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                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB

                     ANNUAL REPORT UNDER SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                     For the fiscal year ended June 30, 1999

                         Commission file number 0-22619

                              VALUESTAR CORPORATION
                 (Name of Small Business Issuer in its charter)

            Colorado                                            84-1202005
(State or other jurisdiction of                             (I.R.S. Employer
 incorporation or organization)                           Identification Number)

                          360 - 22nd Street, Suite 210
                            Oakland, California 94612
                                 (510) 808-1300
          (Address and telephone number of principal executive offices)

                 1120A Ballena Blvd., Alameda, California 94501
                                (Former Address)

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

      Securities registered pursuant to Section 12(g) of the Exchange Act:
                        common stock, par value $0.00025
                                (Title of class)

Check  whether the issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the  Exchange  Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports),  and (2) has been
subject to such filing requirements for the past 90 days. Yes _X_ No ___

Check if there is no disclosure of delinquent  filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure  will be contained,  to
the  best  of  registrant's   knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part III of this Form  10-KSB or any
amendment to this Form 10-KSB. [ ]

State issuer's revenues for its most recent fiscal year. $2,329,219

The aggregate  market value of the issuer's common stock held by  non-affiliates
as of August 31, 1999 (assuming for this purpose that only  directors,  officers
and 10% or more shareholders of registrant are affiliates of registrant),  based
on the  average  of  the  closing  bid  and  asked  prices  on  that  date,  was
approximately $9,727,500.

As of August 31,  1999  there were  9,374,132  shares of  ValueStar  Corporation
common stock, par value $.00025, outstanding.


Documents Incorporated By Reference: The information required by Items 9, 10, 11
and 12 of Part III of this Report is incorporated by reference from  ValueStar's
definitive proxy statement  relating to the annual meeting of stockholders to be
held in  1999,  which  definitive  proxy  statement  shall  be  filed  with  the
Securities and Exchange  Commission  within 120 days after the end of the fiscal
year to which this Report relates.

Transitional Small Business Disclosure Format (check one): Yes ___ No _X_

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                                TABLE OF CONTENTS
                                                                            Page

                                     PART I

ITEM 1.  Description of Business                                              2
ITEM 2.  Description of Property                                             10
ITEM 3.  Legal Proceedings                                                   10
ITEM 4.  Submission of Matters to a Vote of Security Holders                 10


                                PART II

ITEM 5.  Market for Common Equity and Related Stockholder Matters            10
ITEM 6.  Management's Discussion and Analysis or Plan of Operation           12
ITEM 7.  Financial Statements                                                21
ITEM 8.  Changes in and Disagreements with Accountants on Accounting
         and Financial Disclosure                                            21


                               PART III

ITEM 9.  Directors, Executive Officers, Promoters and Control Persons;       21
         Compliance With Section 16(a) of the Exchange Act
ITEM 10. Executive Compensation                                              23
ITEM 11. Security Ownership of Certain Beneficial Owners and Management      24
ITEM 12. Certain Relationships and Related Transactions                      26
ITEM 13. Exhibits and Reports on Form 8-K                                    27


SIGNATURES


                           FORWARD-LOOKING STATEMENTS

IN  ADDITION  TO   HISTORICAL   INFORMATION,   THIS   ANNUAL   REPORT   CONTAINS
FORWARD-LOOKING   STATEMENTS  WITHIN  THE  MEANING  OF  THE  PRIVATE  SECURITIES
LITIGATION  REFORM ACT OF 1995 AND THE COMPANY  DESIRES TO TAKE ADVANTAGE OF THE
"SAFE  HARBOR"  PROVISIONS  THEREOF.  THEREFORE,  THE COMPANY IS INCLUDING  THIS
STATEMENT FOR THE EXPRESS  PURPOSE OF AVAILING ITSELF OF THE PROTECTIONS OF SUCH
SAFE  HARBOR  WITH  RESPECT  TO  ALL OF  SUCH  FORWARD-LOOKING  STATEMENTS.  THE
FORWARD-LOOKING  STATEMENTS IN THIS REPORT  REFLECT THE COMPANY'S  CURRENT VIEWS
WITH RESPECT TO FUTURE EVENTS AND FINANCIAL  PERFORMANCE.  THESE FORWARD-LOOKING
STATEMENTS  ARE  SUBJECT TO CERTAIN  RISKS AND  UNCERTAINTIES,  INCLUDING  THOSE
DISCUSSED  HEREIN,  THAT COULD CAUSE ACTUAL  RESULTS TO DIFFER  MATERIALLY  FROM
HISTORICAL   RESULTS  OR  THOSE   ANTICIPATED.   IN  THIS   REPORT,   THE  WORDS
"ANTICIPATES,"  "ESTIMATES," "BELIEVES," "EXPECTS," "INTENDS," "FUTURE," "GOAL,"
"OBJECTIVE" AND SIMILAR EXPRESSIONS IDENTIFY FORWARD-LOOKING STATEMENTS. READERS
ARE CAUTIONED TO CONSIDER THE SPECIFIC RISK FACTORS  DESCRIBED  BELOW AND NOT TO
PLACE UNDUE RELIANCE ON THE FORWARD-LOOKING  STATEMENTS  CONTAINED HEREIN, WHICH
SPEAK ONLY AS OF THE DATE  HEREOF.  THE  COMPANY  UNDERTAKES  NO  OBLIGATION  TO
PUBLICLY   REVISE  THESE   FORWARD-LOOKING   STATEMENTS  TO  REFLECT  EVENTS  OR
CIRCUMSTANCES THAT MAY ARISE AFTER THE DATE HEREOF.


                                     Part I

Item 1. Description of Business.

Overview

ValueStar  Corporation is developing  America's  leading  customer  satisfaction
rating  system  for local  service  and  professional  businesses.  Our  ratings
facilitate  both  traditional  commerce  and  the  rapidly  growing  market  for
electronic  commerce between  quality-conscious  buyers  (consumers and business
consumers) and local service businesses. Businesses that pass a four-step rating
process become eligible to use our certification mark,  ValueStar  Certified(R),
the symbol of high  customer  satisfaction.  Consumers are able to use ValueStar
Certified when shopping to quickly find the best,  top-rated  companies.  We are
based  in  Oakland,   California  and  started  rating  businesses  in  Northern
California in

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1992.  We began  regional  expansion  in July 1998 by starting  rating  sales to
businesses in Southern California. We have expanded rating sales during the last
twelve months to Chicago, Dallas/Fort Worth, Seattle, Philadelphia,  Atlanta and
Washington, D.C.

We  generate  recurring  revenues  from  business  customers  by (a)  conducting
customer  satisfaction  research on local  service  companies in 300  industries
(auto,  home health,  personal and  professional),  (b) certifying  highly rated
businesses, and (c) selling ancillary materials and services. We build ValueStar
Certified brand recognition  through  advertising and cooperative  branding with
our certified business  customers.  Our ratings are delivered on the Internet at
www.valuestar.com, through our Consumer ValueStar Report publication listing our
top-rated  companies  and  through  interactions  between  buyers and  certified
businesses.  To assure  buyers that our ratings are  independent,  accurate  and
unbiased,  we use university partners to audit each customer satisfaction study.
We have  auditing  relationships  with  the  Public  Research  Institute  of San
Francisco  State  University  and the Consumer Law Project of the  University of
Houston.

Our branded ratings provide important buying  information for buyers shopping or
researching  services  on the  Internet.  In addition  to  providing  buyers our
listings of highly  rated  businesses  on the  Internet,  we  developed  and now
operate the  ValueStar  SmartShopper(TM)  service,  allowing  buyers to directly
access and communicate with our top-rated  service  companies through e-mail and
e-mail to fax links.  After conducting a search for a specific type of top-rated
business,  buyers can conduct a personal  "shopping  auction"  by sending  their
service requirements  simultaneously to selected top-rated companies. We believe
SmartShopper is an important service enabling  electronic  commerce for services
on the Internet.

Participating businesses use our ValueStar Certified logo in their own sales and
marketing  communications.  Our  certification  mark piggybacks on the phone and
in-person sales presentations of our business customers and often is included in
their Yellow Page, newspaper, flyer, brochure, TV, radio and other advertising -
generating  millions  of buyer  impressions  of our rating  brand each year.  We
believe this cooperative  branding  (co-branding) helps create a powerful brand,
widening buyer awareness,  driving buyers to our Web site and Consumer ValueStar
Report publication and increasing sales of affiliated  information materials and
services.

During the last three years we have conducted  approximately  400,000 individual
customer  satisfaction  surveys and distributed to local buyers over 1.5 million
copies of Consumer  ValueStar Report,  our semi-annual  publication of top rated
local service  companies.  During the last three years we have grown from 319 to
1,455 certified  businesses at June 30, 1999, while maintaining renewal rates of
our  certified  businesses  averaging  more  than  66%.  We  estimate  that each
certified  business generates  approximately  $1,500 in revenue to us during the
first twelve months after applying for rating and similar recurring  revenues in
future years.  We believe the buyer  enthusiasm  generated by our rating format,
acceptance by certified  businesses  and the  knowledge  and  experience we have
gained  from  pioneering,  operating  and  expanding  our  business  provide the
foundation and experience for further growth and territorial expansion.

Our objective is to become America's  rating system for local service  companies
and establish ValueStar Certified as the premium rating brand. Our goals are (a)
to expand  marketing  and rating  activities  into  additional  regions in North
America and  internationally,  (b) maintain high  business  renewal  rates,  (c)
increase  brand  recognition,   and  (d)  develop  new  products,  services  and
incremental revenue opportunities. We focus significant management and financial
resources to roll out our program to new  regions.  We are also  developing  new
products for buyers and  businesses  to expand our  services.  Our future growth
will require additional  financing and management.  There can be no assurance we
can obtain expansion financing or develop management depth to continue to expand
to new markets or develop new products and services or that such  expansion,  if
possible,  will ever be  profitable.  See "Item 6.  Management's  Discussion and
Analysis or Plan of Operation - Business Risks."

History of Development

Our operations  are conducted  through our wholly owned  California  subsidiary,
ValueStar,  Inc. During late 1990 and 1991,  James Stein (our  President,  Chief
Executive  Officer  and a Director)  developed  the basic  operating  concept of
ValueStar  Certified.  In March 1991,  Mr.  Stein  engaged San  Francisco  State
University  to conduct a buyer  feasibility  study to  determine  the  potential
influence of ValueStar Certified on buyers. A service business feasibility study
was conducted to determine the potential  market for ValueStar  Certified  among
providers of services in the San Francisco Bay area. In October 1991,  base-line
buyer  satisfaction  and  additional  feasibility  research was completed by The
Institute of Social Research at California State - Stanislaus.

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Based on the  information  from those studies and research and using Mr. Stein's
own research and prior  experience in the Yellow Page  publishing  industry,  we
developed initial marketing and support materials.  We also began a relationship
in 1992 by engaging The Public  Research  Institute,  an  auxiliary  unit of San
Francisco  State  University  to  perform  or  audit  surveys  of each  business
applicant's  former customers to provide  confidential,  unbiased and scientific
surveys of customer satisfaction.  In June 1999, we initiated our first regional
audit  agreement  by engaging  the  Consumer  Law Project of the  University  of
Houston to audit our customer satisfaction ratings on a regional basis.

Our sales and  licensing  activities  commenced in the greater San Francisco Bay
area in 1992. In mid-1994,  we added our Consumer  ValueStar Report  publication
and on January 1, 1996, we launched our Internet  strategy on the World Wide Web
at  WWW.VALUESTAR.COM.  We continue to expand our program and services to buyers
and  businesses.   In  1997,  we  expanded  our  Internet   services  by  adding
SmartShopper, a communication link between buyers and highly rated businesses.

We are currently marketing our program to service businesses in a total of eight
market regions.  The following  table  summarizes the market regions in which we
operate:

                  Market Region                               Month of Launch
                  -------------                               ---------------
                  Northern California (greater San            January 1992
                  Francisco Bay area and Sacramento)

                  Southern California (Los Angeles            July 1998
                  and Orange County)

                  Chicago                                     February 1999

                  Dallas/Fort Worth                           April 1999

                  Seattle                                     July 1999

                  Atlanta                                     July 1999

                  Philadelphia                                August 1999

                  Washington, D.C./Baltimore                  August 1999


At June  30,  1999,  we had  1,455  active  certified  businesses  and  over 400
applicant  businesses going through our rating process.  We have not established
any specific timetable for further market region expansion.

Industry Background

The  U.S.  market  research  industry  consists  of a number  of large  national
research  companies  and many small  specialty  research  companies.  Total U.S.
market research expenditures exceeded $3.8 billion in 1997 according to the June
1998 issue of Marketing News. Marketing News estimated that over $320 million of
market research expenditures were for customer satisfaction research.

The result of each successful customer  satisfaction research and service rating
is delivered to buyers in the form of a  certification  mark. The  certification
mark industry includes trade association and various accrediting marks. Examples
of these marks  include the Good  Housekeeping  Seal,  AAA Approved Auto Repair,
J.D.  Powers,  ISO 9000 and various lodging and restaurant  industry ratings and
marks.  Since we believe we provide a valuable resource for consumers to contact
to obtain a  particular  category  of  business,  we share  aspects of  referral
services  and  agencies  like 1-800  Dentists,  1-800  Plumber,  and medical and
contractor referrals.  And since we publish and distribute a periodic listing of
businesses   rated   high  in   customer   satisfaction,   we   share   industry
characteristics  of service guide publishers and the yellow pages industry.  And
finally, we maintain an Internet site of qualifying service businesses and buyer
information  sharing aspects of the growing market for Internet  content such as
electronic yellow pages, directories, and city guide information services.

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The total  dollar value of buyer  services  transacted  in the United  States in
categories rated by ValueStar is estimated at over one trillion dollars annually
based on U.S. Department of Commerce  statistics.  We believe that most of these
services are  transacted  on a localized  basis and there is a need and a demand
for local  ratings of service  providers  comparable  to that  available on many
products.  We believe  that the more than six million  businesses  in the United
States (estimated from data supplied by American Business Information) that make
up the service and professional  business market provide a large opportunity for
ratings.  And although  directory type information is available from yellow page
listings and city guide  services and certain  information  about  complaints is
available through the Better Business Bureau, our research indicates buyers want
to know which companies have been rated high in customer satisfaction.

ValueStar and the Internet

The  Internet  has  emerged  as a global  medium  enabling  millions  of  people
worldwide  to share  information  and  content,  to  communicate  and to conduct
commerce  electronically.  The Internet  provides  organizations and individuals
with new means to conduct  business.  Commercial  uses of the  Internet  include
business-to-business and business-to-consumer  transactions,  product marketing,
advertising,  entertainment,  electronic  publishing,  electronic  services  and
customer support.  International Data Corporation, a leading technology research
organization,  estimates  that the number of web users  worldwide  will increase
from  approximately  97  million  at the end of 1998 to 320  million by the year
2002.  International  Data also estimates that transactions on the web will grow
from $32 billion at the end of 1998 to $426 billion by the year 2002.  According
to a CommerceNet/Nielson  survey, as of March 1997, shopping was one of the most
popular activities on the Internet and that a large growing majority of Internet
users (73%) spend some portion of their time on-line  searching for  information
about a specific product or service.

For  consumers,  the Web  brings  information  and  services  to the  home  with
unparalleled usefulness and immediacy. We believe that although certain services
such as travel are experiencing rapid Internet growth, the lack of standardized,
independent  and  unbiased  buyer  information  will  impede the growth of local
services being transacted on the Internet.  As a result, we believe that ratings
of local  service  businesses  deliver over the Internet  will be a catalyst for
increased shopping of local services on the Internet.

Many Internet content  providers rely on an advertising model like magazines and
broadcast  television or are seeking a formula to charge  consumers for use like
cable television.  Although  Forrester  Research  projects Internet  advertising
expenditures  in the U.S. to increase from $1.3 billion in 1998 to $10.4 billion
in 2002 and some Internet sites are charging consumers, we do not believe either
model has achieved broad based  financial  success.  While providing our branded
content of top-rated service  businesses on the Internet is a valuable component
of our strategy to reach buyers and support businesses,  we are not dependent on
the  Internet as our basic  revenue  source.  However,  we are  researching  and
developing  opportunities,  products  and  services to  leverage  our content to
generate additional Web and Web-related revenues.

The ValueStar Solution

We believe  there is a compelling  buyer and  business  market need for unbiased
ratings of local services. North America contains fragmented, highly competitive
local service industries. This creates a large number of choices for buyers. Our
concept of a local  standardized  rating of service  and  professional  firms by
their own customers  was created on the premise that buyers are  inundated  with
claims  from  businesses  communicated  through  a growing  media  base and have
rightly  become  increasingly  skeptical.  For  businesses,  it is  increasingly
difficult and costly to differentiate on quality or customer satisfaction due to
the  proliferation of claims,  the growth of new media outlets,  competition and
increasing buyer skepticism. We believe buyers want to know which businesses are
better  than  others and to have the  ability to cut  through  the media glut of
information.  This need for unbiased information has been a factor in the growth
of Consumer  Reports  magazine  (product  evaluations and ratings),  J.D. Powers
(customer satisfaction ratings on vehicles,  computers and other businesses) and
the growth experienced by consumer and market research companies.

The factors  affecting the selection of a local service are different than those
involving  a widely  available  product:  (a)  typically,  compared to a product
purchase,  a buyer has more service provider choices from which to discern,  (b)
the quality level of services is less  consistent,  (c) it is more  difficult to
experience  or  compare a service  prior to  purchase,  (d)  services  cannot be
returned,  and (e)  therefore  the entire  decision  process is riskier and more
frustrating  for  buyers.  ValueStar  Certified  is designed to respond to these
factors by providing buyers and businesses with important customer  satisfaction
information  delivered in various media through a recognizable  and  easy-to-use
certification mark. One of the most important attributes of a certification mark
is its availability at the moment of decision.

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We believe the rapidly growing  Internet  environment is an excellent medium for
delivery  of our rating  content and  information.  Our  searchable  database of
top-rated  local  companies  leverages a chief  advantage  of the  Internet  the
ability to access changing information through a simple user interface, 24 hours
a day, 7 days a week. Our listing of quality  businesses,  consumer  information
and  ValueStar's  SmartShopper  utility is available  to Internet  users free of
charge allowing them to reduce the risk and guesswork  associated with selecting
local service or professional businesses.

ValueStar Services to Buyers

Buyers  use  our  ratings  to  quickly  identify  top-rated  local  service  and
professional businesses (including auto, home, health, personal and professional
providers of services) and to make better shopping choices.  Our rating is based
on high customer  satisfaction,  which we believe is intuitively logical to most
buyers.  A study  conducted  by Public  Research  Institute  in 1993 and updated
through 1996  concluded that 2 out of 3 customers who knew a business had earned
ValueStar Certified were influenced by this factor in selecting a business.

Our semi-annual  distribution of our Consumer  ValueStar  Report provides buyers
with an easy reference list of businesses rated high in customer satisfaction, a
quality "yellow page" listing. The July 1999 semi-annual edition was distributed
to  315,000  homes  and  businesses  in  three  market  regions.  This  included
approximately  40,000 to requesting  Consumer  ValueStar Club members  developed
through phone,  mail and Internet queries.  The Consumer  ValueStar Club members
receive the Consumer  ValueStar  Report  publication free every six months along
with other benefits  offered from time to time. We intend to add additional club
member benefits in future periods to further enhance our offering to buyers.

In addition to anytime access to ValueStar  ratings,  buyers can directly access
and communicate with top-rated  service  companies  through e-mail and Web links
from our Web site.  After  conducting a search for a specific  type of top-rated
business,  buyers are able to conduct their own personal  "shopping  auction" by
using our  SmartShopper  service  to send  requirements  to  selected  top-rated
companies  with one simple  form.  We intend to continue to enhance our Internet
offering to buyers and add features, products, services and additional benefits.

We use  marketing  and  promotion  activities  to create and  enhance  buyer and
business  awareness of the meaning and  significance of the ValueStar  Certified
certification mark and the value of our rating process. These activities include
public relations efforts,  community involvement and direct advertising.  Buyers
are also broadly exposed to our  certification  mark through the advertising and
promotional  efforts of businesses who use our certification mark to distinguish
themselves as being rated high in customer satisfaction. Since the certification
mark is  displayed  in a wide  variety of media,  buyers  use the  certification
information quickly and conveniently, all at no charge.

We believe that as each market area matures,  buyers will  increasingly  rely on
ValueStar Certified in their shopping decisions as a result of growing awareness
and a larger base of qualified businesses.

ValueStar Services to Business Owners

Our certified  businesses  use the ValueStar  Certified  program to (a) bring in
more customers,  (b) convert shoppers to buyers,  (c) reduce pricing pressure on
services,  (d)  distinguish  services  from  competitors,  (e) improve  customer
loyalty,  (f) increase  customer referral rates, (g) speed up the selling cycle,
(h) improve employee morale,  (i) enhance marketing and advertising  promotions,
and (j) improve business reputation.  Research conducted for us by The Institute
of Social  Research at California  State - Stanislaus in 1991 indicated that 70%
of  consumers  would pay 10% or more for  services  from  companies  that  could
indicate they earned ValueStar Certified.

One of  the  most  critical  factors  indicating  business  satisfaction  of our
services and which directly  relates to our long-term  success are renewal rates
of certified  businesses.  During the last two fiscal years ending June 30, 1999
an average of 66% of certified  businesses  renewed  their  licenses  indicating
business acceptance of our program.

Our Consumer  ValueStar  Report  provides  certified  businesses  important  and
credible exposure to new customers.  Our free listing of qualified businesses on
the Internet offers small business owners a presence on the Web at no additional
cost. Our SmartShopper  service offers businesses Web generated traffic. We also
offer  businesses the opportunity to expand their listings for an additional fee
and to link their Internet site with our Web site.

Our field  consultants  provide a personal  orientation to each passing business
owner and their  employees  informing  them of the  significance  of earning our
certification  mark  and  educating  them  on  how  to use  the  achievement  in
promotional programs and customer encounters.  A comprehensive  ValueStar manual
is delivered to certified  businesses  reflecting our substantial  experience in
effective use of our mark by businesses.  We use periodic newsletters to further
educate

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businesses on customer  satisfaction  topics and ways to use the mark to improve
business.  Many certified businesses purchase copies of our customized Certified
Profile  Brochure,  which  explains to their  customers  how they  qualified for
ValueStar Certified.

Our brand  recognition  is enhanced by daily use by businesses in all manners of
advertising and media  supplementing  our marketing and promotion  activities to
create and enhance buyer, business and brand awareness.

ValueStar Strategies

Our objective is to become America's  rating system for local service  companies
and establish  ValueStar  Certified as the premium  rating  brand.  We intend to
leverage  our  pioneer  position  by (a)  establishing  our  program in the most
attractive  market regions,  (b) developing a dominant  position in those market
regions,  and (c) using our rating  service as a platform for  multiple  revenue
streams.  Our target U.S. market consists of approximately 6 million service and
professional businesses. The following are key elements of our strategy:

         Continue  Penetration  of the  California  Market - We believe  renewal
         rates  (averaging  66%  during  the last  two  fiscal  years)  indicate
         business satisfaction with the program in California.  Renewals provide
         a continuing  source of predictable  recurring  revenues.  An expanding
         business base also  pressures  other service  businesses to apply to be
         rated.  Our sales,  marketing and promotion  activities are designed to
         increase  new  business,  maintain  high  renewal  rates  and  generate
         ancillary  product  and service  sales.  A growing  base of  businesses
         produces  more  promotions  and  buyer  interactions  increasing  brand
         recognition and awareness.

         Leverage  California's  Success  to New  Markets - We believe we have a
         competitive  advantage  to  enter  new  regions  as  a  result  of  our
         experience in  California.  We have developed a  comprehensive  program
         built on a  significant  base of buyer and business  research.  We have
         created proprietary methods,  training programs and systems to minimize
         the number of personnel,  costs and effort associated with expanding to
         new  market  regions.  And we  have  developed  loyalty  with  existing
         certified businesses and buyers that serves as important references for
         new  customers.  We intend to leverage our  knowledge,  experience  and
         low-cost  centralized  structure  in  our  geographical  expansion  and
         continue to build barriers to entry by competitors. Our rollout process
         enables us to commence  selling to  businesses  in a new market  within
         three months of selection  and to report  initial  revenues  within two
         months of initial sales while minimizing capital and personnel costs.

         Create Strong Brand  Recognition  and Market  Awareness - We believe we
         have  created  the  leading  brand  name for local  service  ratings in
         California.  Our brand franchise helps our marketing to new businesses.
         Our  strategy is to promote,  advertise  and  increase  our  visibility
         through  a  variety  of  marketing,   public  relations  and  promotion
         activities.   We  employ  public   relations,   co-branding   and  paid
         advertising to increase  awareness.  Our Consumer  ValueStar Report and
         our Web site are important marketing elements of our program. Our brand
         building  strategy  also relies  heavily on  promotions  and  awareness
         developed by certified businesses in their promotions,  advertising and
         buyer interactions.

         Develop New Revenue  Opportunities - We seek to expand our services and
         benefits  to  buyers  and  service  businesses.  We  believe  there are
         opportunities to develop incremental revenue opportunities from service
         businesses,  buyers and from use of our content. We believe the growing
         use of the Internet by buyers provides opportunities to use our current
         content and  develop  additional  content  that will be  attractive  to
         buyers and a variety of Web sites. We are currently  investing  product
         development  funds to create new content for buyers.  A growing base of
         loyal ValueStar buyers also provides  additional revenue  opportunities
         in the future.

         Expand  Strategic  Alliances  and  Partnerships  - The  majority of our
         growth  results  from direct  marketing  efforts and buyer and business
         referrals.  We  also  develop  alliances  and  obtain  endorsements  of
         industry associations, chambers of commerce and other organizations. As
         our business and buyer membership grows we expect more opportunities to
         enter into  partnerships  or  strategic  alliances  to (a) more rapidly
         expand  certifications  nationally  and  internationally,  (b) generate
         additional  ancillary  revenues,  (c) facilitate brand  awareness,  (d)
         provide   content   to   others,   (e)   facilitate   consumer/business
         transactions,  and (f) enhance  third party  offerings to consumers and
         businesses,  among  other  possibilities.  We  have no  current  plans,
         proposals,  arrangements  or  understandings  regarding any business or
         product acquisitions.

                                       7

<PAGE>


Our  execution of the above  strategies  will require  additional  financing and
management.  There can be no assurance we can obtain additional financing or add
to our  management  team. See "Item 6.  Management's  Discussion and Analysis or
Plan of Operation - Business Risks."

ValueStar Operations

All service businesses and professionals  located in market regions we serve may
apply to be rated.  These include more than 300 industry  categories within five
broad groups:  Automobile  Services  (examples  including auto body shops,  auto
repair, and towing firms),  Health and Well Being Services  (examples  including
acupuncture,  physicians  and  dentists  and health  clubs),  Home  Services and
Repairs (examples including alarm companies, carpet cleaners, movers, locksmiths
and roofers),  Personal Services  (examples  including beauty salons,  limousine
services  and travel  agents)  and  Professional  Services  (examples  including
accountants, attorneys, employment services, insurance and real estate brokers).

Our  marketing  and sales  activities  focus on a targeted  group of service and
professional  businesses  resulting from our research which  identifies the high
priority  accounts  among the  larger  population  of service  and  professional
businesses in each market  region.  We use direct mail,  advertising,  telephone
sales,  videotapes and other  materials  emphasizing  the benefits of becoming a
ValueStar certified business.  Our field consultant personnel make certification
licensing, renewals and ancillary sales.

We modify our certification and rating fees from time to time. From time to time
we also offer discounts,  incentives and  satisfaction  guarantees to applicants
and also from time to time extend  payment terms on fees.  Our fees scale upward
with business size and for multiple location  businesses.  We estimate that each
new certifying business provides average annual revenue of approximately  $1,500
from all sources.

Once a prospective  business agrees to be rated and pays an initial research fee
ranging up to $570 (subject to promotional  discounts),  our research and rating
process begins.  We conduct a complaint  bureau status check,  business  license
verification  and  insurance  verification.  We  perform  customer  satisfaction
research surveys that are independently audited by the Public Research Institute
resulting in a  statistically  computed  rating  score.  To pass and qualify for
ValueStar  certification,  an applicant  must score in the range of very good to
outstanding.

At June 30, 1999 we employed 26 full-time equivalent research and rating persons
engaged in conducting  buyer research and  processing  new and renewal  business
certifications.

In order to assure buyers that ratings  performed by ValueStar are  independent,
scientific,  accurate  and  unbiased,  we maintain  agreements  with  university
partners to audit our customer  satisfaction  research and reports.  In 1992, we
engaged The Public Research Institute,  an auxiliary unit of San Francisco State
University, to perform or audit surveys of each applicant's former customers. In
June 1999, we engaged our first  regional  auditor,  the Consumer Law Project of
the  University  of Houston,  to audit our  customer  satisfaction  ratings on a
regional basis.

All business  applicants receive a ValueStar Research and Rating Report with the
results  of our  research.  Successful  applicants  may  license  the use of the
ValueStar  Certified mark, pursuant to contractual  guidelines  specified in the
terms of our certification agreement, in their advertising, collateral and sales
materials,  stationery,  signage,  announcements,  bid forms,  etc. A  certified
business also receives a ValueStar  plaque,  program manual and labels for their
doors  and  letterhead.  Certified  businesses  are  listed  in our  semi-annual
Consumer ValueStar Report publication and on our Internet site.

We structure staffing,  territories,  training and compensation plans to provide
continuity of field consultant contact with each certified business.  We provide
ongoing training to our employees on new business and renewal development and in
methods  to  support   businesses  in  using  ValueStar   Certified  to  improve
operations.

Each year we solicit  renewals  from  certified  businesses.  Each year  renewal
accounts must pass elements of our research and rating  process and every second
year they must pass our entire research and rating process.

At June 30,  1999,  we had 48  marketing,  sales  and field  consultant  persons
engaged in making sales to new service  providers and promoting our services and
brand.

                                       8

<PAGE>


Product Development

To date, our development  expenses  associated with the design,  development and
testing of our programs and services have not been material.  These expenditures
have  been  included  in sales  and  marketing  or  general  and  administrative
expenses.  In the first  quarter  of  fiscal  2000,  we  commenced  the  design,
development and testing of an expanded  Internet  program using existing and new
content.  The goal of this development is to position  ValueStar as the dominant
infomediary linking buyers with local service businesses.  We plan to capitalize
on our existing  expertise in customer  satisfaction  rating systems to create a
new Internet  service.  The  completion  of  development  and the launch of this
program  will  require  additional  personnel  and  financing.  We have  not yet
determined the timing,  requirements and required  funding for this program.  We
expect to spend more than  $300,000  in product  development  costs in the first
quarter of fiscal 2000.

Competition

We are not aware of a directly  competitive mark or service targeted for a broad
range of service industries. However, we expect competitive offerings to develop
in the future.  We compete for the limited  budgets for spending on  advertising
and promotions among service and professional businesses.  Therefore current and
potential   competition   includes  Yellow  Page   publishers,   newspapers  and
periodicals, radio and television stations, Internet directories and other forms
of advertising employed in the consumer service  marketplace.  Other current and
potential competitors include referral agencies,  telephone services,  complaint
agencies,  service guide publishers,  industry specific  certification marks and
others.  The competition for service business  advertising and promotional funds
is intense.  There are a large number of  competing  firms and a wide variety of
product offerings. Most of these firms are substantially larger and have greater
financial resources.

The Internet is rapidly evolving and intensely competitive with limited barriers
to entry.  There are a number of potentially  competitive  companies  engaged in
facilitating  business on the Internet  including  providing  more  security for
buyers and greater  informational  content including service business  listings,
referrals and  information.  A number of Internet  sites are  providing  site or
business rankings or ratings, for example  BizRate.com,  deja.com and gomez.com.
But to date, most have focused on rating sites or product  providers.  We expect
Internet competition to develop and intensify in the future.

We believe we provide a valuable  performance  rating our  customers  can use to
distinguish themselves from competitors. We believe ValueStar Certified provides
buyers  a  convenient  and easy  method  of  selecting  service  businesses  and
improving shopping  decisions.  The principal  competitive factors affecting our
market  include  the  quality  and  nature of our  content,  ease of buyer  use,
marketing and sales methods and brand recognition.  We are establishing a market
awareness  and  brand  recognition  in  California.  Barriers  to  entry  by new
competitors   are  limited  and  in  addition  to  the  direct  effects  of  new
competition, new entrants may cause marketplace confusion. This could make sales
efforts more difficult and may result in adverse pricing pressure.  There can be
no  assurance we can  maintain  our  competitive  position or be able to compete
against existing or new competitors in the future.  Furthermore,  as a strategic
response to changes in the competitive environment, we may make certain pricing,
service or marketing  decisions or enter into new ventures or arrangements  that
could have a material  adverse effect on our business,  financial  condition and
results of operations.

Trademarks, Service Marks and Other Proprietary Rights

We own a U.S.  federally  registered  certification  mark on "ValueStar" and the
"ValueStar  Certified"  symbol and have applied for  protection  on ValueStar in
Canada.  We have also received a registration  for "Only the Best Pass the Test"
as a service  mark in the U.S.  We  consider  our  trademarks  and  symbol to be
material  to our  business.  We intend to  vigorously  protect  and  defend  our
trademarks  against  infringement and other  unauthorized  use. We are reviewing
with  counsel one  registration  of  ValueStar  in another  field of use that we
believe could create consumer  confusion in the future.  We are not aware of any
other significant  infringement or other unauthorized use of our trademarks.  We
cannot  assure  that we can  protect  our  trademarks  and  symbol.  The loss or
infringement  of our ValueStar  trademark and symbol or our inability to protect
our mark  adequately  would have a material  adverse  effect on our business and
operations.  It is possible that  competitors or others will adopt service names
similar to "ValueStar", thereby impeding our ability to build brand identity and
possibly leading to customer and consumer confusion.

We copyright our materials and publications and seek to maintain certain aspects
of our business  operations as trade  secrets.  We have  developed  consumer and
business databases, training systems, software and systems that are proprietary.
With the increased use of patents to protect service products and techniques, we
are currently  reviewing the use of patent applications as an additional tool to
protect new products and services we are  developing.  There can be no assurance
of future patents or protection.

                                       9

<PAGE>


Government Regulation and Legal Issues

We are not currently  subject to direct  regulation other than federal and state
regulation applicable to businesses generally.

Our operations  require that our  certification  mark only be used by qualifying
companies  and  that  its  use be  discontinued  if a  business  ceases  to be a
licensee.  We  vigorously  defend our contract  rights,  including  taking legal
action as required. As we expand to new areas and our certification becomes more
recognized and valuable, it may be increasingly difficult to police unauthorized
use of our certification mark or confusing marks.

Although we are not a direct  referral  service,  we may be subject to claims by
buyers for the  actions of  certified  businesses.  Although we do not believe a
claim would have merit,  the costs of defense could be substantial.  There is no
assurance our errors and omissions  insurance would adequately cover any claims.
To date we have  not  been  subject  to any  material  claims  by  customers  of
licensees.

Employees

As of June 30, 1999, we employed 82 full-time persons,  of which 6 are in senior
management,  48 in marketing  and sales,  17 in research  and rating,  and 10 in
accounting and administration.  We employ up to 40 part-time personnel from time
to time and use outside  contractors from time to time for various marketing and
other services. None of our employees are represented by a collective bargaining
arrangement and we have experienced no work stoppages.
We consider our relations with employees to be favorable.

Our future success will depend in large measure upon the continued contributions
of our  President  and CEO,  James Stein,  and our ability to attract and retain
quality sales and management personnel.  We experience competition for qualified
sales personnel who are in demand by many  competitors and businesses with other
sales  activities.  The loss of the  services of Mr. Stein could have a material
adverse effect on our business. We entered into a three-year employment contract
with Mr.  Stein  effective  July 1,  1998.  We own a $3  million  "key man" life
insurance policy on Mr. Stein, of which $2 million is assigned as collateral for
senior debt.


Item 2. Description of Property

Our corporate and operating  offices are located in approximately  14,900 square
feet of improved office space located at 360 - 22nd Street, Oakland, California.
This facility accommodates administration,  sales and marketing and research and
rating  personnel.  This  facility  is  leased  pursuant  to a  five-year  lease
effective June 1999 at a monthly rate of approximately $17,900. This facility is
adequate  for  present  operations  but should we continue to expand or elect to
provide new products or services,  then we may require  additional  space in the
future.  We have certain  rights of first  refusal on empty space at our current
location.  We believe that additional office space at reasonable  leaseing rates
is available in the greater Oakland area should  additional space be required in
the future.


Item 3. Legal Proceedings

We are not involved in any threatened or pending legal  proceeding other than in
the ordinary course of business.


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

No matter was submitted  during the fourth  quarter of the fiscal year to a vote
of security holders.


                                     PART II

Item 5. Market for Common Equity and Related Stockholder Matters

Market Information

On May 28, 1997 our common stock commenced trading and is quoted on the National
Association of Securities  Dealers,  Inc. ("NASD") OTC Electronic Bulletin Board
(symbol  "VLST").  The market for our common  stock has often been  sporadic and
limited.

                                       10

<PAGE>


The following  table sets forth the high and low bid  quotations  for the common
stock for the fiscal years ended June 30, 1999 and 1998 as provided by the NASD.


                                                           Bid Quotations
                                                          High        Low
                                                          ----        ---
Fiscal Year Ending June 30, 1998
  First Quarter                                         $ 1.4375   $ 0.9375
  Second Quarter                                        $ 1.4375   $ 1.21875
  Third Quarter                                         $ 1.21875  $ 0.90625
  Fourth Quarter                                        $ 0.96875  $ 0.625
Fiscal Year Ending June 30, 1999
  First Quarter                                         $ 0.7813   $ 0.5313
  Second Quarter                                        $ 0.9375   $ 0.625
  Third Quarter                                         $ 1.4375   $ 0.75
  Fourth Quarter                                        $ 1.6563   $ 1.1875


The  above  quotations  reflect  inter-dealer  prices,  without  retail  markup,
markdown or commission and may not represent actual transactions.

The OTC Electronic Bulletin Board, is a screen-based trading system administered
by the NASD.  Securities  traded on the  Bulletin  Board are, for the most part,
thinly traded and subject to special  regulations  (described below) not imposed
on securities listed or traded on the National Association of Securities Dealers
Automated Quotation ("NASDAQ") system or on a national securities exchange.

Like that of securities of other small,  growth-oriented  companies,  our shares
are  expected to  experience  future  significant  price and volume  volatility,
increasing the risk of ownership to investors.  Sales of substantial  amounts of
common stock in the public  market by one or more holders  could  adversely  and
dramatically  affect the prevailing  market price of our common stock due to its
thinly traded  attributes.  Future  changes in market price and volume cannot be
predicted as to timing or extent.  Any historical  performance  that may develop
does not guarantee or imply future performance.  Future announcements concerning
ValueStar  or  our  competitors,  quarterly  variations  in  operating  results,
announcements of technological or service  innovations,  the introduction of new
products  or  services,  changes  in  pricing  policies  by us  or  competitors,
litigation  relating  to services or other  litigation,  changes in  performance
estimates by analysts or others,  issuances  of or  registration  of  additional
securities, or other factors could cause the market price of our common stock to
fluctuate  substantially.  In  addition,  the stock market has from time to time
experienced  significant  price and volume  fluctuations  that have particularly
affected the market price of small  companies  and have often been  unrelated to
the operating performance of particular companies.

Our common stock is defined as a "penny stock" under the Securities Exchange Act
of 1934,  as amended  (the  "Exchange  Act"),  and rules of the  Securities  and
Exchange Commission thereunder. The Exchange Act and penny stock rules generally
impose additional sales practice and disclosure requirements upon broker-dealers
who sell our  securities  to persons other than certain  "accredited  investors"
(generally, institutions with assets in excess of $5,000,000 or individuals with
net worth in excess  of  $1,000,000  or annual  income  exceeding  $200,000,  or
$300,000  jointly  with  spouse)  or in  transactions  not  recommended  by  the
broker-dealer.   For  transactions   covered  by  the  penny  stock  rules,  the
broker-dealer  must make a  suitability  determination  for each  purchaser  and
receive the purchaser's  written  agreement prior to the sale. In addition,  the
broker-dealer   must  make   certain   mandated   disclosures   in  penny  stock
transactions,  including  the actual sale or  purchase  price and actual bid and
offer  quotations,  the  compensation  to be received by the  broker-dealer  and
certain  associated  persons,  and deliver certain  disclosures  required by the
Securities  and  Exchange  Commission.  Consequently,  the penny stock rules may
affect the ability of broker-dealers to make a market in or trade our shares and
thus may also affect the ability of purchasers of shares to resell shares in the
public markets.

We had 130  holders of record of our  common  stock at June 30,  1999,  which we
believe  represents  approximately  300 beneficial  owners. We have never paid a
cash dividend on our common stock and do not expect to pay cash dividends in the
foreseeable  future,  although we may be obligated to pay stock dividends to our
holders of Series A preferred stock.

                                       11

<PAGE>

Recent Sales of Unregistered Securities

No equity  securities  were sold  during the year  ended June 30,  1999 under an
exemption from the  Securities  Act that were not  previously  reported in prior
quarterly  filings.  All such  sales were made under an  exemption  from  either
Section 4(2) or Rule 506 of Regulation D under the Securities Act.

Subsequent Sale of Preferred Stock

Subsequent  to year end,  during  July and  August we issued  225,000  shares of
Series A Convertible  preferred stock, par value $.001 for cash of $10 per share
for gross  proceeds of  $2,250,000.  Dividends  of 8% per annum  compounded  are
payable in  additional  shares of Series A stock.  The dollar amount of Series A
stock is convertible  into shares of common stock at a conversion price of $2.00
per share and are  automatically  converted on the occurrence of certain events.
The Series A stock has a  liquidation  preference  of $10 per share plus accrued
and  unpaid  dividends.   The  Series  A  stock  has  certain  antidilution  and
registration  rights  and has  voting  rights  equal to the  number of shares of
common stock that it is convertible.  In addition, as long as there are at least
100,000  shares of Series A stock  outstanding,  then the  holders  thereof  are
entitled to elect one member of our board of directors.

We sold the Series A stock without an underwriter and no commissions were paid.

The  Series  A stock  was  offered  and  sold  without  registration  under  the
Securities  Act solely to  "accredited"  investors in reliance on the  exemption
provided by Regulation D and Section 4(2)  thereunder and an appropriate  legend
was placed on the Series A stock and will be placed on the  shares  issuable  on
conversion unless registered under the Securities Act prior to issuance.


Item 6. Management's Discussion and Analysis or Plan of Operation.

Overview

We are a  research  and rating  company  and have  designed a rating  system and
certification mark, ValueStar Certified(R),  for service businesses.  Our rating
system is designed to enable  buyers to quickly  determine  those local  service
businesses  that have attained the highest level of customer  satisfaction.  Our
ratings are  provided  on the  Internet  at  www.valuestar.com,  in print in the
Consumer   ValueStar   Report  and  through   customer   promotions   and  buyer
interactions.

Our revenues are generated  primarily  from research and rating fees paid by new
and  renewal  businesses,  certification  fees  from  qualified  applicants  and
renewals and from the sale of  information  products and services.  An important
aspect of our business model is the recurring nature of revenues from businesses
renewing their certification.

Certification  fees,  ranging  from $995 to  approximately  $2,000  depending on
business size, are recognized when material  services or conditions  relating to
the certification have been performed. The material services are the delivery of
certification  materials along with an orientation and the material condition is
the execution of the  certification  agreement  specifying  the  conditions  and
limitations on using the certification. Research and rating fee revenue, ranging
up to $570,  is  deferred  until  the  research  report is  delivered.  Sales of
marketing  materials and Web  advertising  and other  services are recognized as
materials  are shipped or over the period  services are  rendered.  From time to
time we provide  discounts,  incentives  from basic pricing and payment terms on
fees.

We expense research and rating costs as incurred. Costs incurred in printing and
distributing  our Consumer  ValueStar Report  publication for buyers,  currently
published  in January and July,  and any related  revenues are  recognized  upon
publication.  Accordingly,  the costs and revenues from this publication  impact
the revenues and costs in our first and third fiscal quarters.

Certain  direct-response  advertising  costs are deferred and amortized over the
expected  period of future  benefits.  These  costs,  which  relate  directly to
targeted new business solicitations,  primarily include targeted direct-response
advertising programs consisting of direct telemarketing costs. No indirect costs
are  included in  deferred  advertising  costs.  Costs  incurred  for other than
specific targeted customers, including general marketing and promotion expenses,
are expensed as incurred.

Prior to July 1, 1998, we amortized deferred costs on a straight-line basis over
twelve months.  Based on an ongoing  evaluation of the expected period of future
benefits from direct-response advertising, we reduced the period of amortization
from twelve months to sixty days.  Revenues  associated with the direct-response
advertising costs,  which are primarily  certification fees from new businesses,
are being recognized  approximately sixty days after the telemarketing

                                       12

<PAGE>


costs are incurred.  This change in estimate of the amortization period resulted
in a one-time,  non-cash  increase  in selling  expenses of $81,788 in the first
fiscal quarter ended September 30, 1998.

Deferred  costs are  periodically  evaluated  to determine  if  adjustments  for
impairment are necessary.

Since  inception,  we have been  growing and  developing  our  business and have
incurred losses in each year. At June 30, 1999, we had an accumulated deficit of
$8,878,409. There can be no assurance of future profitability.

Effect of Growth in Certified Businesses and Renewals

Our business revenue model, similar to other membership based organizations,  is
predicated on a growing  number of certified  businesses  and  maintaining  high
renewal rates.  Certified  businesses that renew contribute higher gross margins
than new applicants  due to reduced sales and rating costs.  Also, a growing and
larger base of  certified  businesses  reduces the costs  (relative to revenues)
associated  with  printing and  distributing  our Consumer  ValueStar  Report to
buyers,  maintaining  our  www.valuestar.com  Internet site and providing  other
services.  The  marginal  fixed  costs  associated  with  increased  numbers  of
certified  businesses are minimal compared to these base printing,  distribution
and maintenance costs.

Since   considerable   portions  of  our  operations  are  engaged  towards  the
solicitation  of new  service and  professional  business  applicants,  we incur
substantial  costs towards this activity.  Currently,  we defer direct telephone
sales  costs and  amortize  them at the time of  certification,  an  average  of
approximately 60 days. Other costs are expensed as incurred.

At June 30, 1999, we had 1,455  certified  businesses,  compared to 319, 745 and
1,151  licensees on June 30, 1996,  1997 and 1998,  respectively.  The following
table illustrates the changes in certified  businesses and renewal rates for the
fiscal years ended June 30, 1999 and 1998:

                                                     Fiscal Year Ended June 30,
                                                         1999           1998
                                                         -----          -----
         Licensees - beginning of period                 1,151            745
         Adjustments (1)                                   (46)           (20)
         Licensees up for renewal                        1,105            725
         Renewals                                          682             532
         Renewal Percentage                                 62%            73%
         New licensees                                     773            619
         Licensees - end of period                       1,455          1,151

          (1) Non passing renewals, out-of-period renewals and terminations.


Businesses fail to renew their  certification for a variety of reasons including
ownership and management changes,  insufficient funds to pay for our program and
dissatisfaction.  We endeavor to communicate  and  demonstrate  the value of our
services to  business  owners on an ongoing  basis.  Although  our renewal  rate
declined in fiscal 1999 due to our focusing of  resources on new market  regions
and limitations of staffing and funding,  we have made changes in our operations
resulting in improved renewal rates. During the first two months of fiscal 2000,
renewal rates have  approximated  67%. Our goal is to maintain  renewal rates in
the 65% to 70% range.

As a market region matures and we attain a larger base of certified  businesses,
fixed and indirect costs decline as a percentage of revenues. New market regions
provide  additional  revenues to cover  certain base fixed  selling,  marketing,
administration  and overhead costs.  Our more  established  Northern  California
market has achieved a base of certificate holders sufficient to provide positive
regional  operating  margins  (prior to allocation of corporate  administration,
overhead and elective  advertising  and  promotion  costs).  We believe we could
reduce operating costs to achieve break-even operations on reduced levels of new
sales and by maintaining the existing base of renewing businesses in California.
However, any dramatic cutbacks would curtail growth and our ability to expand in
the future.

Future  operations  are  impacted  by changes in cost  structure  and  elections
regarding advertising,  promotions and growth rates (due to the lower margins in
the first year).  We have  recently  increased  numbers of sales,  marketing and
support  personnel.  Rapid  growth,  due to the  nature  of our  operations,  is
expected to contribute to continued operating losses in the foreseeable future.

                                       13

<PAGE>


During the last fiscal year (ended June 30, 1999), we added personnel,  upgraded
computer  systems and increased  overhead to support  expansion  into new market
regions.  This increased our operating losses.  Our personnel have grown from 44
full-time  persons at June 30, 1998 to 82 full-time persons at June 30, 1999. We
also incurred marketing, selling and administrative costs in connection with new
region startups contributing to our larger operating losses.

At June 30, 1999, we had 452 (424 new and 28 renewal) business  customers in the
application  and rating  phase  compared to 410 (349 new and 61 renewal) at June
30, 1998. The total at June 30, 1999, represents approximately 60 days sales. We
recently  installed  new  hardware,  software  and systems to more  automate our
research and rating process and have reduced average the rating processing time.
Business  customers in the rating phase are expected to represent  approximately
$300,000 of revenues  that should be  recognized  in the first quarter of fiscal
2000 (generally analogous to backlog).

Results of Operations

Revenues. Revenues consist of certification and rating fees from new and renewal
business  applicants,  sale  proceeds  from  information  materials  and premium
listings  in our  Consumer  ValueStar  Report  and on our Web  site,  and  other
ancillary revenues. We reported total revenues of $2,329,219 for the fiscal year
ended June 30, 1999, a 45% increase over  revenues of  $1,601,406  for the prior
fiscal  year.  During  fiscal  1999,  certification  fees  accounted  for 76% of
revenue, the same as the prior year. The growth in revenues is the result of our
regional expansion,  improved new sales velocity and the impact of a larger base
of business  member  renewals in Northern  California.  Revenues  for the fourth
fiscal quarter ended June 30, 1999,  were $559,466  compared to $508,829 for the
prior  year  comparable  quarter or a 10%  increase.  We  believe  this  limited
increase in the fourth  quarter was due in part to the delays and  disruption of
our move to new facilities near the end of the fourth quarter.

Revenues for the year from premium listings in our Consumer ValueStar Report and
on our Web site were  $222,100,  an increase of 112% over the  $104,640  for the
prior year. The increase resulted from expanded distribution and more aggressive
marketing of listings.

Our  revenues  can  vary  from  quarter  to  quarter  due to (a) the  impact  of
distributing  the  semi-annual   Consumer   ValueStar  Report  to  buyers,   (b)
seasonality,  (c)  effectiveness of sales methods and promotions,  (d) levels of
expenditures targeted at prospective businesses,  (d) the numbers of certificate
holders up for renewal,  (e) renewal rates, (f) pricing policies,  (g) timing of
completion  of research and ratings,  and (h) other  factors,  some of which are
beyond our control.

Cost of Revenues.  Cost of revenues consists  primarily of rating costs incurred
for performing  customer  satisfaction  research on business  applicants,  costs
related to verifying  insurance and complaint  status,  Web site operating costs
and costs of information  products.  Cost of revenues  represented  44% of sales
during the  fiscal  year ended  June 30,  1999 (58% in the fourth  quarter),  an
increase  from 36% for the fiscal  year ended June 30,  1998 (33% for the fourth
quarter).  We made  changes in fiscal 1999 to make our  ratings  more timely and
efficient.  However,  during the last quarter of the year we incurred  increased
rating  costs on a higher  number  of  businesses  that  elected  not to  become
certified,  primarily  in new  markets  where the value of our  services is less
recognized.  We have  increased  our training of field  personnel and during the
first two months of fiscal 2000 have improved our  certification  rates. We also
believe our move to new facilities  impacted rating operations during the fourth
quarter  increasing costs. We have made operating changes to address this matter
and believe we can improve  percentage  results in the future.  Cost of revenues
may  vary  significantly  from  quarter  to  quarter  both  in  amount  and as a
percentage of sales.

Selling Costs.  Selling costs consist  primarily of personnel  costs for outside
sales  consultants   interacting  with  customers  and  direct  marketing  costs
including lead generation and telemarketing  costs. Selling costs for the fiscal
year ended June 30,  1999,  were  $1,776,390,  or 76% of  revenues,  compared to
$902,320,  or 56% of revenues  for the prior  year.  The  current  year's  first
quarter included an $81,788 one-time, non-cash expense resulting from the change
in  estimate  for  deferred  costs.  Also in  fiscal  1999 we  commenced  rating
businesses  in seven new market  regions,  incurring  an  estimated  $300,000 of
non-deferred  selling costs associated with early startup of these regions.  New
market regions provide only nominal revenues in the first quarter of opening due
to the  approximately  60 to 90 day  lag  from  selling  activities  to  initial
revenues.  Other than direct  targeted  telemarketing  costs, we expense selling
costs as incurred. We expect selling costs as a percentage of revenues will vary
in future  periods,  resulting  from  levels of future  revenues,  variances  in
renewal rates, the effect of new sales  promotions and costs thereof,  timing of
research and rating  completions,  level and  percentage of fixed selling costs,
the  number of new market  regions  opened and other  factors,  some  beyond our
control.

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<PAGE>


Marketing and Promotion  Expenses.  Marketing and promotion expenses  aggregated
$778,435,  or 33% of revenues during fiscal 1999, comparable to $746,639, or 47%
of revenues for fiscal  1998.  Included in  marketing  and selling  expenses are
printing and distribution  costs of our Consumer  ValueStar  Report  publication
targeted at buyers.  Printing and distribution  costs of $266,000 in fiscal 1999
compared to the fiscal 1998 total of $232,000, as we printed and distribute more
copies with additional  pages.  During fiscal 1999, we expended $206,000 on paid
advertising  targeted at expanding  consumer  awareness of ValueStar  Certified.
Paid  advertising  of $310,000 was employed in the prior year.  We limited media
spending during fiscal 1999 due to limited  financial  resources.  During fiscal
1999, we expended $134,000 on promotions  compared to $49,000 for the prior year
with the  increase  due to an  increased  number of  promotions  in the  period.
Generally,  the first and third fiscal quarters have increased costs because our
Consumer  ValueStar Report  publication is printed and distributed  during these
quarters.  Also,  we  generally  expend less  advertising  in our second  fiscal
quarter (fourth calendar  quarter) due to higher media rates associated with the
holiday season.

Marketing and promotion expenses are subject to significant variability based on
decisions  regarding  the  timing  and  size  of  distribution  of our  Consumer
ValueStar Report and decisions regarding paid advertising,  public relations and
market and brand awareness efforts. We anticipate continuing to make significant
expenditures  on marketing and promotion  efforts to support a growing  business
base but  anticipate  these  costs  will  decrease  as an annual  percentage  of
revenues as revenues grow. However, amounts and percentages on a quarterly basis
may vary significantly.

General and Administrative Expenses. General and administrative expenses consist
primarily of expenses for finance, office operations, administration and general
and executive  management  activities,  including  legal,  accounting  and other
professional fees. They totaled $1,802,564 or 77% of revenues for the year ended
June 30, 1999,  compared to $827,955 or 52% of revenues  for the prior year,  an
increase  of  $974,609.  The major  increases  include a  $478,000  increase  in
compensation and benefits due primarily to the increased number of executive and
management  personnel  added in connection with regional  expansion;  a $341,000
increase in  occupancy  and  telephone  costs due to  additional  personnel  and
expanded  operations;  a $51,000  increase in bad debt and guarantee  provisions
versus the prior comparable  period;  an $80,000 increase in depreciation due to
additional equipment;  and a $31,000 increase in travel and entertainment due to
expanded  operations.  General and administrative costs increased to $577,147 or
103% of revenues  during the fourth  quarter of fiscal 1999 compared to $265,719
or 52% of revenues for the prior year's fourth quarter.  Management  anticipates
that  general and  administrative  costs will  continue to exceed  prior  period
levels due to increased  personnel  added to support  future  growth,  increased
general computer, operating, occupancy and corporate costs.

To date, our development  expenses  associated with the design,  development and
testing of our programs and services have not been material.  These expenditures
have  been  included  in sales  and  marketing  or  general  and  administrative
expenses.  In the  first  quarter  of  fiscal  2000  we  commenced  the  design,
development and testing of an expanded  Internet  program using existing and new
content.  We expect to spend more than $300,000 in product  development costs in
the  first  quarter  of  fiscal  2000  and  segregate  these  costs  as  product
development costs. Future levels of product development  expenses will depend on
decisions and factors not currently estimable by our management.

We incurred  interest  expense for the year ended June 30, 1999 of $395,890 that
included  $114,506  of  non-cash  amortization  of  bond  discount  and  accrued
paid-in-kind interest.  Interest for the prior comparable year was $119,023. The
increase  resulted from the significant  additions to our debt to finance growth
and our related losses.

Net Loss.  We had a net loss of  $3,459,744  for the fiscal  year ended June 30,
1999,  compared to a loss of $1,577,181 for the fiscal year ended June 30, 1998.
Our increased  loss is  attributable  primarily to (a)  increased  selling costs
resulting  from the expansion of sales  personnel to new market  regions and (b)
increased general and administrative costs associated with additional management
and support for new market regions. We anticipate we will continue to experience
operating  losses until we achieve a critical mass base of renewing  certificate
holders. We are increasing our business volume (new and renewal  certifications)
and future  quarterly  results  will be  greatly  impacted  by future  decisions
regarding new markets,  advertising and promotion expenditures and growth rates.
Achievement  of  positive  operating  results  will  require  that we  obtain  a
sufficient  base of new and  renewal  business  certifications  to  support  our
operating and corporate costs.  There can be no assurance we can sustain renewal
rates or achieve a profitable base of operations.

Liquidity and Capital Resources

Since we commenced  operations,  we have had significant negative cash flow from
operating  activities.  Our negative  cash flow from  operating  activities  was
$2,941,846  for the year ended June 30, 1999 and  $1,629,721  for the year ended
June 30, 1998. At June 30, 1999, we had a working capital deficit of $1,278,287,
including $1,032,664 representing the current portion of long-term debt. For the
year ended June 30, 1999, our negative cash flow from  operating  activities was

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<PAGE>


due  primarily  to our  continued  operating  losses,  expansion  to new  market
regions, addition of new executive management and investment in business growth.
At June 30,  1999,  our net accounts  receivables  were  $409,806,  representing
approximately  64  days  of  revenues  and  an  annualized   turnover  ratio  of
approximately  5.7 times.  This compares  favorably to  approximately 82 days of
revenues and turnover of approximately  4.4 times at June 30, 1998. Our improved
turnover and reduced accounts  receivable level results primarily from increased
revenues and more  diligent  collection  efforts.  We believe that 60 to 90 days
revenues in  receivables  is reasonable  based on the nature of our business and
the terms we provide certifying  companies on certain fees. At June 30, 1999, we
have  not  experienced  and  we  do  not  anticipate  any  significant  accounts
receivable recoverability problems.

We have financed our operations  primarily through the sale of common equity and
debt  financing.  On March 31, 1999 we obtained net proceeds of $2,310,000  from
the sale of secured  promissory notes. Also during the year ended June 30, 1999,
we obtained  $545,000 in net note and debt  financing  and $623,750  from common
stock sales.  In July and August 1999, we sold  $2,250,000 of Series A preferred
stock  for  cash.  These  funds  are  being  used  for  operations  and  product
development.  We have no commitments for future  investments and there can be no
assurance that we can continue to finance our operations  through these or other
sources. In the past, shareholders,  including from time to time directors, have
advanced funds and at times converted debt funds to equity financing on terms of
new forms of financing. There can be no assurance that shareholders or directors
or others will provide any future financing to ValueStar.

Other than cash on hand of $270,149 at June 30, 1999, net accounts receivable of
$409,806,  and the proceeds from the sale of Series A stock, we have no material
unused  sources  of  liquidity  at this  time.  We  expect  to incur  additional
operating losses in future fiscal quarters as a result of continued  operations,
product  development  expenditures  and  investments  in growth.  The timing and
amounts of these  expenditures and the extent of operating losses will depend on
many factors, some of which are beyond our control.

We have  expanded  operations  into  additional  new market  regions  with seven
additional regions in the last fifteen months (total of eight in the aggregate).
There can be no assurance we can successfully  penetrate the business  community
in new market regions. We expect that we will require a minimum of $3 million of
additional  capital to finance  operations  during the next twelve months.  This
estimate  is  based on the  first  fiscal  2000  quarter  level  of  operations,
anticipated renewal revenues,  anticipated sales levels in current markets,  and
budgeted  product  development  and operating  costs.  To expand into new market
regions  or  launch  new  products  or  services,  we would  require  additional
financing.  Our  actual  results  could  differ  significantly  from  plan  and,
therefore, we may require substantially greater operating funds. Should required
and/or  additional  funds not be  available or planned  operations  not meet our
expectations,  we may  be  required  to  significantly  curtail  or  scale  back
staffing,  advertising,  marketing  expenditures and general operations.  We may
also have to curtail the number of market regions in which we operate, with more
reliance  on  more  established  market  regions  providing  potentially  higher
profitable  renewals.  There can be no assurance that additional funding will be
available to us or on what terms. Potential sources of funds include exercise of
warrants and options,  loans from existing  shareholders or other debt financing
or additional equity offerings.

New Accounting Pronouncements and Issues

The  Financial  Accounting  Standards  Board has  issued new  pronouncements  as
discussed in the  footnotes  to our  financial  statements.  As discussed in the
notes  to  our   financial   statements,   the   implementation   of  these  new
pronouncements  is not  expected  to have a  material  effect  on our  financial
statements.

On September  28, 1998,  the SEC issued a press release and stated that the "SEC
will formulate and augment new and existing accounting rules and interpretations
covering  revenue  recognition,   restructuring   reserves,   materiality,   and
disclosure;" for all publicly-traded  companies.  In response the SEC's Division
of  Corporation  Finance has  established an Earnings  Management  Task Force to
focus  staff  resources  on the  review  of  filings  where  potential  earnings
management  issues  may be  present.  Until  such time as the SEC  staff  issues
interpretative   guidelines,   it  is  unclear   what,   if  any,   impact  such
interpretative  guidance  and  review  of  filings  will  have  on  our  current
accounting  practices.  Our practices have been  consistently  applied since our
initial filing and review by the SEC in 1997. However,  the potential changes in
accounting   practice  being   considered  by  the  SEC  staff,  if  applied  to
certifications in a manner different than currently recognized by us, could have
a material impact on the manner in which we recognize revenue. Any changes would
have no effect on reported cash flow or the economic value of our  certification
business.

Year 2000 Readiness Disclosure

We are aware of the issues  associated  with the  programming  code in  existing
computer  systems  as the Year 2000  approaches.  The  "Year  2000"  problem  is
concerned with whether computer  systems will properly  recognize date

                                       16

<PAGE>


sensitive  information  when  the year  changes  to  2000.  Systems  that do not
properly  recognize  information could generate erroneous data or cause a system
to fail.  The Year  2000  problem  is  pervasive  and  complex  as the  computer
operation  of virtually  every  company will be affected in some way which could
lead to business disruptions in the U.S. and internationally.

We have  identified the following  areas that could be impacted by the Year 2000
issue.  They are (a) our  products,  (b)  internally  used systems and software,
(c)products or services provided by key third parties,  and (d) the inability of
certifying businesses and prospective customers to process business transactions
relating to certifying revenue and product sales.

During the first calendar  quarter ended March 31, 1999, we completed an initial
review of our  internal  systems.  The  review  consisted  of an  evaluation  of
significant  internal hardware systems and major software  application  programs
that are primarily packaged third party "off-the-shelf"  software programs. As a
result of this review, we have identified  certain systems which require further
review  and  probable  upgrades  to be Year 2000  ready,  the costs of which are
included in our  estimates  outlined  below.  We are  currently  evaluating  new
business software  applications and one major selection and evaluation criterion
is full compliance with Year 2000. We do not believe our certification and other
products have any material Year 2000 problems.

In addition, we are in the process of assessing the compliance of our customers,
suppliers and vendors.  We believe that third-party  relationships upon which we
rely represent the greatest risk with respect to the Year 2000 issue, because we
cannot  guarantee  that  third  parties  will be able to  adequately  assess and
address their Year 2000 compliance  issues in a timely manner. As a consequence,
we can give no  assurances  that  issues  related  to Year  2000 will not have a
material  adverse  effect on our  future  results  of  operations  or  financial
condition.

Total costs  relating to our  compliance  efforts,  based on  management's  best
estimates  range from $10,000 to $20,000,  consisting  primarily  of  obtaining,
installing and testing new computers and upgrades of third party "off-the-shelf"
software  programs.  To date,  there have been no material direct  out-of-pocket
costs. Maintenance or modification costs will be expensed as incurred, while the
costs of new computers or software will be  capitalized  and amortized  over the
respective useful life.

Should we not be completely  successful in mitigating internal and external Year
2000 risks,  the likely worst case scenario  could be a system  failure  causing
disruptions of operations,  including, among other things, a temporary inability
to process transactions,  deliver certifications and products,  send invoices or
engage in similar normal  business  activities at our office or with our vendors
and suppliers. If we determine certain suppliers are not Year 2000 compliant, we
may have to arrange for  alternative  sources of supply and the  stockpiling  of
inventory  (mainly  brochures) in the fall of 1999 in  preparation  for the Year
2000.  We cannot  estimate  at this  time the cost or  effect  on our  financial
condition of any  stockpiling  of inventory.  We currently do not have any other
contingency  plans with respect to potential Year 2000 failures of our suppliers
or customers and at the present  time,  after an initial  evaluation,  we do not
intend to develop  one. If these  failures  would  occur,  depending  upon their
duration  and  severity,  they  could  have a  material  adverse  effect  on our
business, results of operations and financial condition.

The  information  set forth  above  under  this  caption  "Year  2000  Readiness
Disclosure"  relates to our efforts to address the Year 2000 concerns  regarding
our (a)  operations,  (b)  products and  technologies  licensed or sold to third
parties and (c) major  suppliers and customers.  Such statements are intended as
Year 2000 Statements and Year 2000 Readiness  Disclosures and are subject to the
"Year 2000 Information Readiness Act."

Tax Loss Carryforwards

As of June 30,  1999,  we had  approximately  $8  million  of  federal  tax loss
carryforwards.  These  losses  create a deferred tax asset.  We have  recorded a
valuation allowance to reduce the net deferred tax asset to zero because, in our
assessment,  it is more likely than not that the  deferred tax asset will not be
realized.  There  may  also  be  limitations  on the  utilization  of  tax  loss
carryforwards to offset any future taxes.

Business Risks

This report  contains a number of  forward-looking  statements  that reflect our
current  views with respect to future events and  financial  performance.  These
forward-looking  statements  are  subject  to certain  risks and  uncertainties,
including  those  discussed  below,  that could cause  actual  results to differ
materially from historical  results or those  anticipated.  In this report,  the
words  "anticipates,"   "believes,"   "expects,"  "intends,"  "future,"  "goal,"
"objective" and similar

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<PAGE>


expressions  identify  forward-looking  statements.  Readers  are  cautioned  to
consider  the  specific  risk  factors  described  below and not to place  undue
reliance on the forward-looking statements contained herein, which speak only as
of the date  hereof.  We  undertake  no  obligation  to  publicly  revise  these
forward-looking  statements,  to reflect events or circumstances  that may arise
after the date hereof.

         Because We Have a History of Losses and Anticipate  Continued Losses in
         Fiscal  2000,  We May Not Have  Sufficient  Capital - We have  incurred
         significant  operating  losses  since our  inception  and  anticipate a
         continuation  of losses in fiscal  2000.  Our  operating  results  have
         fluctuated  in the past and are expected to fluctuate in the future due
         to a number of factors,  many of which are outside our  control.  There
         can be no assurance that we can achieve profitable operations.  We will
         require  additional  capital to continue our operations and growth. The
         failure to obtain additional capital would require us to curtail growth
         and operations that would adversely impact operating results.

         We May Not be Able to Continue as a Going  Concern  Without  Additional
         Capital - Our ability to continue as a going concern is dependent  upon
         achieving and maintaining  profitable  operations,  cutting back on the
         rate of growth or obtaining  additional capital. Our reliance upon debt
         and equity  financing  to fund  losses  from  operations  and cash flow
         deficits,   our  material  net  losses  and  cash  flow  deficits  from
         operations and the possibility  that we may be unable to meet our debts
         as they come due,  raise doubt about our ability to continue as a going
         concern. If we are unable to obtain additional capital or reduce growth
         and operating costs to achieve operating stability,  we may not be able
         to continue as a going concern.

         Additional Funding May Dilute  Shareholders - Additional  financing may
         not be available on favorable  terms or at all. If we raise  additional
         funds by selling stock,  the  percentage  ownership of our then current
         stockholders will be reduced.  Our future capital  requirements are not
         known and depend upon numerous  factors,  including the rate we expand,
         results of  operations,  the extent we develop and launch new  products
         and services,  the effects of competition  and other  factors,  many of
         which are outside our control.

         Terms of Recent  Financings  May  Result  in  Adverse  Consequences  to
         Shareholders in the Future - We have entered into a senior secured debt
         financing  and  a  convertible   preferred  financing  of  which  three
         institutional investor control a majority of each series of securities.
         These securities contain terms and conditions that,  although customary
         in our  opinion  for a  company  in our  circumstances  and  associated
         financial  condition,  could have adverse consequences to shareholders.
         The three  institutional  investors have the ability to enforce certain
         rights or remedies, including the following:

                  o        The three  institutional  investors  effectively have
                           the right through a voting agreement  entered into in
                           connection  with our recent  debt  financing  and the
                           terms of the  Series  A  preferred  stock to  appoint
                           three  directors to  ValueStar's  board.  Although we
                           have  authorized  five  director  positions,  at  the
                           current time we have four  directors.  The  preferred
                           shareholders have appointed one director.  Should the
                           senior note holders  elect to appoint two  additional
                           directors,  then these  investors  could  effectively
                           change  control  of the  company.  This could have an
                           adverse  impact  on  current   shareholders   as  the
                           interests   of  the   senior   debt   and   preferred
                           shareholders   may   differ   from  those  of  common
                           shareholders.

                  o        The senior debt investors received warrants. Prior to
                           a qualifying  public  offering,  qualifying sale or a
                           qualifying senior stock market listing,  in the event
                           of  a   sale   or   disposition   of   ValueStar   or
                           substantially all of our assets, the number of shares
                           of  common  stock  for  which  the  warrants  may  be
                           exercised may be increased,  without a  corresponding
                           increase in the aggregate  consideration.  This would
                           provide  additional  consideration to warrant holders
                           based  on  a  revenue-based  valuation.   This  could
                           significantly  reduce the proceeds available to other
                           common shareholders from a sale.

                  o        The senior  debt  warrant  holders  have "Drag  Along
                           Rights".  Until a qualifying  public offering or sale
                           is completed  by  ValueStar  or a  qualifying  market
                           listing is achieved, then upon either (a) a change in
                           control,  or (b) the loss of Mr.  Stein as  President
                           without  a  replacement  acceptable  to  the  warrant
                           holders, or (c) a non-qualifying  public offering, or
                           (d) certain  defaults under the senior notes, and (e)
                           at any time between April 2004 and April 2009 (unless
                           the  rights  are  earlier

                                       18

<PAGE>


                           terminated), the warrant holders may seek a buyer for
                           ValueStar  or its assets and  ValueStar  and three of
                           our current directors (Jim Stein,  Jerry E. Polis and
                           James A. Barnes) are  obligated to cooperate and take
                           such  actions  to  complete a sale,  consistent  with
                           their  fiduciary  duties.   Upon  such  a  sale,  the
                           warrants  may  be  exercised  for  additional  common
                           shares  resulting  in  additional  dilution  and less
                           proceeds  to  existing  shareholders.  This  dilution
                           could be material should the Drag Along Rights become
                           exercisable and subsequently exercised by the warrant
                           holders.

                  o        The  securities   contain  a  number  of  provisions,
                           including   antidilution   provisions,   registration
                           rights and equity and debt  preemptive  rights.  Upon
                           the  occurrence of future  events,  these  provisions
                           could be  dilutive to  shareholders.  Also should the
                           holders elect to exercise their  registration  rights
                           and sell large  amounts of  securities  in the market
                           this could have an adverse effect on the price of our
                           shares.

                  o        Our  senior  debt  agreement  contains  a  number  of
                           restrictive  covenants.  There can be no assurance we
                           can stay within such  restrictions  and failure to do
                           so without  waivers from the lenders  could result in
                           an  acceleration  in the term of senior debt.  Should
                           our senior debt be  accelerated,  it is unlikely that
                           we could  continue  as a going  concern and we may be
                           required to seek  bankruptcy  protection.  This would
                           have a material adverse impact on  shareholders.  The
                           debt  holders  have waived from time to time  certain
                           restrictions and amended or waived certain  financial
                           covenants.

         The documents  related to the debt  financing were filed as exhibits to
         our Form 8-K dated April 13, 1999. The documents  related to the Series
         A preferred stock financing are filed as exhibits to this Form 10-KSB.

         Competition  and  Technological  Changes May Affect Our  Business - The
         possibility  exists that a business  rating  service and  certification
         mark similar to or  competitive  to ours will be developed.  It is also
         possible that future competition will try to duplicate our concept.  We
         could face head-on  competition  from vastly larger and better financed
         companies  with the means to launch a high-impact  campaign  locally or
         nationally.  Technological  changes in the manner of selecting  service
         businesses and communicating information to consumers could also have a
         negative impact on our business.  As a provider of consumer information
         through the Internet and various media, we will be required to adapt to
         new and  changing  technologies.  There  can be no  assurance  that our
         services will remain viable or competitive in the face of technological
         change.

         We Depend on Our  President  and CEO as the Public Image of ValueStar -
         We are substantially dependent upon the experience and knowledge of our
         President  and CEO,  James  Stein.  Mr.  Stein is  becoming a leader in
         customer satisfaction issues and is our public spokesperson for events,
         including   customer   meetings  and  various   radio  and   television
         appearances.  The loss of Mr.  Stein  could be  detrimental  to the our
         development,  especially  since  we may not  have  the  funds to hire a
         replacement with the requisite expertise.  We have a $3 million key-man
         life  insurance  policy  on Mr.  Stein of which $2 is  assigned  to our
         senior debt holders.

         We Rely on Third Parties for Important Services - Our operations depend
         on a number of third parties.  We have limited control over these third
         parties and other than Public Research Institute,  we have no long-term
         relationships with them. We do not own a gateway onto the Internet, but
         instead rely on an Internet service provider to connect our Web site to
         the Internet. Disruption, temporary or prolonged, of our Web site could
         have a material  adverse  effect on our  business.  We are dependent on
         third parties for printing and  distribution of our Consumer  ValueStar
         Report.  Failure to maintain  satisfactory  relationships on acceptable
         commercial  terms with these third  parties could affect the timing and
         quality of our services to customers and adversely affect our operating
         results.

         We are Developing  New Markets with No Proven  Acceptance - Although we
         believe the factors  driving our business  acceptance in the California
         market  are  similar  throughout  the  United  States,  there can be no
         assurance of  widespread  acceptance.  As a new and  evolving  business
         format,  demand and market  acceptance  are  subject to a high level of
         uncertainty.  We believe the  evolution of our business  will depend in
         part on increasing brand recognition.  Development and awareness of our
         rating brand will depend on co-branding,  with certified businesses and
         our success in  maintaining  our  position as a leader in the rating of
         local service businesses.

                                       19

<PAGE>


         The  Failure  to  Establish  the  ValueStar   Brand  Would  Impair  our
         Competitive  Position - We are highly  dependent  on  establishing  and
         maintaining  our  brand.  Any  event or  circumstance  that  negatively
         impacts our brand could have a direct and  material  adverse  effect on
         our  business,  results  of  operations  and  financial  condition.  As
         competition  develops,  we believe  that  brand  strength  will  become
         increasingly important.  The reputation of our brand will depend on our
         ability to provide  quality  services  to our  customers  and  maintain
         quality and the  integrity of our rating and  certification  service to
         businesses and consumers. We cannot assure you we will be successful in
         maintaining   our  brand  and  delivering   quality  to  customers  and
         consumers. If customers and consumers are not satisfied, their negative
         experiences  might result in publicity that could damage our reputation
         and our competitive position could suffer.

         We Face Risks in Managing a Growing and Changing Business - We continue
         to experience changes in our operations resulting from expansion of our
         business  and other  factors  which  have and may place  demands on our
         administrative,   operational  and  financial  resources.   Our  future
         performance  will depend in part on our ability to manage growth and to
         adapt our administrative,  operational and financial control systems to
         the needs of an  expanding  entity.  The failure of our  management  to
         anticipate,  respond to and manage changing  business  conditions could
         have a  material  adverse  effect  on  ours  business  and  results  of
         operations.  Future  growth will also  require  additional  management.
         There can be no assurance we can attract  appropriate  personnel in the
         future to manage a growing and changing business.

         We Need to Protect Our Trademarks and Intellectual Property - We regard
         our  trademarks,  copyrights,  trade  secrets and similar  intellectual
         property  as  critical  to our  success.  We rely on a  combination  of
         copyright and trademark laws, trade secret protection,  confidentiality
         and contractual  provisions with certain employees and third parties to
         establish and protect our proprietary rights. There can be no assurance
         that  third  parties  will  not  infringe  upon or  misappropriate  our
         proprietary rights. Any misappropriation by competitors or unauthorized
         use by service  businesses of the trademark  ValueStar or the ValueStar
         Certified  certification  mark could have a material  adverse impact on
         our  operations.  A number of  companies  claim  proprietary  rights to
         certain  aspects of Internet  operations.  Although we are not aware of
         any aspect of our  operations  that may infringe on the rights of other
         companies,  there is no  assurance  these  claims will not arise in the
         future.  Although we have limited  resources to protect our rights,  we
         intend to take aggressive actions to protect our certification mark.

         Year 2000 Compliance  Issues Could  Adversely  Impact our Business - We
         have identified certain of our systems which require further review and
         probable upgrades to be Year 2000 ready. We are evaluating new business
         software  applications and one major selection and evaluation criterion
         is full  compliance  with Year 2000. We are assessing the compliance of
         our  customers,  suppliers  and vendors.  We believe  that  third-party
         relationships  upon  which we rely  represent  the  greatest  risk with
         respect to the Year 2000 issue,  because we cannot guarantee that third
         parties will be able to  adequately  assess and address their Year 2000
         compliance  issues  in a  timely  manner.  As a  consequence,  known or
         unknown errors or defects that affect the operation of our software and
         systems and those of third parties and customers, could result in delay
         or loss of revenue, interruption of services,  cancellation of customer
         contracts,  damage to our reputation,  increased  operating  costs, and
         litigation costs, any of which could harm our business.

         We May Become  Subject to Government  Regulation-  We are not currently
         subject to direct  regulation  other than federal and state  regulation
         applicable to businesses generally. However, the liability for Internet
         content  is an  evolving  area of  litigation  and  regulation  and our
         operations may be impacted by litigation and regulation in the future.

         We May Face Legal  Uncertainties  That Could Harm Our Business - We may
         be  subject  to  claims  by  consumers  for the  actions  of  certified
         businesses.  Although we do not  believe a claim would have merit,  the
         costs of defense could be substantial. There is no assurance our errors
         and omissions  insurance would adequately cover any claims. In addition
         to the direct  legal and defense  costs,  litigation  could  negatively
         impact our  reputation  and make selling to and  certifying  businesses
         more difficult.

         Stock Trading Risks and Uncertainties  Increase Risk to Investors - See
         Part II - Item 5 "Market  for  Common  Equity and  Related  Stockholder
         Matters."

                                       20

<PAGE>


Item 7. Financial Statements

The consolidated  financial  statements of the ValueStar required to be included
in this Item 7 are set forth in a separate  section of this report and  commence
on Page F-1 immediately following page 24.


Item  8.  Changes  In and  Disagreements  With  Accountants  on  Accounting  and
Financial Disclosure

Not applicable.


                                    PART III

The information  called for by Items 9, 10, 11 and 12 of Part III of Form 10-KSB
(consisting  of Item 9 - Directors,  Executive  Officers,  Promoters and Control
Persons;  Compliance with Section 16(a) of the Exchange Act, Item 10 - Executive
Compensation,  Item 11 - Security  Ownership  of Certain  Beneficial  Owners and
Management,  and Item 12 - Certain  Relationships  and Related  Transactions) is
incorporated by reference from ValueStar's  definitive  proxy  statement,  which
will be filed with the Securities and Exchange  Commission within 120 days after
the end of the fiscal year to which this Report relates.

Item 13. Exhibits and Reports on Form 8-K

(a) Exhibits

Each  exhibit  marked with an asterisk is filed with this Annual  Report on Form
10-KSB. Each exhibit not marked with an asterisk is incorporated by reference to
the exhibit of the same number (unless otherwise indicated)  previously filed by
us as indicated below.

         Exhibit
         Number                     Description of Exhibit
         ------                     ----------------------
         3.1     Articles of  Incorporation  of the Carson  Capital  Corporation
                 (Colorado)  as filed on January  28,  1987 and filed as Exhibit
                 2.1 to the Company's  Registration  Statement on Form 10-SB, as
                 amended.

         3.1.1   Amendment  to Articles of  Incorporation  as filed on September
                 21,  1992  and  filed  as  Exhibit   2.1.1  to  the   Company's
                 Registration Statement on Form 10-SB, as amended.

         3.1.2   Amendment  to Articles of  Incorporation  as filed on April 24,
                 1997 and filed as Exhibit 2.1.2 to the  Company's  Registration
                 Statement on Form 10-SB, as amended.

         3.2     Bylaws of the  Company  filed as Exhibit  2.2 to the  Company's
                 Registration Statement on Form 10-SB, as amended.

         3.3*    Certificate of  Designation  of Series A Convertible  preferred
                 stock filed with the State of Colorado on July 21, 1999.

         4.1     Form of  Certificate  evidencing  common  stock of the  Company
                 filed as Exhibit 3.1 to the Company's Registration Statement on
                 Form 10-SB, as amended.

         4.3     Form of 12% Promissory Note with Non-Detachable  Stock Purchase
                 Warrants Due March 31, 2001 as amended and restated  (aggregate
                 of $100,000 principal with two lenders) (individual  agreements
                 differ as to payee) and filed as Exhibit  4.3 to the  Company's
                 Form 10-KSB for the year ended June 30, 1998.

         4.4     Form of Stock Purchase  Warrant dated April 30, 1997 granted to
                 five persons  exercisable  into an aggregate of 150,000  common
                 shares at $0.75  per share  until  April 30,  2002  (Individual
                 warrants  differ as to holder and  number of  shares)  filed as
                 Exhibit 3.4 to the  Company's  Registration  Statement  on Form
                 10-SB, as amended.

         4.5     Form of Stock  Purchase  Warrant dated June 30, 1997 granted to
                 three investors exercisable into an aggregate of 200,000 common
                 shares at $1.25 per share  until June 30, 2002 filed as Exhibit
                 3.5 to the Company's  Registration  Statement on Form 10-SB, as
                 amended.

                                       21

<PAGE>


         4.6     Form of Stock  Purchase  Warrant dated October 27, 1997 granted
                 to two investors exercisable into an aggregate of 50,000 common
                 shares at $1.25 per share until September 30, 2002  (individual
                 warrants  are for 25,000  shares  each and differ as to holder)
                 filed as  Exhibit  4.6 to the  Company's  Form  10-QSB  for the
                 quarter ended December 31, 1997.

         4.7     Form of Stock  Purchase  Warrant dated December 9, 1997 granted
                 to  four  persons  for  bank  guarantee   exercisable  into  an
                 aggregate  of 250,000  common  shares at $1.25 per share  until
                 September 30, 2002  (individual  warrants are for 62,500 shares
                 each   and   differ   as   to    holder).    Holders    include
                 officers/directors James Stein and James A. Barnes and director
                 Jerry E.  Polis.  Filed as Exhibit  4.7 to the  Company's  Form
                 10-QSB for the quarter ended December 31, 1997.

         4.8     Form of Stock Purchase  Warrant dated December 12, 1997 granted
                 to three  investors  exercisable  into an  aggregate of 200,000
                 common  shares at $1.25  per  share  until  December  31,  2002
                 (individual   warrants   differ  as  to  number  and   holder).
                 Officer/director  James A.  Barnes is  holder  of a warrant  on
                 20,000 of these  shares.  Filed as Exhibit 4.8 to the Company's
                 Form 10-QSB for the quarter ended December 31, 1997.

         4.9     Form of unsecured 12%  Subordinated  Promissory  Notes due June
                 30, 2000  granted to investors  (individual  notes differ as to
                 date, principal amount and holder). Filed as Exhibit 4.9 to the
                 Company's Form 10-QSB for the quarter ended December 31, 1997.

         4.10    Form of Stock  Purchase  Warrant  granted  to 12%  Subordinated
                 Promissory  Note holders (at the rate of warrants on 500 common
                 shares  for each  $1,000  of  notes)  exercisable  at $1.25 per
                 common share until December 31, 2000 (each  individual  warrant
                 differs  as to number of  shares,  date and  holder).  Filed as
                 Exhibit 4.10 to the Company's Form 10-QSB for the quarter ended
                 December 31, 1997.

         4.11    Form of unsecured 6% Convertible  Subordinated Promissory Notes
                 due June 30, 2001 (individual notes  aggregating  $525,000 were
                 granted to four investors and differ as to principal amount and
                 holder).  Filed as Exhibit 4.11 to the Company's Form 8-K dated
                 May 21, 1998.

         4.12    Form  of  Stock  Purchase  Warrant  granted  to 6%  Convertible
                 Subordinated  Promissory  Note  holders  (on  an  aggregate  of
                 262,500  common  shares)  exercisable at $1.25 per common share
                 until April 30,  2003 (each  individual  warrant  differs as to
                 number of shares  and  holder).  Filed as  Exhibit  4.12 to the
                 Company's Form 8-K dated May 21, 1998.

         4.13    Form  of  Stock  Purchase  Warrant  granted  to 6%  Convertible
                 Subordinated  Promissory  Note  holders  (on  an  aggregate  of
                 262,500  common  shares)  exercisable at $2.00 per common share
                 until April 30,  2003 (each  individual  warrant  differs as to
                 number of shares  and  holder).  Filed as  Exhibit  4.13 to the
                 Company's Form 8-K dated May 21, 1998.

         4.14    Stock  Purchase   Warrant   between  the  Company  and  Jackson
                 Strategic,   Inc.   dated  May  18,  1998  (for  50,000  shares
                 exercisable  at $1.75 per share)  filed as Exhibit  4.14 to the
                 Company's Form 10-KSB for the year ended June 30, 1998.

         4.15    Stock Purchase warrant between the Registrant and Viking Group,
                 L.L.C.,  dated October 20, 1998 (for 200,000 shares exercisable
                 at $0.75 per  share)  filed as  Exhibit  4.15 to the  Company's
                 Registration Statement on Form S-3 dated October 27, 1998.

         4.16    Form of Stock  Purchase  Warrant  granted in December  1998 and
                 January 1999 to seven investors  exercisable  into an aggregate
                 of 500,000  common shares at $1.00 per share until December 31,
                 2003 (individual warrants differ as to number, date and holder)
                 filed as  Exhibit  4.16 to the  Company's  Form  10-QSB for the
                 quarter  ended  December  31, 1998.  Officer/director  James A.
                 Barnes is the  indirect  holder of a warrant on 25,000 of these
                 shares.

                                       22

<PAGE>


         4.17    Note  Purchase  Agreement  between the  Company's  wholly-owned
                 subsidiary (ValueStar,  Inc.) and three institutional investors
                 dated  March 31,  1999 filed as Exhibit  4.17 to the  Company's
                 report on Form 8-K dated April 13, 1999.

         4.17.1* First Amendment to Note Purchase  Agreement dated September 20,
                 1999  between  the  Company  and  the  Company's   wholly-owned
                 subsidiary (ValueStar, Inc.) and three institutional investors

         4.18    Form of 8% Senior Note dated March 31, 1999 between  ValueStar,
                 Inc.  and three  institutional  investors  for an  aggregate of
                 $2.45 million (individual notes differ as to holder and amount)
                 filed as Exhibit 4.18 to the Company's report on Form 8-K dated
                 April 13, 1999.

         4.19    Shareholder Agreement between the Company,  three institutional
                 investors and certain  stockholders  of the Company dated March
                 31, 1999 filed as Exhibit 4.19 to the Company's  report on Form
                 8-K dated April 13, 1999.

         4.19.1* Waiver  Agreement  between  the  Company,  three  institutional
                 investors  and certain  stockholders  of the Company dated July
                 21, 1999.

         4.20    Warrant   Purchase   Agreement   between  the  Company,   three
                 institutional investors and certain stockholders of the Company
                 dated  March 31,  1999 filed as Exhibit  4.20 to the  Company's
                 report on Form 8-K dated April 13, 1999.

         4.21    Form of A, B and C  Warrants  issued  by the  Company  to three
                 institutional   investors  dated  March  31,  1999  (individual
                 warrants  differ as to holder and number) filed as Exhibit 4.21
                 to the Company's report on Form 8-K dated April 13, 1999.

         4.22    Security Agreement dated March 31, 1999 between ValueStar, Inc.
                 and three institutional  investors filed as Exhibit 4.22 to the
                 Company's report on Form 8-K dated April 13, 1999.

         4.23    Trademark  Security  Agreement  dated  March 31,  1999  between
                 ValueStar,  Inc.  and three  institutional  investors  filed as
                 Exhibit  4.23 to the  Company's  report on Form 8-K dated April
                 13, 1999.

         4.24    Form of Stock  Purchase  Warrant dated March 31, 1999 issued to
                 two  individuals  by the  Company for an  aggregate  of 152,728
                 shares  of  common  stock  at  an  exercise   price  of  $1.375
                 (individual warrants differ as to holder) filed as Exhibit 4.24
                 to the Company's report on Form 8-K dated April 13, 1999.

         4.24.1* Form of First  Amendment to Stock Purchase  Warrant dated March
                 31, 1999. The Amendment is dated effective July 15, 1999.

         4.25*   Stock Purchase  Warrant dated June 30, 1999 between the Company
                 and Davric Corporation for an aggregate of 30,000 common shares
                 at an exercise price of $1.50 per share.

         4.26*   Form of Series A preferred stock Purchase Agreement dated as of
                 July 21, 1999  between the Company and  purchasers  of Series A
                 stock (including two directors).

         4.27*   Form  of  Registration   Rights   Agreement  and   Shareholders
                 Agreement  Amendment  dated July 21, 1999  between the Company,
                 senior  note   holders,   two  directors  and  Series  A  stock
                 purchasers.

        10.1     Research  and Rating  Agreement  between  the  Public  Research
                 Institute of San Francisco State University and ValueStar, Inc.
                 effective  April 30, 1997 filed as Exhibit 6.1 to the Company's
                 Registration Statement on Form 10-SB, as amended

        10.2(1)  1992  Incentive  Stock  Option  Plan,  As Amended  and filed as
                 Exhibit 6.2 to the  Company's  Registration  Statement  on Form
                 10-SB, as amended

                                       23

<PAGE>


        10.2.1   Standard form of Incentive Stock Option Plan Agreement filed as
                 Exhibit 6.2.1 to the Company's  Registration  Statement on Form
                 10-SB, as amended

        10.3(1)  1992  Non-Statutory  Stock Option Plan, As Amended and filed as
                 Exhibit 6.3 to the  Company's  Registration  Statement  on Form
                 10-SB, as amended

        10.3.1   Standard  form of  Non-Statutory  Stock  Option Plan  Agreement
                 filed as Exhibit 6.3.1 to the Company's  Registration Statement
                 on Form 10-SB, as amended

        10.4     Employment  Agreement between the Company and James Stein dated
                 as of July 1, 1998 filed as Exhibit 10.4 to the Company's  Form
                 10-KSB for the year ended June 30, 1998.

        10.5*    Office Lease  between the  Company's  Subsidiary  and Broadlake
                 Partners dated April 20, 1999.

        10.6     (not used)

        10.7     1996 Stock  Option  Plan,  as amended and restated and filed as
                 Exhibit 6.7 to the  Company's  Registration  Statement  on Form
                 10-SB, as amended

        10.7.1   Standard  form of 1996  Stock Plan  Agreement  filed as Exhibit
                 6.7.1 to the Company's Registration Statement on Form 10-SB, as
                 amended

        10.8     1997 Stock  Option Plan filed as Exhibit  6.8 to the  Company's
                 Registration Statement on Form 10-SB, as amended

        10.8.1   Standard  form of 1997  Stock Plan  Agreement  filed as Exhibit
                 6.8.1 to the Company's Registration Statement on Form 10-SB, as
                 amended

        10.8.2   First  Amendment to 1997 Stock Option Plan dated March 31, 1998
                 and filed as Exhibit  10.8.2 to the  Company's  Form 10-KSB for
                 the year ended June 30, 1998.

        10.9     1997 Employee Stock  Compensation  Plan filed as Exhibit 6.9 to
                 the Company's Registration Statement on Form 10-SB, as amended

        10.10    Form of  Non-Qualified  Stock Option Agreement dated as of July
                 6, 1998  between the Company  and three  directors  covering an
                 aggregate of 200,000 shares  (individual  agreements vary as to
                 number of shares and holder, Mr. Stein as to 100,000 shares and
                 Mr.  Polis and Mr.  Barnes as to 50,000  shares  each) filed as
                 Exhibit 10.10 to the  Company's  Form 10-KSB for the year ended
                 June 30, 1998.

        10.11    Promissory  Note  between the  Company  and Davric  Corporation
                 dated August 14, 1998 filed as Exhibit  10.11 to the  Company's
                 Form 10-KSB for the year ended June 30, 1998.

        10.12    Promissory  Note  between the  Company  and Davric  Corporation
                 dated November 15, 1998 filed as Exhibit 10.12 to the Company's
                 Form 10-QSB for the quarter ended December 31, 1998.

        10.12.1* First  Amendment  to  Promissory  Note  between the Company and
                 Davric Corporation dated June 30, 1999.

        10.13    Press  release  issued by the Company on April 1, 1999 filed as
                 Exhibit 10.13 to the Company's Form 8-K dated April 13, 1999.

        21.1*    Subsidiary of the Company

        23.1*    Consent of Moss Adams LLP

                                       24

<PAGE>


        27.1*    Financial Data Schedule

-----------------------
        *        Filed herewith.
        (1)      Indicates management contract or compensatory plan.


(b) Reports on Form 8-K.

The Company  filed one report on Form 8-K during the last fiscal  quarter of the
year ended June 30,  1999.  The report  dated April 13, 1999  reported an Item 5
event related to placement of $2.45 million of senior debt.

                                       25

<PAGE>


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


                              VALUESTAR CORPORATION

                          INDEPENDENT AUDITOR'S REPORT
                                       AND
                        CONSOLIDATED FINANCIAL STATEMENTS

                             JUNE 30, 1999 and 1998









--------------------------------------------------------------------------------
<PAGE>


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





                                    CONTENTS


                                                                            PAGE

INDEPENDENT AUDITOR'S REPORT.................................................F-1


CONSOLIDATED FINANCIAL STATEMENTS

     Balance sheet...........................................................F-2

     Statements of operations................................................F-3

     Statements of stockholders' deficit.....................................F-4

     Statements of cash flows................................................F-5

     Notes to financial statements...........................................F-6


--------------------------------------------------------------------------------
<PAGE>

INDEPENDENT AUDITOR'S REPORT





To the Board of Directors
Valuestar Corporation


We have  audited  the  accompanying  consolidated  balance  sheet  of  Valuestar
Corporation,  as of June 30, 1999,  and the related  consolidated  statements of
operations,  stockholders'  deficit, and cash flows for the years ended June 30,
1999  and  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 audits 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 our audits provide a reasonable basis for our opinion.

In our opinion,  the  consolidated  financial  statements as of and for the year
ended June 30, 1999,  present fairly,  in all material  respects,  the financial
position of the Company as of June 30, 1999,  and the results of its  operations
and cash flows for the years ended June 30, 1999 and 1998,  in  conformity  with
generally accepted accounting principles.

The accompanying  consolidated  financial statements have been prepared assuming
the  Company  will  continue as a going  concern.  As  discussed  in Note 2, the
Company's  recurring losses and its inability to generate  sufficient cash flows
from  operations  to meet its  obligations  raises  substantial  doubt about the
Company's  ability to continue as a going concern.  The  consolidated  financial
statements do not include any adjustments  that might result from the outcome of
this uncertainty.


                                                  /s/ Moss Adams LLP

Santa Rosa, California
August 9, 1999,  except for Note 15,
      which is as of August 30, 1999



                                                                        Page F-1

<PAGE>


                                                           VALUESTAR CORPORATION
                                                      CONSOLIDATED BALANCE SHEET
                                                                   June 30, 1999

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

                                     ASSETS

CURRENT ASSETS
     Cash                                                           $   270,149
     Receivables                                                        409,806
     Inventory                                                            4,008
     Prepaid expenses                                                    59,446
                                                                    -----------

             Total current assets                                       743,409

PROPERTY AND EQUIPMENT                                                  501,605

DEFERRED COSTS                                                          100,839

INTANGIBLE AND OTHER ASSETS                                             194,130
                                                                    -----------

             Total assets                                           $ 1,539,983
                                                                    ===========

                      LIABILITIES AND STOCKHOLDERS' DEFICIT

CURRENT LIABILITIES
     Accounts payable                                               $   461,825
     Accrued liabilities and other payables                             189,759
     Deferred revenues                                                   27,430
     Note payable - shareholder                                         280,000
     Current portion of capitalized leases                               30,018
     Current portion of long-term debt                                1,032,664
                                                                    -----------

             Total current liabilities                                2,021,696

CAPITAL LEASE OBLIGATIONS, net of current portion                       113,541

LONG-TERM DEBT, net of current portion                                1,795,438
                                                                    -----------

             Total liabilities                                        3,930,675
                                                                    -----------

STOCKHOLDERS' DEFICIT
     Common stock, $.00025 par value; 20,000,000 shares
         authorized, 9,374,132 shares issued and outstanding              2,344
     Additional paid-in capital                                       6,485,373
     Accumulated deficit                                             (8,878,409)
                                                                    -----------

             Total stockholders' deficit                             (2,390,692)
                                                                    -----------

             Total liabilities and stockholders' deficit            $ 1,539,983
                                                                    ===========


The accompanying notes are an integral part of these financial statements.
--------------------------------------------------------------------------------
                                                                        Page F-2
<PAGE>

                                                           VALUESTAR CORPORATION
                                           CONSOLIDATED STATEMENTS OF 0PERATIONS
                                              Years Ended June 30, 1999 and 1998

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


                                                      1999              1998
                                                  -----------       -----------

REVENUES                                          $ 2,329,219       $ 1,601,406
                                                  -----------       -----------

OPERATING EXPENSES
     Cost of revenues                               1,035,401           580,041
     Selling                                        1,776,390           902,320
     Marketing and promotion                          778,435           746,639
     General and administrative                     1,802,564           827,955
                                                  -----------       -----------

                                                    5,392,790         3,056,955
                                                  -----------       -----------

LOSS FROM OPERATIONS                               (3,063,571)       (1,455,549)
                                                  -----------       -----------

OTHER INCOME (EXPENSE)
     Interest expense                                (395,890)         (119,023)
     Miscellaneous                                       (283)           (2,609)
                                                  -----------       -----------

                                                     (396,173)         (121,632)
                                                  -----------       -----------

NET LOSS                                          $(3,459,744)      $(1,577,181)
                                                  ===========       ===========

LOSS PER COMMON SHARE                             $     (0.39)      $     (0.19)
                                                  ===========       ===========

WEIGHTED AVERAGE OF COMMON SHARES
     OUTSTANDING                                    8,966,203         8,500,228
                                                  ===========       ===========



The accompanying notes are an integral part of these financial statements.
--------------------------------------------------------------------------------
                                                                        Page F-3
<PAGE>
<TABLE>

                                                                                                VALUESTAR CORPORATION
                                                                     CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
                                                                                   Years Ended June 30, 1999 and 1998

---------------------------------------------------------------------------------------------------------------------
<CAPTION>
                                                       Common Stock           Additional
                                                 -------------------------     Paid-in     Accumulated
                                                   Shares        Amount        Capital       Deficit         Total
                                                 -----------   -----------   -----------   -----------    -----------
<S>                                                <C>         <C>           <C>           <C>            <C>
Balance, June 30, 1997                             8,326,246   $     2,082   $ 3,759,351   $(3,841,484)   $   (80,051)

Sale of stock at $1.00 per unit, consisting
    of one share and one warrant                     220,000            55       219,945          --          220,000
Conversion of debt to stock at $1.00 per unit,
    consisting of one share and one warrant           30,000             7        29,993          --           30,000
Stock issued for services at $.96875 per share        91,250            23        88,375          --           88,398
Stock on option exercise at $.50 per share            15,000             4         7,496          --            7,500
Issuance of warrants for bank guarantee                 --            --          20,000          --           20,000
Issuance of warrants with debt                          --            --         118,000          --          118,000
Issuance of warrants for services                       --            --           4,000          --            4,000
Net loss                                                --            --            --      (1,577,181)    (1,577,181)
                                                 -----------   -----------   -----------   -----------    -----------

Balance, June 30, 1998                             8,682,496         2,171     4,247,160    (5,418,665)    (1,169,334)

Sale of stock at $1.00 per unit, consisting
    of one share and one warrant                     500,000           125       499,875          --          500,000
Exercise of warrants at $0.75 per share              150,000            37       112,463          --          112,500
Options exercised at $0.75 per share                  15,000             4        11,246          --           11,250
Conversion of debt to stock
    at $1.00 per share                                26,636             7        26,629          --           26,636
Issuance of warrants with debt                          --            --       1,520,000          --        1,520,000
Issuance of warrants for services                       --            --          60,000          --           60,000
Issuance of options for services                        --            --           8,000          --            8,000
Net loss                                                --            --            --      (3,459,744)    (3,459,744)
                                                 -----------   -----------   -----------   -----------    -----------

Balance, June 30, 1999                             9,374,132   $     2,344   $ 6,485,373   $(8,878,409)   $(2,390,692)
                                                 ===========   ===========   ===========   ===========    ===========
<FN>


The accompanying notes are an integral part of these financial statements.
----------------------------------------------------------------------------------------------------------------------
                                                                                                             Page F-4
</FN>
</TABLE>
<PAGE>
<TABLE>

                                                                   VALUESTAR CORPORATION
                                                   CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                      Years Ended June 30, 1999 and 1998

----------------------------------------------------------------------------------------
<CAPTION>
                                                               1999            1998
                                                            -----------    -----------
<S>                                                         <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITIES
     Net loss                                               $(3,459,744)   $(1,577,181)
     Adjustments to reconcile net loss to net
         cash used by operating activities:
            Depreciation                                         89,988         11,125
            Amortization of intangible assets                     7,657           --
            Amortization of bond discount                        84,645         12,532
            Change in allowance for doubtful accounts           (30,921)        45,000
            Accrued interest included in long-term debt          29,861           --
            Warrants and options issued for services             68,000         24,000
            Common stock issued for services                       --           88,398
         Changes in:
            Receivables                                         (17,516)      (110,827)
            Inventory                                            20,388          3,467
            Prepaid expenses                                    (55,544)         3,133
            Deferred costs                                       30,091          3,155
            Other assets                                        (17,890)          --
            Accounts payable                                    264,415       (175,816)
            Accrued liabilities and other payables               44,314         38,993
            Deferred revenues                                       410          4,300
                                                            -----------    -----------
                Net cash used by operating activities        (2,941,846)    (1,629,721)
                                                            -----------    -----------

CASH FLOWS FROM INVESTING ACTIVITIES
     Property and equipment acquisitions                       (381,326)       (18,400)
                                                            -----------    -----------

CASH FLOWS FROM FINANCING ACTIVITIES
     Proceeds from sale of stock                                623,750        227,500
     Proceeds from senior debt                                2,450,000           --
     Debt acquisition fee                                      (140,000)          --
     Net borrowings (repayments) under line of credit          (250,000)       250,000
     Proceeds from debt                                         781,150      1,525,000
     Payments on capital leases                                 (13,908)          --
     Payments on debt                                          (256,275)          --
                                                            -----------    -----------
                Net cash provided by financing activities     3,194,717      2,002,500
                                                            -----------    -----------

NET INCREASE (DECREASE) IN CASH                                (128,455)       354,379
CASH, beginning of year                                         398,604         44,225
                                                            -----------    -----------

CASH, end of year                                           $   270,149    $   398,604
                                                            ===========    ===========

SUPPLEMENTAL CASH-FLOW INFORMATION
     Cash paid during the year for:
         Interest                                           $   272,425    $    89,666
         Income taxes                                       $       800    $       800
     Non-cash investing and financing activities:
         Equipment acquired under capital leases            $   157,467           --
         Conversion of debt to equity                       $    25,000    $    30,000
         Warrants issued with debt                          $    20,000    $   118,000
         Intangible assets acquired with warrants           $    40,000           --

<FN>
The accompanying notes are an integral part of these financial statements.
----------------------------------------------------------------------------------------
                                                                                Page F-5
</FN>
</TABLE>
<PAGE>

                                                           VALUESTAR CORPORATION
                                      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE  1 -  DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
           POLICIES

Description of operations - The Company,  a Colorado  corporation,  conducts its
operations through ValueStar,  Inc., a wholly-owned subsidiary.  ValueStar, Inc.
was  incorporated  in  California  in  1991,  and is a rating  company  that has
pioneered a new business  certification mark (ValueStar Certified) -- signifying
high customer  satisfaction -- enabling  consumers to quickly determine the best
local service businesses.  The Company generates revenues by conducting customer
satisfaction  research on local service companies in 300 industries;  certifying
highly rated  businesses;  and selling  ancillary  materials and  services.  The
Company's activities are currently conducted in eight regional markets.

Principles of consolidation - The consolidated  financial statements include the
accounts of Valuestar Corporation and its wholly-owned subsidiary.  All material
intercompany transactions and balances have been eliminated.

Inventory - Inventory  consists of  promotional  materials for sale to ValueStar
Certified businesses and direct advertising material, and is stated at the lower
of cost (first-in, first-out method) or market.

Property  and  equipment  -  Property  and  equipment  are  stated  at cost  and
depreciated  using the straight line method over estimated useful lives of three
to seven years.

Income  taxes - Income taxes are  recognized  using  enacted tax rates,  and are
composed  of  taxes  on  financial   accounting  income  that  is  adjusted  for
requirements  of current  tax law and  deferred  taxes.  Deferred  taxes are the
expected future tax consequences of temporary  differences between the financial
statement carrying amounts and tax bases of existing assets and liabilities.

Use of estimates - The  preparation of financial  statements in conformity  with
generally accepted accounting principles requires the Company make estimates and
assumptions affecting the reported amounts of assets, liabilities,  revenues and
expenses,  and the disclosure of contingent assets and liabilities.  The amounts
estimated could differ from actual results.

Revenue  recognition - The Company's  revenues are primarily from  certification
and rating fees,  and are recognized  when all related  services are provided to
the customer.  Rating services are primarily  related to a survey of a business'
customers  and the  delivery  of a  ratings  report.  Services  associated  with
certification  include an orientation on becoming a ValueStar Certified business
and the delivery of  certification  materials  and  manuals.  Sales of marketing
materials and other services are recognized as materials are shipped or services
are rendered.

Concentration of credit risk - Financial instruments  potentially subjecting the
Company to concentrations of credit risk consist primarily of demand deposits in
excess of FDIC limits and trade  receivables.  The Company's demand deposits are
placed  with  major  financial  institutions.  The risk  associated  with  trade
receivables  is  mitigated  by the  Company's  ability  to remove  certification
information from the customer's premises. For the periods presented,  there were
no customers that accounted for over 10% of revenues generated by the Company or
of accounts receivable at June 30, 1999.

Loss per common  share - Loss per common  share is computed  using the  weighted
average  number  of common  shares  outstanding.  Since a loss  from  operations
exists,  a diluted  earnings  per  share  number is not  presented  because  the
inclusion of common stock  equivalents in the computation would be antidilutive.
Common stock equivalents associated with warrants, stock options and convertible
notes, which are exercisable into 6,270,977 and 3,241,490 shares of common stock
at June 30, 1999 and 1998,  respectively,  could potentially dilute earnings per
share in future years.

Fair value of financial  instruments - The Company measures its financial assets
and liabilities in accordance with generally accepted accounting principles. The
fair value of a financial instrument is the amount at which the instrument could
be exchanged in a current  transaction  between willing parties.  For certain of
the Company's  financial  instruments,  including cash,  accounts receivable and
accounts  payable,  the carrying amount  approximates  fair value because of the
short maturities.  The carrying amount of the Company's short-term and long-term
debt approximates fair value because interest rates available to the Company for
issuance of similar debt with similar terms and maturities are approximately the
same.

--------------------------------------------------------------------------------
                                                                        Page F-6
<PAGE>

                                                           VALUESTAR CORPORATION
                          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

NOTE  1 -  DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
           POLICIES (Continued)

Deferred  costs - All direct costs  related to  marketing  and  advertising  the
ValueStar  certification  to businesses and consumers are expensed in the period
incurred,  except for  direct-response  advertising costs, which are capitalized
and amortized over the expected  period of future  benefits.  Deferred costs are
periodically evaluated to determine if adjustments for impairment are necessary.
An  ongoing   evaluation  of  the  expected   period  of  future  benefits  from
direct-response advertising resulted in the period of amortization being reduced
from twelve months to sixty days in the first  quarter of fiscal 1999.  Revenues
associated  with the  direct-response  advertising  costs,  which are  primarily
certification  fees from  businesses  new to  ValueStar,  are  being  recognized
approximately  sixty days after the  direct-response  costs are  incurred.  This
change in estimate of the amortization  period resulted in a one-time,  non-cash
increase in selling  expenses of $81,788 in the first fiscal quarter of the year
ended June 30, 1999.

Intangible assets - Intangible assets are stated at cost and amortized using the
straight line method over  estimated  useful  lives.  Deferred  financing  costs
resulting  from the issuance of the  Company's  senior debt are being  amortized
over the term of the debt,  and logo costs are being  amortized over five years.
Management  evaluates,  on an ongoing  basis,  the carrying  value of intangible
assets and makes a specific  provision  against an asset when an  impairment  is
identified.

Stock-based  compensation  -  The  Company  accounts  for  stock-based  employee
compensation  arrangements  in  accordance  with the  provisions  of  Accounting
Principles  Board  Opinion No. 25,  "Accounting  for Stock Issued to  Employees"
("APB No. 25"),  and complies  with the  disclosure  provisions  of Statement of
Financial   Accounting   Standards   No.  123,   "Accounting   for   Stock-Based
Compensation"  ("SFAS No. 123"). Under APB No. 25,  compensation  expense is the
excess,  if any, of the fair value of the Company's stock at a measurement  date
over the amount that must be paid to acquire the stock.  SFAS No. 123 requires a
fair value  method to be used when  determining  compensation  expense for stock
options  and  similar  equity  instruments.  SFAS No.  123  permits a company to
continue to use APB No. 25 to account for stock-based compensation to employees,
but proforma disclosures of net income and earnings per share must be made as if
SFAS  No.  123 had  been  adopted  in its  entirety.  Stock  options  issued  to
non-employees are valued under the provisions of SFAS No 123.

Comprehensive income - The Company has adopted Statement of Financial Accounting
Standards No. 130, "Reporting  Comprehensive  Income" ("SFAS No. 130") effective
June 30, 1999. SFAS No. 130  establishes  standards for reporting and display of
comprehensive  income,  its components and accumulated  balances.  Comprehensive
income is defined to include all changes in equity except those  resulting  from
investments by owners and distributions to owners. Among other disclosures, SFAS
No. 130 requires that all items that are required to be recognized under current
accounting  standards as  components  of  comprehensive  income be reported in a
financial statement with the same prominence as other financial statements.  For
the years  ended June 30,  1999 and 1998,  there were no items of  comprehensive
income.

Segment  information  - The  Company  adopted the  provisions  of  Statement  of
Financial  Accounting  Standards  No.  131,  "Disclosures  about  Segments of an
Enterprise  and Related  Information"  ("SFAS No.  131").  SFAS No. 131 requires
public  companies to report  financial and descriptive  information  about their
reportable  operating  segments.  The Company  identifies its operating segments
based on how management  internally evaluates separate financial information (if
available),  business  activities  and  management  responsibility.  The Company
believes it operates in a single business  segment and adoption of this standard
did  not  have  a  material  impact  on  the  Company's  consolidated  financial
statements.  Through  June  30,  1999,  there  have  been  no  material  foreign
operations.

Recent accounting  pronouncements - The Financial Accounting Standards Board has
issued  SFAS  No.  133  "Accounting  for  Derivative   Instruments  and  Hedging
Activities." SFAS No. 133 is effective for fiscal years beginning after June 15,
2000,  and requires  companies  to record  derivatives  on the balance  sheet as
assets or liabilities,  measured at fair market value. Gains or losses resulting
from changes in the values of those  derivatives  are accounted for depending on
the use of the derivative and whether it qualifies for hedge accounting. The key
criterion for hedge accounting is that the hedging  relationship  must be highly
effective  in  achieving  offsetting  changes in fair value or cash  flows.  The
Company does not expect the  adoption of SFAS No. 133 to have a material  effect
on the Company's consolidated financial statements.

--------------------------------------------------------------------------------
                                                                        Page F-7
<PAGE>

                                                     VALUESTAR CORPORATION NOTES
                                TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

NOTE 2 - GOING CONCERN

The Company has experienced recurring losses from operations and the use of cash
from  operations.  A  substantial  portion  of the  losses  is  attributable  to
marketing and promotion costs associated with increasing consumers' awareness of
the meaning of ValueStar  Certified;  marketing to businesses  the advantages of
becoming  ValueStar  Certified;   and  discounting  certain  fees  to  encourage
businesses to become ValueStar Certified.

It is management's plan to seek additional  financing through private placements
as well as other means (see Note 15). Management believes the additional capital
it is seeking  will be  available  in the future and will  enable the Company to
achieve sales growth and, ultimately, profitable operations.

The  consolidated  financial  statements  have been  prepared on a going concern
basis,  which  contemplates  the  realization  of  assets  and  satisfaction  of
liabilities in the normal course of business.  Cash flows from future operations
may not be sufficient to enable the Company to meet its obligations,  and market
conditions  and the  Company's  financial  position  may  inhibit its ability to
achieve profitable operations.

These factors,  as well as the future availability or inadequacy of financing to
meet future needs,  could force the Company to reduce the emphasis on the growth
in new certified  businesses  and place  increased  reliance on more  profitable
renewals. Such actions could have an adverse impact on the Company's operations.


NOTE 3 - RECEIVABLES


Trade receivables                                                       $453,885
Less allowance for doubtful accounts                                      44,079
                                                                        --------

                                                                        $409,806
                                                                        ========


NOTE 4 - PROPERTY AND EQUIPMENT


Computer equipment                                                      $336,575
Fixtures and equipment                                                    58,056
Office equipment                                                          14,079
Equipment and software under capital leases                              157,467
Leasehold improvements                                                    46,994
                                                                        --------

                                                                         613,171
Less accumulated depreciation and amortization                           111,566
                                                                        --------

                                                                        $501,605
                                                                        ========


NOTE 5 - DEFERRED COSTS

Deferred costs consists of direct-response  advertising  programs  consisting of
telemarketing,  printing and mailing costs.  These direct costs are  capitalized
and  amortized  over  a  sixty-day  period.  At  June  30,  1999,   $100,839  of
direct-response  advertising  costs were  capitalized  and reported as an asset.
Advertising  and promotion costs charged to expense were $1,273,400 and $964,500
for the years ended June 30, 1999 and 1998, respectively.


NOTE 6 - INTANGIBLE AND OTHER ASSETS

Deferred financing costs                                                $180,000
Security deposits                                                         17,890
Logos                                                                      4,949
                                                                        --------

                                                                         202,839
Less accumulated amortization                                              8,709
                                                                        --------

                                                                        $194,130
                                                                        ========

--------------------------------------------------------------------------------
                                                                        Page F-8
<PAGE>


                                                           VALUESTAR CORPORATION
                          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

NOTE 6 - INTANGIBLE AND OTHER ASSETS (Continued)


In  connection  with the  issuance of the Senior  Notes  (Note 10),  the Company
incurred  costs of $180,000,  which  included  $40,000 as the value  assigned to
warrants issued in connection with arranging the financing.


NOTE 7 - ACCRUED LIABILITIES AND OTHER PAYABLES


Payroll and payroll taxes                                               $118,880
Accrued vacation costs                                                    32,782
Accrued interest                                                          11,000
Other                                                                     27,097
                                                                        --------

                                                                        $189,759
                                                                        ========




NOTE 8 - RELATED PARTY DEBT

The Company is obligated to a company affiliated with a director for a $300,000,
15%,  unsecured  subordinated  promissory  note that is due June 30, 2000.  This
note, issued in November 1998, was due on June 30, 1999, but was renegotiated at
that date. In connection with the extension of the due date, the Company granted
warrants on 30,000 shares of common stock,  which are  exercisable  at $1.50 per
share for a period of five  years.  The  Company  allocated  $20,000 of the note
proceeds  to the value of  detachable  stock  warrants,  and is  amortizing  the
resulting debt discount over the term of the note.

The 12% Notes  Payable (Note 10) includes  $50,000 due to a person  related to a
Company  director,  and an  aggregate of $80,000 of the 12%  Subordinated  Notes
Payable is due to entities related to a Company director.

The two 15% Equipment  Notes (Note 10),  aggregating  $224,875 at June 30, 1999,
are due to a company affiliated with a Company director.


NOTE 9 - CAPITAL LEASE OBLIGATIONS

The Company has entered into certain  capital lease  obligations  related to the
purchase of equipment. The leases bear interest at rates ranging from 10% to 24%
and require monthly  payments of principal and interest.  The leases are secured
by the equipment and mature during 2002 through 2004.

Future minimum lease payments on capital lease obligations are as follows:



                Year Ending June 30,
                --------------------
                        2000                                            $ 57,957
                        2001                                              57,957
                        2002                                              43,016
                        2003                                              26,528
                        2004                                              11,914
                                                                        --------
                                                                         197,372
Less portion representing interest                                        53,813
                                                                        --------
Present value of net minimum lease payments                              143,559
Less current portion                                                      30,018
                                                                        --------
                                                                        $113,541
                                                                        ========

--------------------------------------------------------------------------------
                                                                        Page F-9
<PAGE>

                                                           VALUESTAR CORPORATION
                          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

NOTE 10 - LONG-TERM DEBT


8% Senior Secured Notes; principal of $2,450,000; interest is paid
monthly, with the principal repaid in 16 quarterly payments of
$153,125 commencing in March 2002, and maturing December 2005;
net of unamortized note discount of $1,415,501                        $1,034,499

12% Notes;  unsecured; interest is paid monthly, with a balloon
principal payment due in March 2001; net of unamortized note
discount of $6,364                                                        93,636

12% Subordinated Notes; unsecured; interest is paid monthly,
with a balloon principal payment due in June 2000; net of
unamortized note discount of $26,896                                     973,104

6% Convertible Notes; subordinated and unsecured;
interest is payable in kind on conversion or at maturity
in June 2001; includes $34,050 of accrued interest;
net of unamortized note discount of $32,062                              501,988

15% Equipment Note due to related party; due in monthly
installments of principal and interest of $2,022 to maturity in
August 2003; secured by equipment and software                            74,875

15% Equipment Note due to related party; due in monthly
installments of principal and interest of $5,550 to maturity
in June 2002; secured by equipment and software                          150,000
                                                                      ----------

                                                                       2,828,102
Less current portion                                                   1,032,664
                                                                      ----------

                                                                      $1,795,438
                                                                      ==========



The 8% Senior  Secured  Notes  ("Senior  Notes")  were  issued  with  detachable
warrants to three institutional  investors on March 31, 1999, and are secured by
substantially  all assets of the  Company  and its  subsidiary,  including a key
person life insurance policy. Certain events,  including the loss of James Stein
as President, may result in certain prepayment penalties and the acceleration of
payment under the Senior Notes. The Senior Notes also contain various  financial
covenants,  primarily  relating  to minimum  net worth,  maximum  debt,  capital
additions  and net income or loss.  The  noteholders  have  waived and  modified
certain  covenants  through June 30, 1999. The Company  recorded a debt discount
and  allocated  $1,450,000  of the  proceeds  to the value of  detachable  stock
warrants (see Note 13).

The 6% Convertible Notes, and the accrued interest thereon, are convertible into
common stock at $1.00 per common share.

Maturities of long-term debt are as follows:


                     Year Ending June 30,
                     --------------------
                             2000                 $1,045,654
                             2001                    652,994
                             2002                    357,602
                             2003                    612,500
                             2004                    612,500
                          Thereafter                 918,750
                                                  ----------
                                                  $4,200,000
                                                  ==========

--------------------------------------------------------------------------------
                                                                       Page F-10
<PAGE>


                                                           VALUESTAR CORPORATION
                          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

NOTE 11 - INCOME TAXES

The significant temporary differences between the carrying amounts and tax bases
of existing  assets and  liabilities  that give rise to deferred  tax assets and
liabilities  include  deferring  the  deduction,  for tax  purposes,  of various
reserves and accrued but unpaid expenses.

A valuation  allowance  is required  for those  deferred tax assets that are not
likely to be realized.  Realization is dependent upon future earnings during the
period  that  temporary   differences  and  carryforwards  are  expected  to  be
available. Because of the uncertain nature of their ultimate utilization,  based
upon the Company's past performance,  a complete valuation allowance is recorded
against these deferred tax assets.

The Tax  Reform Act of 1986 and the  California  Conformity  Act of 1987  impose
restrictions  on the  utilization  of net  operating  losses  in the event of an
"ownership  change," as defined by Section  382 of the  Internal  Revenue  Code.
There has not been a determination  whether an ownership change has taken place,
but net operating losses available to the Company for use in future years may be
limited  because  a change  in  ownership  could  result  from the  issuance  of
additional stock.

The following table summarizes the components of net deferred tax assets:


                                                      1999              1998
                                                  -----------        -----------

Federal tax loss carryforward                     $ 2,030,000        $ 1,156,000
State tax loss carryforward                           336,000            215,000
Reserves and allowances                                25,000             48,000
State tax deferrals                                  (109,000)              --
Unamortized bond discount                             508,000             33,000
                                                  -----------        -----------

                                                    2,790,000          1,452,000
Less valuation allowance                            2,790,000          1,452,000
                                                  -----------        -----------

                                                  $        --        $        --
                                                  ===========        ===========



The  Company's  federal and state net  operating  losses that are  available for
carryforward will expire as follows:



                Date of Expiration                Federal         California
                ------------------            ---------------   ---------------

                       2000                   $            -    $      736,000
                       2001                                -           763,000
                       2002                                -           579,900
                       2003                                          1,753,000
                       2007                           98,900                 -
                       2008                          410,500                 -
                       2009                          365,700                 -
                       2010                          178,600                 -
                       2011                          736,900                 -
                       2012                        1,525,000                 -
                       2013                        1,299,400                 -
                       2019                        3,505,000                 -
                                              ---------------   ---------------

                                              $    8,120,000    $    3,831,900
                                              ==============    ==============


NOTE 12 - CAPITAL STOCK

The Company has designated 5 million shares of capital stock as preferred stock,
with a par value of  $0.00025  per share.  There  were no issued or  outstanding
shares  of  preferred  stock at June 30,  1999.  See Note 15 for the  subsequent
issuance of preferred stock.

--------------------------------------------------------------------------------
                                                                       Page F-11
<PAGE>

                                                           VALUESTAR CORPORATION
                          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
--------------------------------------------------------------------------------


NOTE 13 - STOCK OPTIONS AND WARRANTS

Stock options - In 1992 the Board of Directors approved the 1992 Incentive Stock
Option Plan (ISO Plan) and the 1992 Non-Statutory  Stock Option Plan (NSO Plan).
Both plans expire in 2002. Each plan reserves 250,000 shares of common stock for
incentive and  nonstatutory  stock  options.  Options under the ISO Plan and NSO
Plan expire over a period not to exceed ten years from the date of grant.

In 1996 the  stockholders  approved the 1996 Stock Option Plan. The plan expires
in 2006 and  reserves  300,000  shares of common  stock for  nonqualified  stock
option. Options under the plan expire over a period not to exceed ten years from
the date of grant.

In 1997 the  stockholders  approved the 1997 Stock Option Plan. The plan expires
in  2007  and  reserves   500,000  shares  of  common  stock  for  Incentive  or
Nonqualified  Stock Options.  Options under the plan expire over a period not to
exceed ten years from the date of grant.

The following  tables summarize the number of options granted and exercisable at
June  30,  1999,  and  the  weighted   average  exercise  prices  and  remaining
contractual lives of the options:



                                                                Weighted
                                                                Average
                                             Shares          Exercise Price
                                           ---------         --------------

Balance, July 1, 1997                        704,000          $   0.47
Granted                                      190,550          $   1.00
Canceled                                      (2,000)         $   1.00
Exercised                                    (15,000)         $   0.50
Expired                                         --             --
                                           ---------

Balance, June 30, 1998                       877,550          $   0.59
Granted                                      395,600          $   1.18
Canceled                                    (147,050)         $   0.73
Exercised                                    (15,000)         $   0.75
Expired                                         --             --
                                           ---------

Balance, June 30, 1999                     1,111,100          $   0.78
                                           =========

Exercisable at June 30, 1999                 743,303          $   0.58
                                           =========
<TABLE>
<CAPTION>
                                                                                       Weighted        Weighted average
                                                                                       average          exercise price
                           Number               Number             Weighted           remaining           of options
    Range of           outstanding at       exercisable at          average          contractual        exercisable at
 exercise prices        June 30, 1999        June 30, 1999      exercise price           life            June 30, 1999
------------------    ------------------    ----------------    ----------------    ---------------   --------------------
<S>                       <C>                   <C>                  <C>                  <C>               <C>
 $    0.40-0.50             550,000             550,000              $ 0.43               1.03              $ 0.43
 $       0.75                25,000              18,334              $ 0.75               2.15              $ 0.75
 $    1.00-1.375            515,100             173,969              $ 1.11               3.96              $ 1.02
 $       1.69                21,000               1,000              $ 1.69               4.76              $ 1.69
                      ------------------    ----------------
                          1,111,100             743,303              $ 0.78               2.49              $ 0.58
                      ==================    ================

</TABLE>

The non-exercisable options vest over a period of up to three years.

During fiscal 1999, the Company recorded non-cash compensation expense of $8,000
under its stock  option  plans to  non-employees  through the granting of 15,000
options.

--------------------------------------------------------------------------------
                                                                       Page F-12
<PAGE>

                                                           VALUESTAR CORPORATION
                          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

NOTE 13 - STOCK OPTIONS AND WARRANTS (Continued)

Had  compensation  costs for the  Company's  stock option plans been  determined
based  upon the fair  value at the  grant  date for  awards  under  these  plans
consistent  with the  methodology  prescribed  under SFAS 123, the Company's net
loss and loss per common share would have been as follows:


                                                    1999               1998
                                                 -----------        -----------

Loss for the year                                $(3,459,744)       $(1,577,181)
Compensation expense                                 (93,766)           (50,000)
                                                 -----------        -----------

Pro forma net loss                               $(3,553,510)       $(1,627,181)
                                                 ===========        ===========

Pro forma loss per common share                  $     (0.40)       $     (0.19)
                                                 ===========        ===========


The fair  value of each  option  and  warrant  granted  during  1999 and 1998 is
estimated on the date of grant using the Black-Scholes option-pricing model with
the following assumptions:  (1) dividend yield of 0%, (2) expected volatility of
48% to 81% in 1999 and 25% in 1998, (3) risk free interest rate of 4.6% to 5.5%,
and (4) an  expected  life of the options of from 3 to 5 years.  Options  issued
during 1999 and 1998 have an estimated  weighted average fair value of $0.28 and
$0.30, respectively.

Stock  Warrants - In  connection  with the sale of the Senior Notes on March 31,
1999 (see Note 10),  the  noteholders  were  granted  warrants  to  purchase  an
aggregate  of  1,527,250  shares of Common  Stock of the  Company at an exercise
price of $1.00 per share ("A  Warrants"),  warrants to purchase an  aggregate of
527,514 shares of Common Stock at a nominal per share exercise price of $0.00025
("B  Warrants"),  and  warrants to purchase an  aggregate  of 231,132  shares of
Common  Stock at an  exercise  price of $1.00 per share  ("C  Warrants").  The C
Warrants or underlying  shares of Common Stock may be repurchased by the Company
at $6.00 per share  (less any  unpaid  exercise  price) on an all or none  basis
until March 31, 2004 as long as the  Company is not in default  with  respect to
the Senior Notes or related  agreements.  The warrants  expire on the earlier of
six years from the date the Senior Notes are paid in full or March 31, 2009. The
warrants  may be  exercised  by  payment of cash,  cancellation  of debt or on a
cashless basis.

The holders of the A, B and C Warrants  were  granted  antidilution  provisions,
registration  rights and certain equity and debt preemptive  rights.  Prior to a
qualifying public offering (proceeds of $15 million at a price of at least $5.00
per share and a valuation of at least $40 million), qualified sale (valuation of
at least  $40  million  and  minimum  proceeds  of $5.00 to $7.00  per  share to
Holders) or a qualifying  stock market listing  (Nasdaq  National  Market or New
York Stock  Exchange and minimum  price and trading  volume),  in the event of a
sale or  disposition  of the Company or  substantially  all of its  assets,  the
number of shares of Common Stock for which the Warrants may be exercised  may be
increased,  without a corresponding increase in the aggregate consideration,  to
provide  additional  consideration  to the  holders of the  warrants  based on a
revenue  determined  valuation.  A sale may  also be  initiated  by the  warrant
holders in certain instances as described in the next paragraph.

The holders of the A, B and C Warrants have certain "Drag Along Rights." Until a
qualifying  public  offering or sale is completed by the Company or a qualifying
market  listing is  achieved,  then upon  either  (i) a change in  control  (the
current three  directors  owning less than 20% of the Company on a fully diluted
basis),  or (ii)  the loss of Mr.  Stein  as  President  without  a  replacement
acceptable to the holders,  or (iii) a non-qualifying  public offering,  or (iv)
certain  defaults under the Senior Notes, and (v) at any time between April 2004
and April 2009 (unless the rights are earlier terminated), the holders of the A,
B, and C Warrants may seek a buyer for the Company or its assets and the Company
and the current three directors are obligated to cooperate and take such actions
to complete a sale,  consistent with their fiduciary  duties.  Upon such a sale,
the A, B and C Warrants may be exercised for  additional  shares of Common Stock
resulting in additional dilution to existing  shareholders of the Company.  This
dilution could be material  should the Drag Along Rights become  exercisable and
subsequently exercised by the holders.

The Company  determined the fair value of the A, B and C Warrants at $1,450,000.
The  Company  also  issued  warrants  on 152,728  shares of common  stock to two
individuals in connection with arranging the Senior Note financing.

--------------------------------------------------------------------------------
                                                                       Page F-13
<PAGE>

                                                           VALUESTAR CORPORATION
                          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

NOTE 13 - STOCK OPTIONS AND WARRANTS (Continued)

At June  30,  1999,  the  Company  had the  following  stock  purchase  warrants
outstanding, each exercisable into one common share:

        Number                Exercise Price            Expiration Date
    --------------          --------------------     -----------------------
          500,000    (1)           $ 1.25                December, 2000
           50,000                  $ 1.25                March, 2001
          200,000    (1)           $ 1.25                June, 2002
          300,000    (1)           $ 1.25                September, 2002
          200,000    (1)           $ 1.25                December, 2002
           50,000                  $ 1.75                May, 2003
          262,500    (2)           $ 1.25                April, 2003
          262,500    (3)           $ 2.00                April, 2003
          200,000                  $ 0.75                October, 2003
          500,000    (1)           $ 1.00                December, 2003
          152,728    (1)           $ 1.38                March, 2004
           30,000    (1)           $ 1.50                March, 2004
        1,527,250                  $ 1.00                March, 2009
          527,514                  $ 0.00025             March, 2009
          231,132    (4)           $ 1.00                March, 2009
    --------------
        4,993,624
    ==============



(1)  These  warrants are callable at a stock price of $5.00 per share subject to
     certain conditions.

(2)  These  warrants are callable at a stock price of $3.00 per share subject to
     certain conditions.

(3)  These  warrants are callable at a stock price of $4.50 per share subject to
     certain conditions.

(4)  These  warrants may be  repurchased by the Company at $6.00 per share until
     March 31, 2004, subject to certain conditions.

An aggregate of 327,500 of the above warrants are held by officers and directors
of the Company or their affiliates.  Some warrants contain certain  registration
rights.


NOTE 14 - COMMITMENTS AND CONTINGENCIES

The Company has  assessed  its  exposure  with  respect to Year 2000  technology
compliance as limited,  although it is not possible to quantify the effects Year
2000 compliance issues will have on customers or suppliers,  and does not expect
any interruption in its normal business  activities.  The Company has identified
and  evaluated the changes to its computer  systems  necessary to achieve a Year
2000 date  conversion,  and any required  conversion  efforts are underway.  The
Company is also communicating with suppliers, financial institutions, and others
with which it does business to understand  the impact of Year 2000 issues on the
Company. The Company does not believe the cost of achieving Year 2000 compliance
to  be  material.   Additionally,  the  Company  believes,  based  on  available
information,  that it will be able to  manage  its total  Year  2000  transition
without any  material  adverse  effect on its business  operations,  products or
financial prospects.

The president of the Company has an employment agreement that provides, in part,
severance benefits equal to the amount of his annual base salary, $120,000, plus
bonuses.

In June 1999, the Company leased 14,900 square feet of improved  office space in
Oakland, California. The lease expires on June 29, 2004. Office rent expense for
the years ended June 30, 1999 and 1998 was $88,000 and $48,000, respectively.


--------------------------------------------------------------------------------
                                                                       Page F-14
<PAGE>

                                                           VALUESTAR CORPORATION
                          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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


NOTE 14 - COMMITMENTS AND CONTINGENCIES (Continued)

Minimum future commitments under the operating lease are as follows:


               Year Ending June 30,
               --------------------
                       2000                                 $ 214,680
                       2001                                   214,680
                       2002                                   214,680
                       2003                                   214,680
                       2004                                   214,680
                                                        --------------
                                                          $ 1,073,400
                                                        ==============


NOTE 15 - SUBSEQUENT EVENT

During  July and  August  1999 the  Company  issued  225,000  shares of Series A
Convertible  Preferred Stock, par value $.001 ("Series A stock") for cash of $10
per share. Dividends of 8% per annum compounded are payable in additional shares
of Series A stock.  The  dollar  amount of  Series A stock is  convertible  into
shares of common stock at a conversion  price equal to $2.00 per share,  and are
automatically  converted on the occurrence of certain events. The Series A Stock
has certain antidilution and registration  rights, has a liquidation  preference
of $10 per share plus accrued and unpaid dividends,  and has voting rights equal
to the number of shares into which it is  convertible.  In addition,  as long as
there  are at least  100,000  shares  of  Series A Stock  outstanding,  then the
holders are entitled to elect one member to the Company's Board of Directors.



--------------------------------------------------------------------------------
                                                                       Page F-15

<PAGE>


                                   SIGNATURES

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


                                             VALUESTAR CORPORATION


                                             By: /s/ JAMES STEIN
                                                 -------------------------------
                                                 James Stein
                                                 President and Chief Executive
                                                 Officer

Date:  September 22, 1999


<TABLE>
In  accordance  with the Exchange  Act, this report has been signed below by the
following  persons on behalf of the  Registrant and in the capacities and on the
dates indicated.

<CAPTION>
       Name                                        Position                           Date
       ----                                        --------                           ----
<S>                                 <C>                                         <C>
/s/ JAMES STEIN                     President, Chief Executive Officer          September 22, 1999
    -------------------------       and Director
    James Stein                     (principal executive officer)


/s/ MICHAEL J. KELLY                Controller                                  September 22, 1999
    -------------------------       (principal accounting officer)
    Michael J. Kelly


/s/ JAMES A. BARNES                 Treasurer, Secretary and Director           September 22, 1999
    -------------------------       (principal financial officer)
    James A. Barnes


/s/ JERRY E. POLIS                  Director                                    September 22, 1999
    -------------------------
    Jerry E. Polis


/s/ FRITZ T. BEESEMYER              Director                                    September 22, 1999
    -------------------------
    Fritz T. Beesemyer
</TABLE>