Company's
             Form 8-K filed April 14, 1998 and incorporated herein by
             reference).

  10.1    -- Amended and Restated Voting Agreement, dated October 27, 1997
             among the Company, Moovies, and directors and certain officers of
             the Company and Moovies (filed as Exhibit 10 to the Company's Form
             10-Q for the fiscal quarter ended October 31, 1997 and
             incorporated herein by reference).

  10.2    -- Amended and Restated Undertaking Agreement, dated October 27, 1997
             among the Company, Moovies, Daniel A. Potter, John M. Bedard and
             Daniel C. Howard (filed as Exhibit 10.2 of the Company's Form S-4
             Registration Statement filed with the Commission on January 23,
             1998 and incorporated herein by reference).

  10.3    -- Form of 1998 Stock Option Plan (filed as Exhibit 10.3 of the
             Company's Form S-4 Registration Statement filed with the
             Commission on January 23, 1998 and incorporated herein by
             reference).

  10.4    -- Agreement between Rentrak Corporation and the Company (filed as
             Exhibit 10.4 of the Company's Form S-4 Registration Statement
             filed with the Commission on January 23, 1998 and incorporated
             herein by reference).

</TABLE>


                                       44
<PAGE>

<TABLE>
<CAPTION>
 Exhibit
 Number                                  Description
 -------                                 -----------
 <C>     <C> <S>
  10.5    -- Form of Employment Agreement between the Company and Daniel C.
             Howard (filed as Exhibit 10.6 of the Company's Form S-4
             Registration Statement filed with the Commission on January 23,
             1998 and incorporated herein by reference).

  10.6    -- Credit Agreement entered into as of March 6, 1998, among the
             Company, Video Update Canada Inc., various lending institutions
             and Banque Paribas, as agent (the "Credit Agreement") (filed as
             Exhibit 10.1 to the Company's Current Report on Form 8-K filed
             with the Commission on March 11, 1998 and incorporated herein by
             reference).

  10.7    -- U.S. Pledge Agreement in favor of Banque Paribas, as Collateral
             Agent, dated as of March 6, 1998 (filed as Exhibit 10.2 to the
             Company's Current Report on Form 8-K filed with the Commission on
             March 11, 1998 and incorporated herein by reference).

  10.8    -- U.S. Security Agreement among the Company, Various U.S.
             Subsidiaries of the Company, and Banque Paribas, as Collateral
             Agent, dated as of March 6, 1998 (filed as Exhibit 10.3 to the
             Company's Current Report on Form 8-K filed with the Commission on
             March 11, 1998 and incorporated herein by reference).

  10.9    -- Subsidiaries Guarantee Agreement among Various Subsidiaries of the
             Company, and Banque Paribas, as Collateral Agent and as Pledgee,
             dated as of March 6, 1998 (filed as Exhibit 10.4 to the Company's
             Current Report on Form 8-K filed with the Commission on March 11,
             1998 and incorporated herein by reference).

  10.10   -- Warrant Purchase Agreement between the Company, and Banque
             Paribas, Grand Cayman Branch, dated as of March 6, 1998 (filed as
             Exhibit 10.5 to the Company's Current Report on Form 8-K filed
             with the Commission on March 11, 1998 and incorporated herein by
             reference).

  10.11   -- Warrant Agreement between the Company and Banque Paribas, Grand
             Cayman Branch, dated as of March 6, 1998 (filed as Exhibit 10.6 to
             the Company's Current Report on Form 8-K filed with the Commission
             on March 11, 1998 and incorporated herein by reference).

  10.12   -- Registration Rights Agreement between the Company and Banque
             Paribas, Grand Cayman Branch, dated as of March 6, 1998 (filed as
             Exhibit 10.7 to the Company's Current Report on Form 8-K filed
             with the Commission on March 11, 1998 and incorporated herein by
             reference).

  10.13   -- 1996 Stock Option Plan (filed as Exhibit 10a to the Company's
             Quarterly Report on Form
             10-QSB for the fiscal quarter ended July 31, 1996 and incorporated
             herein by reference).

  10.14   -- Form of Franchise Offering Circular (filed as Exhibit 10b to the
             Company's Quarterly Report on Form 10-QSB for the fiscal quarter
             ended July 31, 1996 and incorporated herein by reference).

  10.15   -- Restated Employment Agreement between the Company and Daniel A.
             Potter, effective as of April 30, 1998 (filed as Exhibit 10.15 to
             the Company's Annual Report on Form 10-K for the fiscal year ended
             April 30, 1998 and incorporated herein by reference).

  10.16   -- Restated Employment Agreement between the Company and John M.
             Bedard, effective as of April 30, 1998 (filed as Exhibit 10.16 to
             the Company's Annual Report on Form 10-K for the fiscal year ended
             April 30, 1998 and incorporated herein by reference).

  10.17   -- Form of Merger and Acquisition Agreement between the Company and
             D.H. Blair Investment Banking Corp. (filed as Exhibit 10a to the
             Company's Pre-Effective Amendment No. 1 to its Form SB-2
             Registration Statement (No. 33-89018) originally filed with the
             Commission on March 31, 1995 and incorporated herein by
             reference).

  10.18   -- Form of Amendment to Warrant Agreement dated July 20, 1994 between
             the Company, American Stock Transfer & Trust Company and D.H.
             Blair Investment Banking Corp. (filed as Exhibit 10b to the
             Company's Pre-Effective Amendment No. 1 to its Form SB-2
             Registration Statement (No. 33-89018) originally filed with the
             Commission on March 31, 1995 and incorporated herein by
             reference).

</TABLE>


                                       45
<PAGE>

<TABLE>
<CAPTION>
 Exhibit
 Number                                  Description
 -------                                 -----------
 <C>     <C> <S>
  10.19   -- Stock Exchange Agreement by and between the Company and certain
             stockholders of Tinseltown Video, Inc. (filed as Exhibit 10a to
             the Company's Current Report on Form 8-K filed with the Commission
             on February 16, 1995 and incorporated herein by reference).

  10.20   -- Formula Stock Option Plan (filed as Exhibit 10a to the Company's
             Form SB-2 Registration Statement (No. 33-89018) filed with the
             Commission on January 31, 1995 and incorporated herein by
             reference).

  10.21   -- Form of Franchise Agreement between the Company and Franchisees
             (filed as Exhibit 10d to the Company's Form SB-2 Registration
             Statement (No. 33-79292-C) declared effective by the Commission on
             July 20, 1994 and incorporated herein by reference).

  10.22   -- Form of Consulting Agreement between the Company and D.H. Blair
             Investment Banking Corp. (filed as Exhibit 10f to the Company's
             Form SB-2 Registration Statement (No. 33-79292-C) declared
             effective by the Commission on July 20, 1994 and incorporated
             herein by reference).

  10.23   -- Form of Agency Agreement between the Company and D.H. Blair
             Investment Banking Corp. (filed as Exhibit 10aa to the Company's
             Form SB-2 Registration Statement (No. 33-79292-C) declared
             effective by the Commission on July 20, 1994 and incorporated
             herein by reference).

  10.24   -- 1994 Stock Option Plan (filed as Exhibit 10bb to the Company's
             Form SB-2 Registration Statement (No. 33-79292-C) declared
             effective by the Commission on July 20, 1994 and incorporated
             herein by reference).

  10.25   -- Form of Second Amendment and Waiver to the Credit Agreement, dated
             as of August 12, 1998 (filed as Exhibit 10.25 to the Company's
             Annual Report on Form 10-K for the fiscal year ended April 30,
             1998 and incorporated herein by reference).

  10.26   -- Form of First Amendment to Warrant Agreement between the Company
             and Banque Paribas, dated as of August 12, 1998 (filed as Exhibit
             10.26 to the Company's Annual Report on Form 10-K for the fiscal
             year ended April 30, 1998 and incorporated herein by reference).

  10.27   -- Third Amendment to Credit Agreement (filed as Exhibit 10.1 to the
             Company's Form 10-Q filed March 17, 1999 and incorporated herein
             by reference).

  10.28   -- Fourth Amendment to Credit Agreement (filed as Exhibit 10.2 to the
             Company's Form 10-Q filed March 17, 1999 and incorporated herein
             by reference).

  10.29   -- Fifth Amendment to Credit Agreement (filed as Exhibit 10.3 to the
             Company's Form 10-Q filed March 17, 1999 and incorporated herein
             by reference).

  10.30   -- Sixth Amendment to Credit Agreement and Waiver (filed as Exhibit
             10a to the Company's Form 8-K filed July 1, 1999 and incorporated
             herein by reference).

  10.31   -- Seventh Amendment to Credit Agreement and Waiver (filed as Exhibit
             10b to the Company's Form 8-K filed July 1, 1999 and incorporated
             herein by reference).

  10.32   -- Form of Warrant between the Company and U.S. Bancorp Libra, a
             division of U.S. Bancorp Investments, Inc. (filed as Exhibit 4a to
             the Company's Form 8-K filed July 1, 1999 and incorporated herein
             by reference).

  10.33   -- Form of Warrant between the Company and Existing Lenders under the
             Credit Agreement (filed as Exhibit 4b to the Company's Form 8-K
             filed July 1, 1999 and incorporated herein by reference).

  10.34   -- Form of Warrant between the Company and C Term Loan Participants
             under the Credit Agreement (filed as Exhibit 4c to the Company's
             Form 8-K filed July 1, 1999 and incorporated herein by reference).

</TABLE>


                                       46
<PAGE>

<TABLE>
<CAPTION>
 Exhibit
 Number                                  Description
 -------                                 -----------
 <C>     <C> <S>
  10.35   -- Registration Rights Agreement between the Company and U.S. Bancorp
             Libra, a division of U.S. Bancorp Investments, Inc. and certain
             Investors dated June 23, 1999 (filed as Exhibit 4d to the
             Company's Form 8-K filed July 1, 1999 and incorporated herein by
             reference).

  10.36   -- Warrant between the Company and Ingram Entertainment Inc. dated
             May 11, 1999.

  10.37   -- Registration Rights Agreement by and between the Company and
             Ingram Entertainment Inc. dated May 11, 1999.

  10.38   -- Promissory Note of the Company to the order of Ingram
             Entertainment Inc. dated May 11, 1999.

 +10.39   -- Revenue Sharing Agreement dated as of November 20, 1998, between
             the Company and the party named therein.

 +10.40   -- Revenue Sharing Agreement dated as of October 20, 1998, between
             the Company and the party named therein.

 +10.41   -- Revenue Sharing Agreement dated as of July 22, 1998, between the
             Company and the party named therein.

 +10.42   -- Revenue Sharing Agreement dated as of June, 1998, between the
             Company and the party named therein.

 +10.43   -- Revenue Sharing Agreement dated as of June 1998, between the
             Company and the party named therein.

  10.44   -- Employment Agreement dated as of April 8, 1999, between the
             Company and Michael G. Schifsky.

  10.45   -- Employment Agreement dated as of April 20, 1999, between the
             Company and Richard Bedard.

  10.46   -- Master Lease Agreement dated as of November 23, 1998 between the
             Company and Heller Financial Leasing, Inc.

  16      -- Letter of Ernst & Young LLP (filed as Exhibit 16 to the Company's
             Form 8-K filed February 3, 1999 and incorporated herein by
             reference).

  18.1    -- Letter on Change in Accounting Principles (filed as Exhibit 18 to
             the Company's Annual Report on Form 10-KSB for the fiscal year
             ended April 30, 1996 and incorporated herein by reference).

  18.2    -- Letter on Change in Accounting Principles.

  21      -- List of the Company's Subsidiaries (filed as Exhibit 21 to the
             Company's Annual Report on Form 10-K for the fiscal year ended
             April 30, 1998 and incorporated herein by reference).

  23.1    -- Consent of Deloitte & Touche LLP.

  23.2    -- Consent of Ernst & Young LLP.

  27.1    -- Financial Data Schedule.

  27.2    -- Financial Data Schedule--Restated 1997.

  27.3    -- Financial Data Schedule--Restated 1998.
</TABLE>
--------
+ Exhibits for which Company is seeking confidential treatment for certain
  portions. The confidential material in Exhibits 10.39, 10.40, 10.41, 10.42
  and 10.43 has been redacted and separately filed with the Securities and
  Exchange Commission.

                                      47
<PAGE>

  (b) Reports on Form 8-K

  Set forth below is a list of reports on Form 8-K that were filed during the
last quarter of the period covered by this report, listing the items reported,
any financial statements filed, and the dates of such reports.

  1. Form 8-K filed February 3, 1999 reporting a change in the Company's
certifying accountants and the resignation of director F. Andrew Mitchell.

                                      48
<PAGE>

                                  SIGNATURES

  In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                          Video Update, Inc.


                                                   /s/ Daniel A. Potter
Date: August 13, 1999                     By: _________________________________
                                                     Daniel A. Potter
                                               Chairman and Chief Executive
                                                          Officer

  In accordance with the Securities Exchange Act of 1934, as amended, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.

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

<S>                                    <C>                             <C>
         /s/ Daniel A. Potter          Chairman and Chief Executive      August 13,
______________________________________  Officer (Principal                  1999
           Daniel A. Potter             Executive Officer)

          /s/ John M. Bedard           President and Director            August 13,
______________________________________                                      1999
            John M. Bedard

         /s/ Daniel C. Howard          Chief Operations Officer and      August 13,
______________________________________  Director                            1999
           Daniel C. Howard

        /s/ Paul M. Kelnberger         Chief Financial Officer           August 13,
______________________________________                                      1999
          Paul M. Kelnberger

         /s/ Dale E. Lauwagie          Director                          August 13,
______________________________________                                      1999
           Dale E. Lauwagie

       /s/ Bernard R. Patriacca        Director                          August 13,
______________________________________                                      1999
         Bernard R. Patriacca

        /s/ Theodore J. Coburn         Director                          August 13,
______________________________________                                      1999
          Theodore J. Coburn
</TABLE>

                                      49
<PAGE>

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                           Page
                                                                           ----
<S>                                                                        <C>
Reports of Independent Auditors..........................................  F-2

Consolidated Balance Sheets as of April 30, 1998 and 1999................  F-4

Consolidated Statements of Operations for the years ended April 30, 1997,
 1998 and 1999...........................................................  F-5

Consolidated Statements of Stockholders' Equity for the years ended April
 30, 1997, 1998 and 1999.................................................  F-6

Consolidated Statements of Cash Flows for the years ended April 30, 1997,
 1998 and 1999...........................................................  F-7

Notes to Consolidated Financial Statements...............................  F-8
</TABLE>

                                      F-1
<PAGE>

                        REPORT OF INDEPENDENT AUDITORS

Board of Directors
Video Update, Inc.

  We have audited the accompanying consolidated balance sheet of Video Update,
Inc. and subsidiaries as of April 30, 1999, and the related consolidated
statements of operations, stockholders' equity and cash flows for the year
ended April 30, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.

  We conducted our audit 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 audit provides a reasonable basis
for our opinion.

  In our opinion, these financial statements present fairly, in all material
respects, the consolidated financial position of Video Update, Inc. at April
30, 1999, and the consolidated results of its operations and its cash flows
for the year ended April 30, 1999 in conformity with generally accepted
accounting principles.

  As discussed in Note 2 to the consolidated financial statements, in 1999 the
Company changed its method of accounting for the amortization of its video and
game rental inventory.

                                          /s/ Deloitte & Touche LLP

Minneapolis, Minnesota
August 12, 1999

                                      F-2
<PAGE>

                        REPORT OF INDEPENDENT AUDITORS

Board of Directors
Video Update, Inc.

  We have audited the accompanying consolidated balance sheet of Video Update,
Inc. and subsidiaries as of April 30, 1998, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
two years in the period ended April 30, 1998. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our 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, these financial statements present fairly, in all material
respects, the consolidated financial position of Video Update, Inc. at April
30, 1998, and the consolidated results of its operations and its cash flows
for each of the two years in the period ended April 30, 1998 in conformity
with generally accepted accounting principles.

                                          /s/ Ernst & Young LLP

Minneapolis, Minnesota
August 13, 1998

                                      F-3
<PAGE>

                               VIDEO UPDATE, INC.

                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                           April 30,  April 30,
                                                             1998       1999
                                                           ---------  ---------
                                                             (in thousands)
<S>                                                        <C>        <C>
                          ASSETS
Cash and cash equivalents................................. $  1,433   $   1,235
Accounts receivable.......................................    4,737       3,826
Merchandise inventory.....................................    9,167       6,393
Video and game rental inventory--net......................   97,734      45,040
Property and equipment--net...............................   69,720      59,395
Prepaid expenses..........................................    4,162       6,419
Income taxes receivable...................................    2,430         --
Deferred income taxes.....................................    2,592         --
Goodwill--net.............................................   80,664      77,715
Other assets..............................................    5,792       7,185
                                                           --------   ---------
    Total assets.......................................... $278,431   $ 207,208
                                                           ========   =========
           LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable............................................. $104,488   $ 116,014
Accounts payable..........................................   39,045      56,055
Accrued expenses..........................................   12,841      23,054
Accrued rent..............................................    5,073       7,118
Accrued compensation......................................    7,685       8,062
                                                           --------   ---------
    Total liabilities.....................................  169,132     210,303
                                                           --------   ---------

Commitments and contingencies (Note 9)

Preferred Stock, par value $.01 per share:
  Authorized shares--5,000,000
  Issued shares--none.....................................      --          --
Class A Common Stock, par value $.01 per share:
  Authorized shares--60,000,000
  Issued and outstanding shares--29,278,518 at April 30,
   1998 and 29,278,457 at April 30, 1999..................      293         293
  Additional paid-in capital..............................  117,641     116,372
  Retained deficit........................................   (7,674)   (118,045)
  Foreign currency translation............................     (961)     (1,715)
                                                           --------   ---------
    Total stockholders' equity............................  109,299      (3,095)
                                                           --------   ---------
    Total liabilities and stockholders' equity............ $278,431   $ 207,208
                                                           ========   =========
</TABLE>

                            See accompanying notes.

                                      F-4
<PAGE>

                               VIDEO UPDATE, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                Fiscal Year Ended April 30,
                                               -------------------------------
                                                 1997      1998        1999
                                               --------- ---------  ----------
                                                 (In thousands, except per
                                                      share amounts)
<S>                                            <C>       <C>        <C>
Revenues:
  Rental revenue.............................. $ 83,489  $ 138,279  $  221,409
  Product sales...............................    7,743     17,075      31,915
  Service fees................................      567        800         772
                                               --------  ---------  ----------
                                                 91,799    156,154     254,096
Costs and expenses:
  Store operating expenses....................   70,205    129,920     232,287
  Selling, general and administrative.........    7,883     25,223      26,179
  Cost of product sales.......................    3,705      9,809      20,257
  Store closing charge........................      --       5,082      14,798
  Inventory valuation charge..................      --         --       50,629
  Amortization of goodwill....................    1,613      2,353       4,471
                                               --------  ---------  ----------
                                                 83,406    172,387     348,621
                                               --------  ---------  ----------
Operating income (loss).......................    8,393    (16,233)    (94,525)

Interest expense..............................     (892)    (4,292)    (13,695)
Other income (expense)........................      461        (71)        677
                                               --------  ---------  ----------
                                                   (431)    (4,363)    (13,018)
                                               --------  ---------  ----------
Income (loss) before income taxes.............    7,962    (20,596)   (107,543)

Income tax expense (benefit)..................    3,342     (6,116)      2,828
                                               --------  ---------  ----------
Net income (loss)............................. $  4,620  $ (14,480) $ (110,371)
                                               ========  =========  ==========
Net income (loss) per share, basic............ $   0.29  $   (0.71) $    (3.77)
                                               ========  =========  ==========
Net income (loss) per share, diluted.......... $   0.28  $   (0.71) $    (3.77)
                                               ========  =========  ==========
</TABLE>


                            See accompanying notes.

                                      F-5
<PAGE>

                               VIDEO UPDATE, INC.

                 CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
                         (In thousands, except shares)

<TABLE>
<CAPTION>
                                                                                      Accumulated
                                                               Additional Retained       Other     Officers'
                              Class A            Class B        Paid-in   Earnings   Comprehensive   Notes
                           Common Stock       Common Stock      Capital   (Deficit)     Income     Receivable
                         ------------------ ------------------ ---------- ---------  ------------- ----------
                         Number of          Number of
                           Shares    Amount   Shares    Amount   Amount    Amount       Amount       Amount     Total
                         ----------  ------ ----------  ------ ---------- ---------  ------------- ---------- ---------
<S>                      <C>         <C>    <C>         <C>    <C>        <C>        <C>           <C>        <C>
Balance at April 30,
 1996..................  11,017,735   $110   2,000,000   $ 20   $ 61,029  $   2,186     $   (34)    $(1,811)  $  61,500
Payment on notes issued
 by officers for
 exercise of options...         --     --          --     --         --         --          --          131         131
Issuance of shares in
 connection with the
 Subsequent Public
 Offering net of
 registration
 expenses..............   7,015,000     70         --     --      24,962        --          --          --       25,032
Issuance of shares in
 connection with the
 Company's
 acquisitions..........     136,606      2         --     --          90        --          --          --           92
Issuance of shares
 related to employee
 stock options
 exercised.............       1,000    --          --     --           4        --          --          --            4
Comprehensive Income:
 Net income (loss).....         --     --          --     --         --       4,620         --          --        4,620
 Foreign currency
  translation..........         --     --          --     --         --         --         (387)        --         (387)
                                                                                                              ---------
 Total comprehensive
  income (loss)........         --     --          --     --         --         --          --          --        4,233
                         ----------   ----  ----------   ----   --------  ---------     -------     -------   ---------
Balance at April 30,
 1997..................  18,170,341    182   2,000,000     20     86,085      6,806        (421)     (1,680)     90,992
Adjustment of shares
 issued in
 acquisition...........     (65,811)   --          --     --        (500)       --          --          --         (500)
Issuance of shares in
 connection with the
 Moovies acquisition...   9,303,927     93         --     --      28,107        --          --          --       28,200
Release, partial
 forfeiture and
 conversion of escrow
 shares................   1,170,000     11  (1,300,000)   (13)     3,546        --          --          --        3,544
Issuance of warrants in
 connection with the
 Senior Facility.......         --     --          --     --       1,730        --          --          --        1,730
Conversion of Class B
 to Class A Common
 Stock.................     700,000      7    (700,000)    (7)       --         --          --          --          --
Acquisition related
 deficiency payments...         --     --          --     --      (1,327)       --          --          --       (1,327)
Forgiveness of officers
 note receivable.......         --     --          --     --         --         --          --        1,680       1,680
Comprehensive Income:
 Net income (loss).....         --     --          --     --         --     (14,480)        --          --      (14,480)
 Foreign currency
  translation..........         --     --          --     --         --         --         (540)        --         (540)
                                                                                                              ---------
 Total comprehensive
  income (loss)........         --     --          --     --         --         --          --          --      (15,020)
                         ----------   ----  ----------   ----   --------  ---------     -------     -------   ---------
Balance at April 30,
 1998..................  29,278,457    293         --     --     117,641     (7,674)       (961)        --      109,299
Revaluation of stock
 warrants..............         --     --          --     --         192        --          --          --          192
Acquisition related
 deficiencies..........         --     --          --     --      (1,461)       --          --          --       (1,461)
Comprehensive Income:
 Net income (loss).....         --     --          --     --         --    (110,371)        --          --     (110,371)
 Foreign currency
  translation..........         --     --          --     --         --         --         (754)        --         (754)
                                                                                                              ---------
 Total comprehensive
  income (loss)........         --     --          --     --         --         --          --          --     (111,125)
                         ----------   ----  ----------   ----   --------  ---------     -------     -------   ---------
Balance at April 30,
 1999..................  29,278,457   $293         --    $--    $116,372  $(118,045)    $(1,715)    $    --   $  (3,095)
                         ==========   ====  ==========   ====   ========  =========     =======     =======   =========
</TABLE>

                              See accompany notes.

                                      F-6
<PAGE>

                               VIDEO UPDATE, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                 Fiscal Year Ended April 30,
                                                 -----------------------------
                                                   1997      1998      1999
                                                 --------  --------  ---------
                                                       (In thousands)
<S>                                              <C>       <C>       <C>
Operating activities
  Net income (loss)............................. $  4,620  $(14,480) $(110,371)
  Adjustments to reconcile net income (loss) to
   net cash provided by operating activities:
    Depreciation and amortization...............   25,702    48,459     89,494
    Deferred income taxes.......................    1,486    (4,356)     2,592
    Inventory valuation charge..................      --        --      50,629
    Compensation expense from release of escrow
     shares.....................................      --      3,546        --
    Compensation expense related to restated
     employment agreements......................      --      7,161        458
    Charge for store closings...................      --      5,082     14,798
  Changes in operating assets and liabilities,
   net of acquisitions of businesses:
    Accounts receivable.........................   (3,332)     (191)       911
    Merchandise inventory.......................   (2,772)     (960)     1,977
    Income taxes................................      503    (3,397)     2,430
    Other assets................................   (1,270)   (5,873)    (4,316)
    Accounts payable............................    3,891     6,770     17,010
    Accrued rent................................    1,516     2,834      2,045
    Accrued liabilities.........................      483    (1,190)     1,050
                                                 --------  --------  ---------
      Net cash provided by operating
       activities...............................   30,827    43,405     68,707
Investing activities
  Purchase of video and game rental inventory...  (33,434)  (61,752)   (71,212)
  Purchase of property and equipment............  (14,951)  (17,458)   (12,962)
  Proceeds from sale-leaseback..................      --        --       5,000
  Investment in businesses, net of cash
   acquired.....................................  (21,340)    3,027        --
  Payment of deficiency on stock guarantee......      --     (1,327)      (241)
  Other investing activities....................      292       --         --
                                                 --------  --------  ---------
      Net cash used in investing activities.....  (69,433)  (77,510)   (79,415)
Financing activities
  Proceeds from notes payable...................   26,326   103,700     27,300
  Payments of notes payable.....................  (10,621)  (20,046)   (16,036)
  Payment of acquisition debt...................      --    (50,000)       --
  Proceeds from issuance of common stock........   25,032       --         --
  Other financing activities....................        4       --         --
                                                 --------  --------  ---------
      Net cash provided by financing
       activities...............................   40,741    33,654     11,264
Effect of exchange rate changes on cash.........     (387)     (540)      (754)
                                                 --------  --------  ---------
Increase (decrease) in cash and cash
 equivalents....................................    1,748      (991)      (198)
Cash and cash equivalents at beginning of the
 Year...........................................      676     2,424      1,433
                                                 --------  --------  ---------
Cash and cash equivalents at end of the Year.... $  2,424  $  1,433  $   1,235
                                                 ========  ========  =========
</TABLE>

                            See accompanying notes.

                                      F-7
<PAGE>

                              VIDEO UPDATE, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

               For the years ended April 30, 1999, 1998 and 1997

1. Significant Accounting Policies

 Nature of Business

  Video Update, Inc. and subsidiaries ("Video Update" or the "Company") own
and operate retail video stores and sell and support retail video franchises.
Company-owned stores are located in the United States and Canada with
franchises located principally in the United States.

 Consolidation

  The accompanying financial statements present the consolidated financial
position, results of operations and cash flows of the Company. All inter-
company accounts and transactions have been eliminated.

 Use of Estimates

  The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. The most significant estimates and
assumptions relate to the amortization methods and useful lives of video and
game rental inventory and goodwill. These estimates and assumptions could
change and actual results could differ from these estimates.

 Basis of Presentation

  The Company utilizes an unclassified balance sheet presentation. This format
was adopted on the basis that the video and game rental inventory represents
assets used by the Company to generate current operating income, and
management believes that to classify all of these costs as non-current would
be misleading to the readers of the financial statements because it would not
indicate the level of assets expected to be converted into cash in the next
year as a result of the rentals of the videos and games.

 Service Fees

  The Company receives continuing monthly royalty and other fee revenue from
its franchisees based on a percentage of the franchisees' gross monthly
revenue. Royalty fee and other fee revenues will continue for the initial
terms of the franchise agreements, after which the revenues will be based upon
renewed franchise agreements. Origination franchise fees collected are
deferred and not recorded as revenue in the statement of operations until the
franchisee has executed a lease or a letter of intent of a franchised store
location.

 Cash Equivalents

  The Company considers all highly liquid investments with a remaining
maturity of three months or less when purchased to be cash equivalents.

 Merchandise Inventory

  Merchandise inventory is stated at the lower of cost (first in, first out)
or market. Inventory consists of videos and games held for sale, supplies and
concessions.

                                      F-8
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


 Video and Game Rental Inventory

  Video rental inventory is stated at cost, and is amortized over the
estimated economic life as follows:

<TABLE>
<CAPTION>
     Number of
       Copies
    of Title Per
       Store                                 Amortization Policy
    ------------                             -------------------
   <S>                      <C>
   One through three....... Accelerated basis to a net book value of $8.00 over
                            the first three months and then straight-line over
                            33 months to a salvage value of $4.00 per video.

   Four and over........... Accelerated basis to a net book value of $4.00 over
                            the first three months and then fully amortized on a
                            straight-line basis over nine months.
</TABLE>

  Game rental inventory is amortized on a straight-line basis to $10.00 over
12 months then straight-line over 6 months to a salvage value of $4.00 per
game.

 Property and Equipment

  Furniture and equipment are recorded at cost and depreciated using the
straight-line method over the estimated economic life of the asset of five to
ten years. Leasehold improvements are recorded at cost and depreciated using
the straight-line method over the estimated economic life of the lease term.

 Goodwill

  Goodwill, consisting principally of excess cost over net assets from the
acquisitions of businesses, is net of accumulated amortization of
approximately $5,121,000 and $9,592,000 at April 30, 1998 and 1999,
respectively and is being amortized on a straight-line basis over 20 years. If
facts and circumstances suggest that the goodwill will not be recoverable, as
determined based on the undiscounted cash flows of the assets acquired over
the remaining amortization period, the Company's carrying value of goodwill
will be reduced to its estimated fair value.

 Income Taxes

  The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standard ("SFAS") No. 109 "Accounting for Income Taxes."
Deferred income taxes are recorded to reflect the tax consequences of
differences between the tax and financial reporting bases of assets and
liabilities.

 Stock-based Compensation

  The Company implemented only the net earnings and earnings per share
disclosure provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation," in fiscal 1997. The Company has elected to recognize
compensation expense for its stock based compensation plans in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." Accordingly, no compensation expense is recognized for stock
options with exercise prices equal to, or in excess of, the market value of
the underlying shares of stock at the date of grant.

 Long-Lived Assets

  The Company adopted SFAS No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to Be Disposed Of," effective May 1,
1996. SFAS No. 121 prescribes the accounting treatment for long-lived assets,
identifiable intangibles and goodwill related to those assets when there are

                                      F-9
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

indications that the carrying values of those assets may not be recoverable.
In performing such review for recoverability, the Company compares the
expected future cash flows to the carrying value of long-lived assets and
identifiable intangibles. If the anticipated undiscounted future cash flows
are less than the carrying amount of such assets, the Company's carrying
amount will be reduced to its estimated fair value.

 Fair Value of Financial Instruments

  At April 30, 1998 and 1999, the carrying value of financial instruments such
as cash and cash equivalents, accounts receivable, accounts payable and notes
payable approximated their fair values (see Note 16 of the Notes to
Consolidated Financial Statements for further information).

 Revenue Recognition

  Revenue on videos and games is recognized at the time of rental or sale.

 Earnings Per Share

  In 1997, the Financial Accounting Standards Board issued SFAS No. 128,
"Earnings per Share". SFAS No. 128 replaced the previously reported primary
and fully diluted earnings per share with basic and diluted earnings per
share. Unlike primary earnings per share, basic earnings per share excluded
any dilutive effect of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts for all periods have been
presented to conform to the SFAS No. 128 requirements.

  The following table is a reconciliation of the basic and diluted earnings
per share computation:

<TABLE>
<CAPTION>
                                                    Fiscal Year Ended April
                                                              30,
                                                   ---------------------------
                                                    1997     1998      1999
                                                   ------- --------  ---------
                                                   (In thousands, except per
                                                         share amounts)
   <S>                                             <C>     <C>       <C>
   Numerator:
   Numerator for basic and diluted earnings per
    share--net income (loss)...................... $ 4,620 $(14,480) $(110,371)
                                                   ======= ========  =========
   Denominator:
   Denominator for basic earnings per share--
    weighted average shares
     Class A common shares........................  15,185   20,412     29,278
     Class B common shares........................     700      --         --
                                                   ------- --------  ---------
   Denominator for basic earnings per share.......  15,885   20,412     29,278
   Effect of dilutive securities:
     Employee stock options.......................     200      --         --
     Contingent stock acquisition.................     177      --         --
                                                   ------- --------  ---------
   Dilutive potential common shares...............     377      --         --
                                                   ------- --------  ---------
   Denominator for diluted earnings per share--
    adjusted weighted-average shares and assumed
    conversions...................................  16,262   20,412     29,278
                                                   ======= ========  =========
   Basic net income (loss) per share.............. $  0.29 $  (0.71) $   (3.77)
                                                   ======= ========  =========
   Diluted net income (loss) per share............ $  0.28 $  (0.71) $   (3.77)
                                                   ======= ========  =========
</TABLE>

                                     F-10
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


 Reclassification

  Certain reclassifications have been made to the prior year financial
statements to conform with the 1999 presentation.

2. Change in Amortization Method for Video and Game Rental Inventory

  Effective February 1, 1999, the Company changed the amortization policy for
videos to the method as described in Note 1 of the Notes to Consolidated
Financial Statements. The adoption of the new method of amortization has been
accounted for as a change in accounting estimate effected by a change in
accounting principle.

  Prior to February 1, 1999, base stock videos were amortized over 36 months
on a straight-line basis to a salvage value of $6.00 per video; the fourth
through ninth copies of each title per store were amortized straight-line over
6 months to a book value of $6.00 and then fully amortized straight-line over
30 months; the tenth and any succeeding copies of each title per store were
amortized straight-line over 6 months to a book value of $6.00 and then fully
amortized straight-line over 3 months. Video games were fully amortized
straight-line over a period of 36 months.

  The new method accelerates the rate of amortization and has been adopted as
a result of revenue sharing agreements with studios, which have increased the
copy-depth, which is satisfying consumer demand over a shorter period of time.
The Company believes accelerating expense recognition during the first 3
months more closely matches the new business model of higher revenue generated
following a title's release. Under the new accounting method, the Company
expenses revenue sharing payments as revenues are earned pursuant to
contractual arrangements.

  The new method of accounting has been applied to rental inventory held as of
February 1, 1999. The Company recorded a pre-tax charge of approximately
$50,629,000 to operating expenses in the fourth quarter of 1999. The effect of
the change had the impact of decreasing inventory and increasing amortization
expense through a one-time charge.

3. Moovies, Inc. Acquisition

  In March 1998 the Company completed the acquisition of Moovies, Inc.
("Moovies") in a tax-free reorganization, whereby Moovies stockholders
received .75 shares of Video Update Class A Common Stock in exchange for each
share of Moovies common stock. Video Update issued approximately 9.3 million
shares in this transaction. The acquisition was accounted for under the
purchase method of accounting and the excess of the cost over the estimated
fair value of the assets acquired, estimated to be approximately $46,291,000,
will be amortized over 20 years.

  In March 1998, the stockholders in conjunction with the Moovies transaction
approved the termination and cancellation of the Escrow Agreement by and among
American Stock Transfer & Trust Company, Video Update and certain stockholders
of Video Update. As a result: (i) 10% or 130,000 of the 1,300,000 shares of
Class B Common Stock held in escrow were forfeited; (ii) the remaining
1,170,000 shares of common stock were released from escrow, resulting in a
one-time compensation expense charge of approximately $3,546,000 which the
Company recognized as selling, general and administrative expense in the
fourth quarter of fiscal 1998; and, (iii) all 1,870,000 shares of Class B
Common Stock were converted into Class A Common Stock and the preferential
voting rights were eliminated.

                                     F-11
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  During the fourth quarter of 1998, the Company performed an analysis of the
stores acquired in the acquisition of Moovies, Inc. and adopted a business
restructuring plan to close approximately 17 of the acquired stores. This
resulted in a reserve of approximately $1,843,000 of future cash outlays for
lease terminations and miscellaneous closing costs, which was recorded in the
balance sheet as a result of purchase accounting. In fiscal year 1999, the
Company expended approximately $579,000 for lease terminations and
miscellaneous closing costs which reduced the reserve. Successful negotiations
of lease terminations resulted in an excess reserve of approximately $619,000
that was recorded as an adjustment to goodwill. The April 30, 1999 reserve of
approximately $645,000 represents future expected cash outlays for lease
terminations.

4. Provision for Store Closing and Other Charges

  During the fourth quarter of 1998, the Company began and completed an
extensive analysis of its base store performance and adopted a business
restructuring plan to close approximately 24 of its stores. This analysis
resulted in the Company recording a pretax charge of approximately $5,100,000.
The components of the restructuring charge included approximately $2,700,000
in reserves of future cash outlays for lease terminations and miscellaneous
closing costs, as well as approximately $2,400,000 in asset write downs
comprised of $1,596,000 and $804,000 for property and equipment and goodwill,
respectively. The revenues of stores identified for closure were not material
for the fiscal years ended April 30, 1997 and 1998. During fiscal year 1999,
$473,000 was expended for lease terminations and miscellaneous closing costs.
Successful negotiations of lease terminations resulted in an excess reserve of
approximately $1,337,000 that was recorded as an increase to net income. The
April 30, 1999 reserve of approximately $890,000 represents future expected
cash outlays for lease terminations.

  In addition, during the fourth quarter of fiscal 1998, the Company recorded
approximately the following significant charges in its selling, general and
administrative expenses: (i) $3,800,000 related to the Moovies acquisition,
$3,546,000 of which was a non-cash, non-tax deductible charge to compensation
expense related to the release of 1,170,000 shares of Class B Common Stock
from escrow (see Note 12 of the Notes to Consolidated Financial Statements
"Stockholders' Equity"); (ii) $3,236,000 non-cash charge relating to the
restated employment agreements for the Company's Chief Executive Officer and
its President, representing amounts which will be applied to their existing
stock option related loan obligations to the Company and $3,925,000 which will
be used by the executives to pay income taxes and loans arising from the same
stock option transaction (see Note 8 of the Notes to Consolidated Financial
Statements "Related Party Transactions"); and, (iii) $700,000 for the
previously capitalized bank fees related to the Company's previous Revolving
Credit Facility which was repaid prior to its maturity (see Note 7 of the
Notes to Consolidated Financial Statements "Notes Payable").

  During the fourth quarter of 1999, the Company began and completed an
extensive analysis of each store's performance and adopted a business
restructuring plan to close approximately 70 of its stores. This analysis
resulted in the Company recording a pretax charge of approximately
$16,135,000. The components of the restructuring charge included approximately
$9,535,000 in reserves of future cash outlays for lease terminations and
miscellaneous closing costs, as well as approximately $6,600,000 in net asset
write-downs. The revenues of stores identified for closure were approximately
$5,193,000, $11,592,000 and $17,742,000 for the fiscal years ended April 30,
1997, 1998, and 1999, respectively.

                                     F-12
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


5. Video and Game Rental Inventory--Net

<TABLE>
<CAPTION>
                                                                April 30,
                                                            -------------------
                                                              1998      1999
                                                            --------  ---------
                                                              (In thousands)
   <S>                                                      <C>       <C>
   Video and game rental inventory......................... $171,072  $ 232,374
   Accumulated amortization................................  (73,338)  (187,334)
                                                            --------  ---------
                                                            $ 97,734  $  45,040
                                                            ========  =========
</TABLE>

  Amortization expense for video and game rental inventory, which is included
in store operating expenses, was $20,317,000, $37,613,989 and $63,781,000 for
the years ended April 30, 1997, 1998 and 1999, respectively. Accumulated
amortization at April 30, 1999 also includes $50,629,000 related to the
valuation charge (see Note 2 of the Notes to Consolidated Financial Statements
"Change in Amortization Method for Video and Game Rental Inventory").

6. Property and Equipment--Net

<TABLE>
<CAPTION>
                                                                 April 30,
                                                             ------------------
                                                               1998      1999
                                                             --------  --------
                                                              (In thousands)
   <S>                                                       <C>       <C>
   Land..................................................... $    488  $    488
   Buildings................................................    1,403     1,403
   Furniture and equipment..................................   45,720    43,463
   Leasehold improvements...................................   34,454    36,204
   Accumulated depreciation.................................  (12,345)  (22,163)
                                                             --------  --------
                                                             $ 69,720  $ 59,395
                                                             ========  ========
</TABLE>

  Depreciation expense was $3,307,000, $6,880,000, and $11,370,000 for the
years ended April 30, 1997, 1998 and 1999, respectively.

                                     F-13
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


7. Notes Payable

  Simultaneously with the closing of the Movies transaction the Company
announced that a syndicate lead by Banque Paribas had extended a $120 million
Senior Facility (the "Senior Facility"), which replaced the previous revolving
credit facility. During fiscal year 1999 the Senior Facility was reduced to
$115 million. The notes payable balance consists of the following:

<TABLE>
<CAPTION>
                                                                April 30,
                                                            ------------------
                                                              1998      1999
                                                            --------  --------
                                                             (In thousands)
   <S>                                                      <C>       <C>
   Senior Facility with banks consisting of two term loans
    of $52,500,000 and $42,500,000; interest at 9.25% and
    9.50%, respectively; with principal payments beginning
    in May 1999, maturing in April 2002 and April 2003,
    respectively. Secured by substantially all assets of
    the Company...........................................  $ 95,000  $ 95,000
   Capital expenditure loan with banks; interest payable
    April 30, 1999 at 9.19%; with monthly payments begin-
    ning July 2000, and final maturity April 2002. Secured
    by substantially all assets of the Company............     4,500    15,000
   Revolving loan with banks; interest payable April 30,
    1999 at 9.21%; maturity April 2002. Secured by sub-
    stantially all assets of the Company..................     4,200     5,000
   Note payable with interest at 6.25% (see Note 18)......     2,000     2,000
   Note payable in monthly installments of $6,180 until
    January 2000, with a balloon payment of approximately
    $458,000, interest at the United States government
    treasury securities rate plus 4.5% (8.99% at April 30,
    1999). The note is secured by a mortgage and specific
    assets of the Company.................................       507       481
   Note payable with monthly installments of approximately
    $1,000 with interest rate of 12% maturing in May
    1999..................................................        11         1
   Discount on debt for 1,000,000 bank warrants; expiring
    March 2003............................................    (1,730)   (1,468)
                                                            --------  --------
                                                            $104,488  $116,014
                                                            ========  ========
</TABLE>

  The weighted-average interest rate on borrowings outstanding was 7.61%,
9.29% and 9.33% at April 30, 1997, 1998 and 1999, respectively.

  The aggregate maturities (effective May 28, 1999--See Notes 19 and 20 of the
Notes to Consolidated Financial Statements "Subsequent Events") of the notes
payable at April 30, 1999 are as follows:

<TABLE>
<CAPTION>
                                                                  (In thousands)
   <S>                                                            <C>
   2000 (9 months)...............................................    $  3,880
   2001..........................................................      18,912
   2002..........................................................      24,875
   2003..........................................................      59,565
   2004..........................................................      10,250
   Thereafter....................................................         --
                                                                     --------
                                                                     $117,482
   Discount on debt..............................................      (1,468)
                                                                     --------
                                                                     $116,014
                                                                     ========
</TABLE>

  The Senior Facility replaced the Company's previous $60 million revolving
credit facility. The Senior Facility consists of the following: (i) two term
loans totaling $95 million; (ii) a $15 million capital expenditure line; and,
(iii) a $10 million revolving line (reduced to $5 million in fiscal 1999). The
Company borrowed the

                                     F-14
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

$95 million under the two term loans in conjunction with the closing of the
Moovies merger and the proceeds were used to refinance the current
indebtedness of Moovies and Video Update and pay transaction expenses. The
capital expenditure line was primarily available to fund the conversion of the
Moovies stores and integration costs, the opening of new stores and selected
acquisitions. In fiscal year 1999, the Senior Facility was amended to modify
the terms of the capital expenditure line to allow usage for working capital
needs. The revolving line is available for normal working capital needs. The
facility is secured by all of the Company's assets. In connection with the
Senior Facility, the Company also issued five year warrants to Banque Paribas
to purchase one million shares of the Company's Class A Common Stock at an
exercise price of $2.68. The warrants were valued at $1,730,000 and resulted
in an increase in paid in capital and corresponding discount on debt. In
fiscal year 1999, the warrants were repriced to a more current market price in
conjunction with amendments to the Senior Facility as described above. This
discount, as well as related bank fees, will be amortized over the life of the
Senior Facility (see Note 20 of the Notes to Consolidated Financial
Statements).

  The Senior Facility includes negative, affirmative and financial covenants
including, but not limited to, minimum free cash flow, consolidated
indebtedness to consolidated free cash flow, maximum leverage, minimum fixed
charge coverage, a prohibition or restriction on capital expenditures, debt
and guarantees, liens and encumbrances on any property, mergers,
consolidations, investments, advances, divestitures, change of business or
conduct of business, joint ventures, partnerships, the creation of new
subsidiaries, dividends, distributions, repurchases or redemptions of
outstanding stock (including options or warrants), the voluntary prepayment,
repurchase redemption or defeasance of debt, and the acquisition, sale or
transfer, lease or sale-leaseback of assets. The Senior Facility is secured by
substantially all of the Company's assets as well as by pledges of its stock
in its subsidiaries, which subsidiaries also have provided guarantees of the
Company's obligations. The Company was not in compliance of certain of the
financial covenants of the Senior Facility at April 30, 1999. The Company has
obtained waivers with respect to the non-complying conditions and has further
amended the Senior Faiclity (see Note 20 of the Notes to Consolidated
Financial Statements).

8. Related Party Transactions

  Family members of stockholders and a Company director own a majority
interest at April 30, 1997, 1998 and 1999 in one, three and three franchise
stores, respectively. The amount of service fees earned from these franchisees
was approximately $25,000, $73,104 and $102,650 for the years ended April 30,
1997, 1998 and 1999, respectively. The amount due from the franchisees at
April 30, 1997, 1998 and 1999 approximated $2,850, $73,322 and $19,331,
respectively.

  During the years ended April 30, 1997, 1998 and 1999, the Company incurred
expenses of approximately $271,000, $561,000 and $270,000, respectively, to
Johnson, West & Co., PLC ("Johnson, West & Co.") for accounting and tax
services. A director of the Company is a member of Johnson, West & Co.

  Each of Messrs. Potter and Bedard have issued notes to the Company (the
"Recourse Notes") in connection with stock option exercises, for approximately
$2,080,147 and $1,155,637, respectively, including accrued interest through
April 30, 1998. In fiscal 1999, the Recourse Notes accrued additional interest
of $147,097 and $81,721 for a total Recourse Note balance of $2,227,244 and
$1,237,358 for Messrs. Potter and Bedard, respectively. The Recourse Notes
were issued by the executives upon their exercise in August 1995 of 420,000
options granted to them under the Stock Option Plans in May 1995 at an
exercise price of $4.3125, the fair market value of the stock on the date the
options were granted. The Recourse Notes represent the total exercise price of
such options plus amounts advanced by the Company to such executives to
satisfy then anticipated tax liabilities. The Recourse Notes, which provide
for full recourse against the respective officer's personal assets and Company
stockholdings, are evidenced by promissory notes bearing accrued interest at a
rate of 8% per annum with payment of principal and interest due on October 4,
1999. In the event that the obligors sell shares of the Company's stock, the
net proceeds thereof will be applied to payment, in part or in full, of the
Recourse Notes.

                                     F-15
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  In connection with the restated employment agreements for Mr. Potter and Mr.
Bedard, the Board has approved an accrual of bonuses that will be directed
primarily to satisfying obligations arising from the Recourse Notes. For
fiscal year 1998, bonus payments aggregating $816,580 were awarded as
reimbursement of previous payments of principal and interest on the Recourse
Notes and accompanying tax liability to the recipients. In addition, the Board
has approved the subsequent payment of additional aggregate bonuses of
approximately $6,345,000 to be used primarily to satisfy the Recourse Notes,
as well as the anticipated income tax liabilities to the executives subject to
any required approvals. In fiscal 1999, the Company accrued an additional
bonus of approximately $458,000 to be used to satisfy the fiscal 1999 accrued
interest related to the Recourse Notes as well as the anticipated income tax
liabilities of the executives subject to any required approvals. If such
bonuses are not effected, the Recourse Notes will remain outstanding. The
Company recorded compensation expense of approximately $7,162,000 in general
and administrative expense in 1998 to reflect these revisions. The resultant
accrual for compensation expense has been recorded as an offset to the
officers' loan obligations, in essence treated as loan forgiveness, with the
balance of the accrual included in accrued compensation in the balance sheet
as of April 30, 1998 and 1999 (see Note 4 of the Notes to Consolidated
Financial Statements "Provision for Store Closing and Other Charges").

9. Commitments and Contingencies

 Employment Contracts

  In fiscal 1998, the Company entered into employment agreements with three of
its executive officers. In fiscal 1999, the Company entered into employment
contracts with two additional officers. The agreements provide for annual base
salary amounts as well as provisions for potential bonuses and stock option
grants. The agreements further provide for specified additional payments in
the event of termination or transactions that would result in change of
control of the Company.

 Lease Agreements

  The Company leases office and retail space under operating leases with terms
of 6 to 204 months. These leases generally have a term of 3 to 10 years and
provide options to renew for periods ranging from 3 to 5 additional years.
Under the leasing agreements, the Company is generally responsible for the
real estate taxes, insurance, and other expenses related to the property. The
leases expire at varying dates through 2015. The Company also leases vehicles
and computer equipment.

  In November 1998, the Company entered into a sale/leaseback arrangement with
respect to certain of its furniture, fixtures, equipment and signage used in
selected retail locations. Under the arrangement the Company obtained
approximately $5.0 million.

  At April 30, 1999, minimum annual rental commitments under non-cancelable
operating leases are as follows:

<TABLE>
<CAPTION>
                                                                  (In thousands)
                                                                  --------------
   <S>                                                            <C>
   2000 (9 months--see Note 19)..................................    $ 38,235
   2001..........................................................      44,654
   2002..........................................................      36,882
   2003..........................................................      31,434
   2004..........................................................      29,704
   Thereafter....................................................     109,932
                                                                     --------
   Total minimum lease payments..................................    $290,841
                                                                     ========
</TABLE>

                                     F-16
<PAGE>

                               VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  Rent expense, principally retail and office space, under operating leases
amounted to $13,513,000, $28,180,000 and $47,201,000 for the years ended April
30, 1997, 1998 and 1999, respectively.

 Supplier Agreement

  The Company has an agreement with a United States supplier of video rental
tapes. Under the terms of the agreement, the Company has purchase obligations
related to all non-studio revenue sharing rental tape purchases. The quantity
of purchases is subject to availability by the supplier and the established
credit limit for the Company.

10. Income Taxes

  Income (loss) before income taxes consisted of the following:

<TABLE>
<CAPTION>
                                                    Fiscal Year Ended April
                                                              30,
                                                   ---------------------------
                                                    1997     1998      1999
                                                   ------  --------  ---------
                                                        (In thousands)
<S>                                                <C>     <C>       <C>
United States..................................... $5,525  $(21,308) $ (94,635)
Canada............................................  2,437       712    (12,908)
                                                   ------  --------  ---------
Net income (loss) before income taxes............. $7,962  $(20,596) $(107,543)
                                                   ======  ========  =========

  Income tax expense is as follows:

<CAPTION>
                                                    Fiscal Year Ended April
                                                              30,
                                                   ---------------------------
                                                    1997     1998      1999
                                                   ------  --------  ---------
                                                        (In thousands)
<S>                                                <C>     <C>       <C>
Current:
  Federal......................................... $1,384  $ (1,812) $     154
  State...........................................    422        52        100
  International...................................     50       --         --
                                                   ------  --------  ---------
                                                    1,856    (1,760)       254
Deferred:
  Federal.........................................    413    (3,706)   (30,093)
  State...........................................    (15)   (1,062)    (5,786)
  International...................................  1,088       412     (5,695)
                                                   ------  --------  ---------
                                                    1,486    (4,356)   (41,574)
  Less: Valuation allowance.......................    --        --      44,148
                                                   ------  --------  ---------
                                                    1,486    (4,356)     2,574
                                                   ------  --------  ---------
Total income tax expense (benefit)................ $3,342  $ (6,116) $   2,828
                                                   ======  ========  =========
</TABLE>

                                      F-17
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  Components of the net deferred tax asset, resulting from differences in book
and income tax accounting methods, are as follows:

<TABLE>
<CAPTION>
                                                            Fiscal Year Ended
                                                                April 30,
                                                            -------------------
                                                              1998      1999
                                                            --------  ---------
                                                              (In thousands)
<S>                                                         <C>       <C>
Deferred income tax liabilities:
  Tax over book depreciation and amortization.............. $ (4,798) $     --
  Tax over book mergers basis adjustment...................     (254)       --
                                                            --------  ---------
    Deferred income tax liabilities........................   (5,052)       --
Deferred income tax assets:
  Book over tax depreciation and amortization..............      --       9,853
  Book over tax deferred expense...........................      --         738
  Book over tax rent expense...............................    1,613      2,339
  Book over tax deferred revenue...........................      --          25
  Book over tax employment related accruals................    2,414      2,586
  Net operating loss carryforwards.........................    1,649     24,372
  Book over tax restructuring and other accruals...........    1,968      4,235
                                                            --------  ---------
    Deferred income tax assets.............................    7,644     44,148
Deferred tax asset valuation allowance.....................      --     (44,148)
                                                            --------  ---------
                                                               7,644        --
                                                            --------  ---------
Net deferred income tax assets............................. $  2,592  $     --
                                                            ========  =========
</TABLE>

  The reconciliation of the federal statutory rate (34%) to the Company's
effective income tax rate is as follows:

<TABLE>
<CAPTION>
                                               Fiscal Year Ended April 30,
                                               -------------------------------
                                                 1997      1998        1999
                                               --------- ---------   ---------
                                                      (In thousands)
<S>                                            <C>       <C>         <C>
Federal tax at statutory rate.................     34.0%     (34.0)%     (34.0)%
State tax, net of federal benefit.............      2.8       (3.3)       (3.6)
Release of escrow shares......................      0.0        5.8         0.0
International.................................      3.5        0.5        (1.3)
Goodwill amortization.........................      1.0        0.7         0.3
Other.........................................      0.7        0.6         0.0
Change in valuation allowance.................      0.0        0.0        41.2
                                               --------  ---------   ---------
                                                   42.0%     (29.7)%       2.6%
                                               ========  =========   =========
</TABLE>

  Realization of the future tax benefits related to the deferred assets is
dependent on many factors, including the Company's ability to generate taxable
income within the net operating loss carryforward period. Management has
considered these factors in reaching its conclusion as to the valuation
allowance for financial reporting purposes.

  At April 30, 1999, the Company has United States federal and state tax loss
carryforwards of approximately $84 million which expire between the years 2007
to 2014. Approximately $20 million of the net operating loss carryforward is
limited to $1.5 million each year in accordance with the Internal Revenue
Code.

                                     F-18
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


11. Supplemental Cash Flow Information

<TABLE>
<CAPTION>
                                                          Fiscal Year Ended
                                                              April 30,
                                                        ----------------------
                                                         1997   1998    1999
                                                        ------ ------- -------
                                                            (In thousands)
<S>                                                     <C>    <C>     <C>
Interest paid.......................................... $  390 $ 3,223 $12,345
Income taxes paid (refunded)........................... $1,394 $ 1,725 $(2,175)
Common stock issued in Moovies acquisition............. $  --  $28,200 $   --
</TABLE>

12. Stockholders' Equity

 Class A Common Stock; Class B Common Stock

  In connection with the Company's initial public offering, all of the holders
of the Company's Class B Common Stock placed on a pro rata basis, an aggregate
of 1,300,000 shares (the "Escrow Shares") into escrow. As a result of the
Stockholders' vote to release 90% of the shares from escrow in fiscal 1998,
the remaining 130,000 shares were forfeited. The shares released from escrow
and the remaining 700,000 shares of Class B Common Stock outstanding were
converted into Class A Common Stock. As a result, as of April 30, 1998 and
1999, there were no shares of Class B Common Stock outstanding.

  The Securities and Exchange Commission requires that the release of the
Escrow Shares to officers, directors, employees and consultants of the Company
be recognized as a compensatory non-cash compensation expense in the statement
of operations with a corresponding offset as an increase to additional paid-in
capital. As such, stockholders' equity in total did not change. The expense of
$3,546,000 was equal to the fair market value of the Escrow Shares on the date
of release.

 Shareholders' Rights Agreement

  In April 1998, the Board of Directors approved the declaration of a dividend
of one preferred share purchase right (a "Right") for each outstanding share
of Class A Common Stock, par value $.01 per share (the "Common Shares") and
for each outstanding Class B Warrant ("Warrants"), of the Company. The
dividend was paid on April 24, 1998 (the "Record Date") to the stockholders
and Class B Warrant holders of record on that date. Each Right entitles the
registered holder to purchase from the Company one one-hundredth of a share of
Series A Junior Participating Preferred Stock, par value $.01 per share (the
"Preferred Shares"), of the Company at a price of $20.00 per one one-hundredth
of a Preferred Share (the "Purchase Price") subject to adjustment.

  Until the earlier to occur of (i) 10 days following a public announcement
that a person or group of affiliated or associated persons have acquired
beneficial ownership of 15% or more of the outstanding Common Shares (an
"Acquiring Person") or (ii) 10 business days (or such later date as may be
determined by action of the Board of Directors prior to such time as any
person or group of affiliated persons becomes an Acquiring Person) following
the commencement of, or announcement of an intention to make, a tender offer
or exchange offer the consummation of which would result in the beneficial
ownership by a person or group of 15% or more of the outstanding Common Shares
(the earlier of such dates being called the "Distribution Date"), the Rights
will be evidenced, with respect to any of the Common Shares or Warrant
certificates outstanding as of the Record Date, by such Common Share
certificate or such Warrant certificate, as the case may be.

  In the event that any person or group or affiliated of associated persons
becomes an Acquiring Person, proper provision shall be made so that each
holder of a Right, other than Rights beneficially owned by the Acquiring
Person (which will thereafter be void), will thereafter have the right to
receive upon exercise--in lieu of Preferred Shares--that number of Common
Shares having a market value of two times the exercise price of the Right. At
any time after any person or group becomes an Acquiring Person and prior to
the acquisition by

                                     F-19
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

such person or group of 50% or more of the outstanding Common Shares, the
Board of Directors of the Company may exchange the Rights (other than Rights
owned by such person or group which will have become void), in whole or in
part, at an exchange ratio of one Common Share, or one one-hundredth of a
Preferred Share (or of a share of a class or series of the Company's preferred
stock having equivalent rights, preferences and privileges), per Right
(subject to adjustment).

  Until a Right is exercised, the holder thereof, as such, will have no rights
as a stockholder of the Company, including, without limitation, the right to
vote or to receive dividends.

 Warrants--Class A and B

  Each of the units sold in connection with the Company's public offerings
consisted of one share of Class A Common Stock of the Company, one Class A
Warrant and one Class B Warrant. The components of the units were separately
transferable immediately. When issued, each Class A Warrant, upon its
exercise, entitled the holder to purchase one share of the Company's Class A
Common Stock and one Class B Warrant. The Class A Warrant exercise price was
$6.50 per share subject to certain adjustments. In August 1995, the Company
called for redemption all of its outstanding Class A Warrants. The redemption
date set forth in the Notice of Redemption was September 7, 1995.
Approximately 4,502,000 Class A Warrants were exercised resulting in net
proceeds to the Company of approximately $28,414,000. At April 30, 1999, the
Company had Class B Warrants outstanding enabling the holders the ability to
purchase approximately 8,005,000 shares of Class A Common Stock at $8.75 per
share. Such warrants expired in July 1999. In addition, there were 500,000
Class B Warrants outstanding that were issued by the Company in a 1994 bridge
financing. These warrants provided the holders the ability to purchase the
underlying Class A Common Stock of the Company at $8.75 per share and expired
in July 1999.

 Blair Options

  At April 30, 1999 the Company had 117,500 shares of Class A Common Stock
reserved for issuance upon exercise of the Unit Purchase Option (the "Initial
Option") at an aggregate exercise price of $734,375, issued to D.H. Blair
Investment Banking Corp. ("Blair") in connection with its services as
underwriter of the Company's initial public offering; 230,550 shares of Class
A Common Stock reserved for issuance upon exercise of the Unit Purchase Option
(the "Subsequent Option") at an aggregate exercise price of $1,033,500, issued
to Blair or its' affiliates in connection with its services as underwriter of
the Company's subsequent public offering (collectively, the Initial Option and
the Subsequent Option are referred to as the "Blair Options"); 348,050 shares
of Class A Common Stock reserved for issuance upon exercise of the redeemable
Class A Warrants (the "Class A Warrants") underlying the Blair Options, at an
exercise price of $6.50 per share; and 696,100 shares of Class A Common Stock
issuable upon exercise of the Class B Warrants underlying the Blair Options,
at an exercise price of $8.75 per share. The issuable Class A Warrants and the
issuable and outstanding Class B Warrants underlying the Blair Options expired
in July 1999.

13. Stock Option Plans

  In April 1994, the Company established an incentive stock option plan (the
"1994 Stock Plan") whereby 150,000 shares of Class A Common Stock have been
reserved. The options can be either incentive stock options or non-qualified
options, as defined by Section 422 of the Internal Revenue Code ("Section
422") to be granted to eligible individuals. The exercise price for the
incentive stock options granted under the 1994 Stock Plan may not be less than
the fair market value of the Class A Common Stock on the date the option is
granted.

  In September 1994, the Board of Directors approved the Formula Stock Option
Plan (the "Formula Plan") whereby 50,000 shares of Class A Common Stock have
been reserved. The Formula Plan provides for the

                                     F-20
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

granting of options to non-management directors of the Company. The exercise
price for the incentive stock options granted under the plan may not be less
than the fair market value of the Class A Common Stock on the date the option
is granted. To date, none of these options have been exercised.

  In May 1995, the Company established an additional stock option plan (the
"1995 Plan") whereby 850,000 shares were reserved for grant to eligible
individuals to purchase Class A Common Stock of the Company. Options under the
1995 Plan may be incentive stock options or non-qualified options. The
exercise price for the incentive stock options granted under the 1995 Plan may
not be less than fair market value of the Class A Common Stock on the date the
option is granted. In August 1995, 420,000 options were exercised by the CEO
and President of the Company.

  In June 1996, the Board of Directors approved an additional stock option
plan (the "1996 Plan"). The 1996 Plan provides for the granting of up to
820,000 options to eligible individuals to purchase shares of Class A Common
Stock of the Company. Options under the 1996 Plan may be incentive stock
options or non-qualified stock options. The exercise price for the incentive
stock options granted under the plan, may not be less than the fair market
value of the Class A Common Stock on the date the option is granted. To date,
none of these options granted under such plan have been exercised.

  In January 1998, the Board of Directors approved an additional stock option
plan (the "1998 Plan"). The 1998 Plan provides for the granting of up to
1,750,000 options to eligible individuals to purchase shares of Class A Common
Stock of the Company. Options under the 1998 Plan may be incentive stock
options or non-qualified stock options. The exercise price for the incentive
stock options granted under the plan may not be less than the fair market
value of the Class A Common Stock on the date the option is granted. To date,
none of these options have been exercised.

  In August 1999, the Board of Directors approved the repricing of
approximately 1,360,000 stock options to $1.06 per share.

  In fiscal 1997, the Company adopted the disclosure-only provision of SFAS
No. 123 for Stock-based Compensation. SFAS No. 123 allows companies to
continue to account for those plans using the accounting prescribed by APB
Opinion 25, "Accounting for Stock Issued to Employees". The Company has
elected to continue to account for stock-based compensation using APB 25,
making pro forma disclosure of net earnings and earnings per share as if the
fair value based method had been applied.

  Accordingly, no compensation expense has been recorded for the stock option
plans. Had compensation expense for the stock option plans been determined
based on the fair value at the date of grant for awards in fiscal 1997, 1998,
and 1999, consistent with SFAS No. 123, the Company's net earnings and
earnings per share for the fiscal years shown below would have been reported
as follows:

<TABLE>
<CAPTION>
                                                     1997    1998      1999
                                                    ------ --------  ---------
                                                         (In thousands,
                                                    except per share amount)
<S>                                                 <C>    <C>       <C>
Net income (loss)--pro forma....................... $4,217 $(15,700) $(111,481)
Basic net income (loss) per share--pro forma....... $  .27 $   (.77) $   (3.81)
Diluted net income (loss) per share--pro forma..... $  .26 $   (.77) $   (3.81)
</TABLE>

                                     F-21
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  The fair market value of each option grant is estimated on the date of the
grant using the Black-Scholes option-pricing model with the following weighted
average assumptions:

<TABLE>
<CAPTION>
                                                          1997    1998    1999
                                                         ------- ------- -------
   <S>                                                   <C>     <C>     <C>
   Expected dividend yields.............................      0%      0%      0%
   Expected stock price volatility......................   42.5%   88.9%   69.5%
   Risk free interest rate..............................    5.1%    5.5%    4.6%
   Expected life of options............................. 5 years 5 years 5 years
</TABLE>

  The pro forma effect of net income and earnings per share is not
representative of the pro forma earnings in future years because it does not
take into consideration pro forma compensation expense related to grants made
prior to 1996.

  The weighted average fair value for options granted during fiscal 1997, 1998
and 1999 is $1.89, $1.45 and $0.83 per share, respectively.

  Option activity is summarized as follows:

<TABLE>
<CAPTION>
                                                                    Weighted
                                                    Outstanding Average Exercise
                                                      Options   Price Per Share
                                                    ----------- ----------------
   <S>                                              <C>         <C>
   Outstanding at April 30, 1996...................    534,450        5.15
     Granted.......................................    861,200        4.14
     Exercised.....................................     (1,000)       4.31
     Canceled......................................    (13,700)       5.45
                                                     ---------
   Outstanding at April 30, 1997...................  1,380,950        4.53
     Granted.......................................  1,015,402        6.93
     Exercised.....................................        --          --
     Canceled......................................   (193,650)       4.49
                                                     ---------
   Outstanding at April 30, 1998...................  2,202,702        5.64
     Granted.......................................    174,000        1.06
     Exercised.....................................        --
     Canceled......................................   (733,202)       7.36
                                                     ---------
   Outstanding at April 30, 1999...................  1,643,500        4.17
                                                     ---------
   Exercisable at April 30, 1997...................    293,480        5.40
   Exercisable at April 30, 1998...................  1,021,578        7.85
   Exercisable at April 30, 1999...................    947,923        4.95
</TABLE>

  The following table summarizes information concerning currently outstanding
and exercisable options:

<TABLE>
<CAPTION>
                                  Weighted
                                  Average   Weighted              Weighted
                                 Remaining  Average               Average
       Range of        Options   Contracted Exercise    Number    Exercise
   Exercise Prices   Outstanding    Life     Price   Exerciseable  Price
   ---------------   ----------- ---------- -------- ------------ --------
   <S>               <C>         <C>        <C>      <C>          <C>
        $0 to $3.50     529,000     9.15     $2.45     116,583     $3.14
     $3.51 to $5.00     807,600     7.24      4.06     583,650      4.07
     $5.01 to $8.00     231,150     3.17      5.95     171,940      6.01
    $8.01 to $12.00      47,600     5.10     10.58      47,600     10.58
   $12.01 to $16.00      28,150     6.62     14.51      28,150     14.51
   ----------------   ---------     ----     -----     -------     -----
       $0 to $16.00   1,643,500     7.21     $4.17     947,923     $4.95
   ================   =========     ====     =====     =======     =====
</TABLE>

                                     F-22
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


14. Acquisitions

  During fiscal year 1997 and 1998, the Company acquired, in 11 transactions,
one video retail store previously operated by Video Update franchisees, and
341 video retail stores operated by unaffiliated third party operators (the
"Acquisitions"). There were no acquisitions in fiscal year 1999. The purchase
method of accounting has been used to account for each of the Acquisitions and
the Acquisitions are included in the Company's consolidated financial
statements from the date of acquisition.

  During fiscal 1997, the Company acquired, in 10 transactions, 74 retail
stores. The aggregate purchase price of these acquisitions totaling
approximately $22,513,000 included approximately $20,977,000 in cash,
approximately $927,000 in transaction costs, and 136,500 shares of Class A
Common Stock valued at approximately $609,000. The excess of the cost over the
estimated fair value of the assets acquired of approximately $13,367,000
(goodwill) is being amortized over 20 years on a straight-line basis.

  During fiscal 1998, the Company acquired, in 1 transaction, 267 retail
stores. The aggregate purchase price of this acquisition totaled approximately
$83,458,900 included approximately $50,171,200 in assumed indebtedness,
approximately $5,087,500 in transaction costs, and 9,303,927 shares of Class A
Common Stock valued at approximately $28,200,200. The excess of the cost over
the estimated fair value of the assets acquired (goodwill) of approximately
$46,291,000 is being amortized over 20 years on a straight-line basis.

  The following unaudited pro forma information presents the consolidated
results of operations of the Company as if the fiscal year 1997 and 1998
acquisitions had been completed at the beginning of the year in which the
acquisition occurred and the immediately preceding year. There were no
acquisitions in fiscal 1999. In the opinion of the Company's management, all
adjustments necessary to present fairly such pro forma summary have been made
based on the terms and structure of the transactions.

<TABLE>
<CAPTION>
                                                   Fiscal Year Ended April 30,
                                                   ---------------------------
                                                       1997          1998
                                                   ------------- -------------
                                                    (In thousands, except per
                                                           share data)
   <S>                                             <C>           <C>
   Revenues....................................... $     200,244 $     248,134
   Net income (loss) from continuing operations... $       9,558 $     (28,562)
   Basic net income (loss) per share.............. $         .33 $        (.98)
   Diluted net income (loss) per share............ $         .32 $        (.98)
</TABLE>

  This unaudited pro forma financial summary does not necessarily indicate the
actual results had the Acquisitions occurred at the beginning of the
respective periods, nor do they purport to indicate the results of future
operations of the Company.

  During October 1996, a cash deficiency payment was made with regard to one
acquisition in the cash amount of $87,135. During November 1996, a cash
deficiency payment was made with regard to one acquisition in the amount of
$88,547. Also, during November 1996, the Company satisfied a deficiency
payment of $77,951 with regard to one acquisition with 15,106 shares of Class
A Common Stock. During fiscal 1998, cash deficiency payments were made with
regard to one acquisition in the amount of $1,327,000. In addition, in fiscal
1998, 65,750 shares placed in escrow as a result of an acquisition were
cancelled.

  In connection with an acquisition that the Company completed in fiscal 1996,
the Company was obligated to make deficiency payments to the sellers equal to
the difference between a guaranteed price for each share issued, and the
actual market price obtained for such shares as of specified dates. During
fiscal 1999, deficiency payments of approximately $181,000 were made with
respect to this acquisition and in June 1999 a final payment of approximately
$71,000 (including approximately $60,000 for deficiency payments) was made in
full settlement of all obligations related to the sellers.

                                     F-23
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  The Company is currently disputing a deficiency payment allegedly due with
respect to 239,163 shares which were issued to a seller in the Videoland
acquisition (see Note 18 of the Notes to Consolidated Financial Statements
"Legal Proceedings"); the seller is claiming a deficiency payment of
approximately $1,220,000 based on proceeds from the sale of Class A Common
Stock during the six month period of March 1996 to September 1996. The Company
has the option of satisfying approximately $1,220,000 (with respect to 239,163
shares) through the issuance of additional shares of Class A Common Stock.

15. Geographic Business Operations

  The Company owns and operates retail video stores in the United States and
in Canada. A summary of the Company's operations by geographic area is
presented for fiscal 1997, 1998, and 1999. All inter-company revenues and
expenses have been eliminated.

<TABLE>
<CAPTION>
                                                          Operating   Long-Lived
                                               Revenues Income (Loss)   Assets
                                               -------- ------------- ----------
                                                        (In thousands)
   <S>                                         <C>      <C>           <C>
   Fiscal 1997
     United States............................ $ 71,650   $  6,913     $ 65,749
     Canada...................................   20,149      1,480       20,117
                                               --------   --------     --------
                                               $ 91,799   $  8,393     $ 85,866
                                               ========   ========     ========
   Fiscal 1998
     United States............................ $116,958   $(17,579)    $150,061
     Canada...................................   39,196      1,346       26,560
                                               --------   --------     --------
                                               $156,154   $(16,233)    $176,621
                                               ========   ========     ========
   Fiscal 1999
     United States............................ $212,980   $(81,748)    $ 97,268
     Canada...................................   41,116    (12,777)      13,560
                                               --------   --------     --------
                                               $254,096   $(94,525)    $110,828
                                               ========   ========     ========
</TABLE>

16. Financial Instruments with Off-Balance-Sheet Risk and Fair Value of
Financial Instruments

  The Company is party to financial instruments with off-balance-sheet risk
which are entered into in the normal course of business to meet its financing
needs and to manage its exposure to fluctuations in market rates. These
financial instruments include swap agreements and interest rate caps. The
instruments involve, to a varying degree, elements of credit and market risk
in addition to amounts recognized in the financial statements. The Company
does not hold or issue financial instruments for trading purposes.

  The swap agreements are contracts to exchange fixed and floating payments
periodically over the life of the agreements without the exchange of the
underlying notional amounts. The notional amounts of such agreements are used
to measure amounts to be paid or received and do not represent the amount of
the exposure to credit loss. The amounts to be paid or received under the swap
agreements are accrued consistently with the terms of the agreements and
market rates. The agreements are with major financial institutions which are
currently expected to fully perform under the terms of the agreements, thereby
mitigating the credit risk from the transactions in the event of
nonperformance by the counter-parties. In addition, the Company continuously
monitors the credit ratings of the counter-parties, and the likelihood of
default is considered remote.


                                     F-24
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  The Company had two interest rate swaps at April 30, 1999 as detailed below.

  The notional amount of the first variable-to-fixed swap agreements totaled
$14,700,000 at April 30, 1999, with a pay rate of 6.737% and a receive rate of
4.99% based on three month LIBOR. The agreement expires in April 2000.

  The notional amount of the second variable-to-fixed swap agreement is
$4,920,000 which will be in effect beginning April 30, 2000, with a pay rate
of 5.94% and a receive rate based on three month LIBOR. The agreement expires
April 2001.

  The carrying amounts and estimated fair values of the Company's swap
instrument at April 30, 1999 are as follows (in thousands):

<TABLE>
<CAPTION>
                                                             Carrying    Fair
                                                            Amount (A) Value (A)
                                                            ---------- ---------
   <S>                                                      <C>        <C>
   Swap agreements expiring April 2000.....................    $ 0       $(117)
   Swap agreements expiring April 2001.....................    $ 0       $  15
</TABLE>

(A) Carrying amount represents accrued payments under the swap agreements. The
    fair value represents the estimated amount that the Company would
    receive/(pay) to the counter-parties to terminate the swap agreement at
    April 30, 1999. (B)

17. Quarterly Financial Data (Unaditied)

  Selected quarterly financial data is as follows (in thousands, except per
share data):

<TABLE>
<CAPTION>
                                             1st      2nd      3rd      4th
               Fiscal 1999                 Quarter  Quarter  Quarter  Quarter
               -----------                 -------  -------  -------  --------
<S>                                        <C>      <C>      <C>      <C>
Revenue................................... $61,693  $62,184  $70,692  $ 59,527
Operating income (loss)(1)................  (3,103)  (9,486)   1,160   (83,096)
Net income (loss).........................  (6,478) (12,629)  (2,123)  (89,141)
Basic earnings per share..................   (0.22)   (0.43)   (0.07)    (3.05)
Diluted earnings per share................ $ (0.22) $ (0.43) $ (0.07) $  (3.05)
<CAPTION>
                                             1st      2nd      3rd      4th
               Fiscal 1998                 Quarter  Quarter  Quarter  Quarter
               -----------                 -------  -------  -------  --------
<S>                                        <C>      <C>      <C>      <C>
Revenue................................... $30,806  $33,131  $41,782  $ 50,435
Operating income (loss)(1)................     945     (636)   4,093   (20,635)
Net income (loss).........................     110   (1,007)   1,808   (15,391)
Basic earnings per share..................    0.01    (0.05)    0.10     (0.77)
Diluted earnings per share................ $  0.01  $ (0.05) $  0.10  $  (0.77)
</TABLE>
--------
(1) Certain reclassifications have been made to conform with the 1999 fiscal
    year-end presentation.

18. Legal Proceedings

  In connection with the acquisition of the assets of Videoland, Inc.
("Videoland") in November 1995, the Company issued 239,163 shares of its Class
A Common Stock (the "Videoland Shares") to the sellers of the assets of
Videoland (the "Videoland Sellers"). With respect to the Videoland Shares, the
Company agreed to make a deficiency payment in October 1996 to the Videoland
Sellers if the gross proceeds received by such sellers from the sale of the
Videoland Shares during the six months from March 1996 through September 1996
is not equal to the number of shares of Videoland Shares sold multiplied by
$12.00. The Videoland Sellers were subject to certain "lockup" or sale
restrictions as a condition to any deficiency payment. The Company initiated

                                     F-25
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

an action in federal district court in Minnesota for a declaratory judgment
that the Videoland Sellers are not entitled to any deficiency payment in light
of the failure by such sellers to comply with the lockup or sale restrictions.
In January 1998, the court entered a judgment, payable in the Company's stock
or cash, against the Company in the amount of $1,220,403 plus interest from
October 1996, and attorney's fees. The Eighth Circuit recently denied the
Company's appeal. The Company is exploring further avenues of relief. The
foregoing description is qualified in its entirety by reference to the full
text of the complaint and papers on file in the action.

  In May 1998, Rousnam Video, Inc., a Michigan corporation and Hani (Al)
Monsour (collectively "Monsour") filed a lawsuit in state court (Macomb
County, Michigan) claiming amounts due pursuant to post-closing adjustments
contemplated in connection with an Asset Purchase Agreement among Monsour and
Moovies, Inc. dated as of March 14, 1997, and the alleged default on a
Promissory Note among Monsour and Moovies, Inc. in the amount of $2,000,000
which is currently reflected in notes payable. The trial court has ruled in
favor of the plaintiffs on a motion for summary judgment, and a judgment for
$2,370,195 has been entered against the Company. The Company believes it has
meritorious grounds for its appeal which is currently pending, although
assurances cannot be given as to the outcome of such action. The foregoing
description is qualified in its entirety by reference to the full text of the
complaint and papers on file in the action.

  In May 1998, four stockholders filed suit in the US District Court for the
Central District of California. The Plaintiff stockholders allege that Mr.
Potter and the Company made false and misleading statements or omitted
material information about the Company and the video industry during the
period April 1995 to September 1996, the date of its subsequent public
offering. Plaintiffs are seeking "at least the sum of $967,967," plus
interest, additional damages and attorneys' fees. The Company and Mr. Potter
believe that the claims are unsubstantiated, without merit and they intend to
defend the matter vigorously. A motion to dismiss the First Amended Complaint
was granted, but the court allowed Plaintiffs to re-file. At present, the
Second Amended Complaint has been filed. The Company is in the process of
discovery, which is not scheduled to close until December 1999. The foregoing
description is qualified in its entirety by reference to the full text of the
complaint and papers on file in the action.

  In August 1998, the Company filed suit in federal court in Oregon against
Rentrak Corporation, an Oregon Corporation. The Company alleges that Rentrak
has violated the federal antitrust law, given Rentrak's position in the market
and its exercise of monopoly power. Rentrak has counter-claimed for amounts it
alleges were owed by Moovies, Inc. prior to the acquisition of Moovies, Inc.
by the Company; the Company has denied that any sums are due. Discovery in the
matter is now scheduled to be completed in December 1999. The Company intends
to pursue its claims aggressively, although assurances cannot be given as to
the outcome of this matter. The foregoing description is qualified in its
entirety by reference to the full text of the complaint and papers on file in
the action.

  On June 20, 1999, Allen Industries, Inc., a North Carolina corporation,
filed a lawsuit against the Company claiming approximately $3 million in
unpaid invoices arising out of the conversion of various Moovies stores. The
Company has asserted that Allen Industries breached its contract and performed
defective work. The Company believes that the claims of Allen Industries are
unsubstantiated and without merit. The Company intends to defend the matter
vigorously. The foregoing description is qualified in its entirety by
reference to the full text of the complaint and papers on file in the action.

  On April 12, 1999, Sight and Sound Distributors, Inc., a Delaware
corporation, filed a lawsuit in state court (St. Louis County, Missouri)
alleging that the Company owes approximately $7.7 million for goods and
services purchased from Sight & Sound. The Company filed its answer denying
liability and alleging entitlements to off-sets and credits in the amount of
$3.5 million. The Company is in the process of discovery. A required
settlement conference has been scheduled for December 20, 1999. The foregoing
description is qualified in its entirety by reference to the full text of the
complaint and papers on file in the action.

                                     F-26
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  In addition to the above, the Company is involved in various legal
proceedings arising during the normal course of conducting business.
Management believes that the resolution of these proceedings will not have any
material adverse impact on the Company's financial statements.

19. Change in Fiscal Year-End

  In December 1998, the Company's Board of Directors approved a resolution
changing the Company's fiscal year-end from April 30 to January 31, effective
January 31, 2000.

20. Subsequent Events

  On May 11, 1999, the Company provided a 12% interest bearing promissory note
to Ingram Entertainment, Inc. ("Ingram") for $14,000,000 for the settlement of
accounts payable to be repaid in monthly installments through May 11, 2002.
The Company also issued Ingram a warrant to purchase 1,000,000 shares of Class
A Common Stock for an aggregate purchase price of $810,000 which expires May
11, 2004.

  In August 1999, the Board of Directors approved the repricing of
approximately 1,360,000 stock options to $1.06 per share.

  Effective May 28, 1999, the Company and the bank syndicate amended the terms
of the Senior Facility to, among other things; (i) increase the overall Senior
Facility with a new tranche of C Term loans in the aggregate amount of $10.5
million maturing June 2006, and bearing 12% interest; (ii) revise certain
financial covenants; (iii) revise and defer certain principal payments; (iv)
increase the overall interest rate by 0.75%; and (v) reflect the issuance of
7,481,250 warrants at $0.8719 per share expiring June 2006. The Company is
using proceeds of the new C Term loans for, among other things, the purchase
of rental inventory, payments related to expected store closings, trade
payables, and debt service. The Company believes that its relationship with
the Senior Facility lenders is satisfactory and that it would be able to
obtain any necessary waivers, amendments or modifications to the Senior
Facility if the Company's operating performance causes it to fall short of
certain financial covenants in the Senior Facility, although no assurances can
be given. If the Company is unable to maintain such a level of operations, it
will be required to reduce its overall expenditures and expansion plans to
comply with the covenants and requirements of the Senior Facility.
Additionally, any failure by the Company to maintain its level of operations
within the covenants and requirements of the Senior Facility could cause the
Company to be in default thereunder, allowing the lenders to take legal action
against the Company, including but not limited to, the immediate acceleration
of payment of borrowed funds, which could materially and adversely affect the
Company's operations. The immediate acceleration of debt thereunder or the
lack of further borrowing capacity, in whole or in part, would have a material
adverse effect on the Company's operations and financial condition.

21. Management's Plan

  During fiscal 2000, the Company is proceeding with actions intended to
enhance prospects for revenue growth and profitability including the closing
of approximately 70 under-performing locations; and the continued pursuit of
additional direct revenue sharing arrangements with motion picture studios,
which arrangements allow the Company to provide additional copies of rental
titles. The Company continues to evaluate opportunities to reduce costs and
improve revenues. The Company has maintained a longstanding and satisfactory
relationship with its primary product vendors and has negotiated extended
payment terms with several of these vendors. The loss of its primary product
vendors could have a material adverse effect on the Company. The Company will
continue to focus on reducing the aged accounts payable with payments, the
extension of terms, and negotiated settlements. If the Company is unable to
reduce the aged accounts payable to the satisfaction of the trade creditors,
it could have a material adverse effect on the Company. The Company's
principal capital requirements are for the purchase of rental inventory,
payments related to approximately 70 store closings, payments related to aged
accounts payable, payments of interest and principal related to the
credit/term loan facility (the "Senior Facility") and the Ingram Entertainment
Inc. note, and potential acquisitions that fit its growth strategies. Assuming
the Company is able to maintain a satisfactory relationship with its selected
vendors, its bank lenders,

                                     F-27
<PAGE>

                              VIDEO UPDATE, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

and its trade creditors, the Company expects that cash from operations, trade
credits, equipment leases, available revenue sharing arrangements, and
available borrowings under the Senior Facility will be sufficient to fund
future inventory purchases and other working capital needs for the next 12
months, although no assurances can be given that the Company will not require
additional sources of financing as a result of disappointing operating
results, or unanticipated cash needs or opportunities. Moreover, no assurances
can be given that such additional funds will be available on satisfactory
terms, if at all. If the Company is unable to obtain such additional
financing, the Company may be required to reduce its overall expenditures and
the Company's ability to maintain or expand its current level of operations
could be materially and adversely affected.

                                     F-28