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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, 1998

                         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)

                               1120A Ballena Blvd.
                            Alameda, California 94501
                                 (510) 814-7070
          (Address and telephone number of principal executive offices)

    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. $1,601,406
                                                         ----------
The aggregate  market value of the issuer's Common Stock held by  non-affiliates
as of August 31, 1998 (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 $3,195,000.

As of August 31,  1998  there were  8,682,496  shares of  ValueStar  Corporation
Common Stock, par value $.00025, outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE
                                      None

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          11
ITEM 6.     Management's Discussion and Analysis or Plan of Operation         12
ITEM 7.     Financial Statements                                              19
ITEM 8.     Changes in and Disagreements with Accountants on Accounting      
            and Financial Disclosure                                          19
                                                                             
                                  PART III                                   
                                                                             
ITEM 9.     Directors, Executive Officers, Promoters and Control Persons;     
            Compliance With Section 16(a) of the Exchange Act                 19
ITEM 10.    Executive Compensation                                            21
ITEM 11.    Security Ownership of Certain Beneficial Owners and Management    23
ITEM 12.    Certain Relationships and Related Transactions                    24
ITEM 13.    Exhibits and Reports on Form 8-K                                  25
                                                                           
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  (the "Company" or  "ValueStar") is a rating company that
has pioneered a new rating system and certification mark (ValueStar Certified(R)
) - - signifying  high customer  satisfaction - - enabling  consumers to quickly
determine  the best local  service  businesses.  ValueStar  generates  recurring
revenues by conducting customer satisfaction research on local service companies
in 150 industries (auto, home health, personal and professional),  licensing the
certification  mark to highly rated businesses and selling  ancillary  materials
and  services.  ValueStar  Certified  brand  recognition  is built  through  the
co-branding  promotional  efforts of the  Company  and its  business  licensees.
ValueStar's   independent   rating  and   certification   format  leverages  the
substantial  experience  consumers  demonstrate  in using  product  

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ratings and reduces the guesswork involved in selecting a service business among
those  businesses  making  competing  and  unsubstantiated  claims.  ValueStar's
proprietary  branded  ratings  provides  new  content  for the  rapidly  growing
Internet shopping industry -- making interactive shopping possible for consumers
purchasing  local  services.   The  Company  believes  the  consumer  enthusiasm
generated  by this new rating  format,  business  acceptance  evidenced  by high
renewals and the knowledge and experience gained from pioneering,  operating and
expanding  throughout  Northern  California  provide the  foundation for further
growth and territorial expansion.

During the past two years while  operating  exclusively in Northern  California,
ValueStar has received over 200,000  consumer visits to its Internet Web site, a
proprietary  searchable  database of top rated local companies.  During the same
period  the  Company  has  conducted  more  than  250,000  individual   customer
satisfaction surveys and distributed to local consumers over 1 million copies of
Consumer  ValueStar  Report ("CVR"),  its semi-annual  listing of the area's top
rated  service  companies.  During the last two years the Company has grown from
319 ValueStar  Certified  licensees to 1,188 at June 30, 1998 while  maintaining
renewal  rates  of more  than  70%.  Management  estimates  that  each  licensee
generates  an average of $1,500 in revenue  during the first  twelve  months and
additional  recurring  revenues in future periods from  renewals.  The Company's
goal in  Northern  California  is to  attain  a base of  2,000 - 3,000  business
licensees  during the next two years while  expanding to new major  metropolitan
regions of the U.S.

The Company  believes  that there is a compelling  consumer and business  market
need for unbiased ratings of local services throughout  America.  All regions of
the country are believed to contain fragmented, highly competitive local service
industries - creating a large number of choices for consumers. The proliferation
of media and  billions  of  dollars  of local  business  advertising  containing
conflicting  quality claims increases the risk to consumers in selecting between
competing  services.  And the  Company  expects  that the  large  number of dual
working  households  contribute to reducing the time  available for shoppers' to
perform their own research. Management believes similar factors have contributed
to the  growing  popularity  and  extensive  use of various  product  ratings by
consumers.

The Company's searchable database of top-rated local companies leverages a chief
advantage    of   the    Internet   -   the    ability   to   access    changing
"pocketbook-important"  information through a simple user interface,  24 hours a
day,  7 days a week.  In  addition  to  anytime  access  to  ValueStar  ratings,
consumers  directly  access and  communicate  with top-rated  service  companies
through  e-mail and Web links  within  ValueStar's  WWW.VALUESTAR.COM  Web site.
After conducting a search for a specific type of top-rated  business,  consumers
are also able to  conduct  their own  "shopping  auction"  by using  ValueStar's
SmartShopper(TM)  service  to send  their  requirements  to  selected  top-rated
companies with one simple form.

Each ValueStar licensed business uses the ValueStar  Certified logo in their own
sales and marketing communications. ValueStar's certification mark piggybacks on
the phone and  in-person  sales  presentations  of licensees and in their Yellow
Page, newspaper,  flyer,  brochure, TV, radio and other advertising - generating
millions of consumer  impressions  of the  Company's  rating brand each year. In
Northern  California,  the  Company  estimates  that its  growing  base of 1,188
business  licensees  will  use the  ValueStar  Certified  logo in more  than $24
million  of local  advertising  and  sales  promotions  in the next  year.  This
cooperative  branding  (co-branding)  helps to create a powerful brand with wide
consumer  awareness,  drives  consumers  to  the  Company's  Web  site  and  CVR
publication and increases sales of affiliated information materials and services
to licensees.

As creator of this new  category,  the  Company's  objective  is to leverage its
leading  position in Northern  California to become the leading  national rating
brand of local service companies.  The Company's goal is to expand marketing and
rating activities into additional regions in the United States while maintaining
high  business  renewal  rates,  increasing  brand  recognition  and  developing
incremental  revenue  opportunities.  The  Company  will be  required  to  focus
significant  management and financial resources to roll out the sales, marketing
and research  model used in Northern  California  to new regions.  The Company's
planned growth will require  additional  financing and more management and there
can be no  assurance  the  Company  can obtain  expansion  financing  or develop
management depth to expand to new markets from its Northern California base. See
"Item 6.  Management's Discussion  and Analysis or Plan of  Operation - Business
Risks."

History of Development
The  Company  was  incorporated  in the State of Colorado on January 28, 1987 as
Carson  Capital  Corporation  and on September  21, 1992 its name was changed to
ValueStar Corporation. The Company was inactive until entering into an Agreement
and  Plan of  Reorganization  dated  June  27,  1992  with  ValueStar,  Inc.,  a
California   corporation  and  its  sole  shareholder   James  Stein  (currently
President,  Chief  Executive  Officer and a Director)  whereby  ValueStar,  Inc.
became a wholly-owned  subsidiary of the Company.  The acquisition was accounted
for as a  recapitalization  of  ValueStar,  Inc.  with

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ValueStar,   Inc.  as  the  acquirer  of  ValueStar  Corporation  in  a  reverse
acquisition.  On September 21, 1992 the total authorized shares was reduced from
500,000,000  common  shares  to  20,000,000  common  shares  with a par value of
$.00025 per share.  On April 16, 1997 the  Company's  shareholders  approved the
amendment of the Company's  articles of  incorporation to authorize the issuance
of a maximum of  5,000,000  shares of  preferred  stock,  $.00025  par value per
share. No preferred shares are outstanding.

The Company's  operations  are  conducted  through its  wholly-owned  subsidiary
ValueStar,  Inc. which was  incorporated on September 5, 1991.  Initial business
organization and development  activities  commenced September 22, 1990 and until
September 5, 1991 the business  was operated as a sole  proprietorship  by James
Stein.

During late 1990 and 1991, James Stein developed the basic operating  concept of
ValueStar  Certified.  In March 1991,  Mr.  Stein  engaged San  Francisco  State
University  (SFSU) to  conduct a consumer  feasibility  study to  determine  the
potential  influence of ValueStar  Certified on consumers and a service business
feasibility  study to determine  the potential  market for  ValueStar  Certified
among  providers of consumer  services  (service  providers) in the Bay area. In
October 1991 base-line consumer satisfaction and additional consumer feasibility
research was completed by The Institute of Social Research at California State -
Stanislaus  (ISR).  This  research  provided  an average or  benchmark  customer
satisfaction rating for individual service and professional  industries targeted
by the Company.

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, during
late 1991 the Company  developed initial  marketing and support  materials.  The
Company  also began a  relationship  by engaging The Public  Research  Institute
(PRI),  an auxiliary  unit of SFSU to perform or audit surveys of each ValueStar
business  applicant's  former customers to provide a confidential,  unbiased and
scientific survey of customer  satisfaction.  PRI is operated by faculty of SFSU
and employs  students and others to conduct  research and surveys  primarily for
governmental organizations. Although PRI commenced providing individual business
surveys in early 1992, the  relationship  was formalized into a written contract
in October 1992, with the latest renewal contract effective April 30, 1997.

The  Company's  sales and  licensing  activities  commenced  in the  greater San
Francisco, California area (Bay area) in 1992. In mid-1994 the Company added the
CVR  publication to the program and on January 1, 1996 the Company  launched its
Internet strategy with its own World Wide Web ("Web") site at WWW.VALUESTAR.COM.
In July 1996 the Company expanded to the greater Sacramento, California area and
in 1998 expanded to two additional  Northern  California  counties.  At June 30,
1998 the Company  was rating  businesses  in 17 counties in Northern  California
which it considers as one market region.

Based on its success in Northern California,  in July 1998 the Company commenced
initial marketing to service businesses in the greater Los Angeles area targeted
as its second major market region.

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.  And  Marketing  News  estimated  that over $320
million of market research expenditures were for customer satisfaction research.

The result of the Company's customer satisfaction research and service rating is
delivered to consumers in the form of a  certification  mark. The  certification
mark industry includes trade association and various accrediting marks. Examples
of such marks include the Good  Housekeeping  Seal, AAA Approved Auto Repair and
various  lodging and  restaurant  industry  ratings and marks.  Since  ValueStar
provides a resource for consumers to contact to obtain a particular  category of
business it also shares aspects of referral  services and agencies such as 1-800
Dentists,  medical and contractor referrals. And since the Company publishes and
distributes a periodic listing of businesses rated high in customer satisfaction
it also shares  industry  characteristics  of service guide  publishers  and the
yellow pages  industry.  And finally the Company  maintains an Internet  site of
qualifying  service businesses and consumer  information  sharing aspects of the
growing   market  for  Internet   content  such  as  electronic   yellow  pages,
directories, and city guide information services.

The total dollar value of consumer  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.  The Company believes 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.  Management believes,  other than Northern  California,  that the
more than 

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six million  businesses in the United States (estimated by the Company from data
supplied  by  American  Business  Information)  that  make  up the  service  and
professional   business  market  are  not  currently  being  rated  on  customer
satisfaction.  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,  the  Company's  research
indicates  consumers  want to know  which  companies  have  been  rated  high in
customer satisfaction.

ValueStar and the Internet
The  Internet  and its  World  Wide Web is an  increasingly  significant  global
interactive  medium for  communications,  content  and  commerce.  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  ("IDC")  estimates that the number of Web users
worldwide will increase from 69 million at the end of 1997 to 320 million by the
year 2002. IDC estimates that the total value of goods and services purchased on
the Internet  was $2.6 billion in 1996 and will  increase to $220 billion by the
year 2001. 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.  The Company  believes  that  although
certain services such as travel are experiencing rapid Internet growth, the lack
of standardized,  independent and unbiased consumer  information will impede the
growth of local  services  being  transacted on the Internet.  As a result,  the
Company believes that Internet  directory listings will only add to the consumer
information overload.

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.  To date,  the Company does not believe  either model has had
broad based financial success.  While providing ValueStar's  proprietary branded
content of top-rated service  businesses on the Internet is a valuable component
of the  Company's  strategy to reach  consumers and support its  licensees,  the
Company is not dependent on the Internet as its basic revenue  source.  However,
the Company believes there are opportunities to leverage its proprietary content
to generate future Web and Web-related revenues.

The ValueStar Solution
The Company's concept of a local standardized rating of service and professional
firms by their own  customers  was created  and  developed  on the premise  that
consumers  are  inundated  with claims from  businesses  communicated  through a
growing  media  base  and  have  rightly  become  increasingly  skeptical.   For
businesses,  the Company  believes it is  increasingly  difficult and costly for
them  to  differentiate   on  quality  or  customer   satisfaction  due  to  the
proliferation  of  claims,  the  growth of new media  outlets,  competition  and
increasing consumer skepticism. The Company also believes consumers want to know
which  businesses  are better than others and to have the ability to cut through
the media glut of  information.  The Company  believes  this desire and 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 Company believes the factors  affecting the selection of a local service are
different than those involving a widely available product.  Typically,  compared
to a product  purchase,  a consumer has more service provider choices from which
to  discern,  the  quality  level of  services  is less  consistent,  it is more
difficult to experience or compare a service prior to purchase,  services cannot
be  returned  and  therefore  the entire  decision  process is riskier  and more
frustrating for consumers.  ValueStar  Certified is designed to respond to these
factors  by  providing   consumers  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.

The Company  believes the rapidly growing  Internet  environment is an excellent
medium  for  delivery  of  ValueStar   Certified   rating  content  and  related
information.  The Company's  searchable  database of top-rated  local  companies
leverages a chief  advantage  of the  Internet - the ability to access  changing
"pocketbook-important"  information through a simple user interface,  24 hours a
day, 7 days a week.  The Company also  believes that  "pocketbook"  or financial
related referential  information is a rapidly growing use of the Internet and is
sought after by on-line users.  ValueStar's  listings of 

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quality businesses and consumer  information 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 Consumers
Consumers use ValueStar  Certified  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.  The
Company's  rating  is  based  on high  customer  satisfaction  which  management
believes is intuitively  logical to most consumers.  In a study conducted by PRI
in 1993 and updated  through  1996,  PRI stated that 2 of 3 customers who knew a
business  had earned  ValueStar  Certified  were  influenced  by this  factor in
selecting the business.

The Company's semi-annual distribution of the CVR publication provides consumers
with an easy reference list of businesses rated high in customer satisfaction, a
quality  "yellow  pages"  listing.   The  July  1998  semi-annual   edition  was
distributed  to  approximately  200,000  homes and  businesses  in the  Northern
California  market  including   approximately   25,000  to  requesting  Consumer
ValueStar  Club members  developed  through  phone,  mail and Internet  queries.
ValueStar Consumer Club members receive the CVR publication free each six months
along with prizes and other  benefits  offered from time to time by the Company.
The  Company  intends to add to its club member  benefits  in future  periods to
further enhance the ValueStar offering to consumers.

In addition to anytime  access to  ValueStar  ratings,  consumers  can  directly
access and communicate with top-rated  service  companies through e-mail and Web
links within ValueStar's  WWW.VALUESTAR.COM  Web site. After conducting a search
for a specific  type of top-rated  business,  consumers are also able to conduct
their own "shopping auction" by using ValueStar's  SmartShopper  service to send
their  requirements  to selected  top-rated  companies with one simple form. The
Company  intends to continue to enhance its Internet  offering to consumers  and
add features and additional benefits.

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

The  Company  believes  that as a given  market  area  matures,  consumers  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
ValueStar business licensees use ValueStar Certified to bring in more customers,
convert  shoppers to buyers,  reduce  pricing  pressure  on  services  (research
conducted for the Company by ISR in 1991 indicated  that 70% of consumers  would
pay 10% or more for services  from  companies  that could  indicate  they earned
ValueStar  Certified),  distinguish services from competitors,  improve customer
loyalty,  increase customer referral rates, speed up the selling cycle,  improve
employee  morale,  enhance  marketing  and  advertising  promotions  and improve
business reputation.

Management  believes that one of the most critical factors  indicating  business
satisfaction  of the  Company's  services  and  which  directly  relates  to the
long-term success of the Company are renewal rates of licensees. During the last
two fiscal years ending June 30, 1998 more than 70% of licensed  businesses have
renewed their licenses each year indicating  strong  business  acceptance of the
ValueStar Certified program.

The Company's CVR publication provides licensees important and credible exposure
to new prospective customers.  Management believes the publication also enhances
the business offering and provides a periodic  deadline to encourage  applicants
to apply for rating by a specific  date. The Company's free listing of qualified
businesses  on its Internet site offers the small  business  owner a presence on
the World Wide Web at no additional cost. The Company's  ValueStar  SmartShopper
service  offers  businesses  Web generated  traffic at minimal  cost.  ValueStar
offers  businesses the opportunity to expand their CVR and Internet listings for
an additional fee and to link their Internet site with the ValueStar Web site.

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An  important  part of the  ValueStar  program  is its  daily  use by  qualified
licensees.  A ValueStar field consultant provides a personal orientation to each
passing business owner and their employees informing them of the significance of
earning the certification  mark and educating them on how to use the achievement
in  promotional  programs and customer  encounters.  A  comprehensive  ValueStar
manual is provided to licensees reflecting the Company's substantial  experience
in use of the mark by  businesses.  Periodic  newsletters  are  used to  further
educate  businesses  on  customer  satisfaction  topics  and use of the  mark to
improve  business  operations.  Many  licensees  purchase  copies of a Certified
Profile  Brochure  (customized by ValueStar for each licensee) which explains to
their customers how they qualified for ValueStar Certified.

The Company's brand  recognition is  significantly  enhanced by its daily use by
licensees in all manners of advertising  and media  supplementing  the Company's
marketing and promotion activities to create and enhance consumer,  business and
brand awareness.

The  Company  intends to develop  and offer  other  innovative  features  to its
program and offer new services to business members in the future. ValueStar also
intends to create alliances to link its proprietary information content to other
Internet yellow page sites, city guides and similar services.

At June 30, 1998, the Company had 1,188 active licensees in Northern California.

ValueStar Strategies
The  Company's  objective  is to be the leading  rating  brand of local  service
companies in America.  The Company  intends to leverage its pioneer  position by
focusing its strategy on rapidly  rolling out its service in the most attractive
markets,  establish  a dominant  position  in these  markets  and use its rating
service as a platform  for  multiple  revenue  streams.  The target U.S.  market
consists of over 6 million service and professional businesses and the Company's
research has targeted 2.1 million such  businesses as high priority  accounts in
30 major  prospective  market  regions. The following  are key  elements  of the
Company's strategy:

         Continue  Penetration of the Northern  California  Market - The Company
         believes  its  renewal  rates  (averaging  over 70% during the last two
         fiscal  years)  indicate  licensees'  satisfaction  with the program in
         Northern  California.  Renewals provide the Company a continuing source
         of  predictable  recurring  revenues  and an  expanding  licensee  base
         pressures other service provides to apply for the rating. The Company's
         sales,  marketing and promotion activities are designed to increase new
         licensees,  maintain high renewal rates and generate  ancillary product
         and service sales. A growing base of licensed  businesses produces more
         promotions  and  consumer  interactions  increasing  ValueStar's  brand
         recognition and awareness.  The Company intends to continue to increase
         licensees in Northern California and add additional services.

         Leverage  Northern  California's  Success to New  Markets - The Company
         believes  it has a  competitive  advantage  to enter new  regions  as a
         result of its  experience  in  Northern  California.  The  Company  has
         developed  a  comprehensive  program  built  on a  significant  base of
         consumer and  business  research.  The Company has created  proprietary
         methods, training programs and systems necessary to minimize the number
         of  personnel,  costs  and  effort  associated  with  expanding  to new
         regions.  And ValueStar has  developed  loyalty with existing  business
         licensees and  consumers  which serve as important  references  for new
         customers. ValueStar intends to leverage its knowledge,  experience and
         low-cost  centralized  structure  in  its  geographical  expansion  and
         continue to build  barriers  to entry by  competitors.  Management  has
         designed and developed a detailed  roll-out for new markets and intends
         to refine this plan based on the experience being gathered from the Los
         Angeles area expansion.  The Company's  roll-out process is expected to
         enable it to commence selling to businesses in a new market within four
         months of selection and to report initial revenues within six months of
         initial sales while minimizing capital and personnel costs.

         Create  Strong  Brand  Recognition  and Market  Awareness - The Company
         believes  it has  created  the  leading  brand  name for local  service
         ratings in the Northern  California  region.  The Company  believes its
         brand franchise helps in marketing to business  licensees and providing
         benefits to consumers. In the markets it serves, the Company's strategy
         is to promote,  advertise and increase its visibility through a variety
         of marketing,  public relations and promotion  activities.  The Company
         employs public relations,  co-branding and paid advertising to increase
         awareness.  The CVR  publication and ValueStar's Web site are important
         elements of the  Company's  marketing  and  promotion  activities.  The
         Company's brand building strategy also relies heavily on promotions and
         awareness   developed  by  business   licensees  in  their  promotions,
         advertising and consumer interactions.

                                       7
<PAGE>

         Develop  Incremental  Revenue  Opportunities  - The  Company  seeks  to
         continually   expand  its  services  and  benefits  to  consumers   and
         licensees.  The Company believes that a significant  opportunity exists
         to develop incremental revenue  opportunities from licensed businesses,
         consumers  and  from use of the  Company's  proprietary  content.  This
         includes  expanding the product mix to  businesses  such as the premium
         CVR and Web site  listings  which  were  added in 1996  and  1997.  The
         Company also  believes that a high volume of quality  seeking  consumer
         traffic  on its Web  site  provides  an  attractive  feature  to  other
         businesses.  A growing base of loyal ValueStar consumers is expected to
         provide multiple revenue opportunities in the future.

         Expand  Strategic  Alliances  and  Partnerships  - The  majority of the
         Company's  licensee  growth  has  resulted  from the  Company's  direct
         marketing  efforts and  consumer and  business  referrals.  The Company
         recently  developed an alliance and  obtained  the  endorsement  of the
         California  Optometric  Association.  The Company  believes that as its
         business  and  consumer  membership  grows  there  will  be  many  more
         opportunities  to enter into  partnerships or strategic  alliances with
         third  parties to (i) more  rapidly  expand  licensing  nationally  and
         internationally,  (ii) generate additional  ancillary  revenues,  (iii)
         facilitate brand awareness,  (iv) provide  important content to others,
         (v) facilitate consumer/business  transactions,  and (vi) enhance third
         party offerings to consumers and businesses, among other possibilities.
         Management  views this  strategy as important to the  Company's  future
         development. The Company has no current plans, proposals,  arrangements
         or understandings regarding any business or product acquisitions.

The  Company's  execution of the above  strategies  and expansion to new markets
will require additional financing and management.  There can be no assurance the
Company can obtain additional expansion financing, add to its management team or
successfully  leverage to new markets its Northern  California  experience.  See
"Item 6.  Management's  Discussion  and Analysis or Plan of Operation - Business
Risks."

ValueStar Operations
All service businesses and professionals located in market territories served by
the Company  may apply to be  licensed.  These  include  more than 150  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).

The Company's marketing and sales activities in Northern California have focused
on a proprietary targeted group of service and professional businesses numbering
approximately  50,000 resulting from the Company's research identifying the high
priority  accounts  among the  approximately  175,000  service and  professional
businesses in the area (as computed by the Company from information  provided by
American Business Information).

The Company uses direct mail, advertising, telephone sales, videotapes and other
materials  designed for  businesses and  emphasizing  the benefits of becoming a
ValueStar   licensee.   Effective   January  1,  1997   substantially   all  new
solicitations   and  rating  sales  were   consolidated  in  a  telephone  sales
department. Licensing, renewals and ancillary sales are made by field consultant
personnel.

The Company has modified its  licensing  and rating fees from time to time.  The
Company  from  time to time  provides  discounts,  incentives  and  satisfaction
guarantees to first time  applicants and also from time to time extends  payment
terms on the annual license fees. The licensing fee for businesses scales upward
with business size and for multiple location  businesses.  The Company estimates
that each new licensee  provides average annual revenue of approximately  $1,500
from all sources.

Once a prospective  licensee agrees to be rated and pays an initial research fee
approximating $470 (subject to promotional  discounts),  the research and rating
process begins.  ValueStar  employees  conduct a complaint  bureau status check,
license verification and insurance verification.  Customer satisfaction research
surveys are performed by the Company and independently  audited by PRI resulting
in a statistically computed rating score. To pass and qualify for licensing,  an
applicant  must score in the range of very good to outstanding as established by
ValueStar and PRI.

                                       8
<PAGE>

At June 30,  1998 the Company  employed 22  full-time  equivalent  research  and
rating persons  engaged in conducting  consumer  research and processing new and
renewal business licenses.

All applicant companies receive a ValueStar Research and Rating Report providing
the  results of how the  business  rates in  customer  satisfaction.  Successful
applicants  may license the use of the ValueStar  Certified  mark  (according to
agreed-upon guidelines specified by the terms of the license agreement) in their
advertising, collateral and sales materials, stationery, signage, announcements,
bid forms, etc. A licensee also receives a ValueStar plaque,  program manual and
labels for their doors and  letterhead.  Licensees  are listed in the  Company's
semi-annual CVR publication and on the Company's Internet site.

Staffing, territories, training and compensation plans are structured to provide
continuity  of field  consultant  contact with each  licensee.  The Company also
provides ongoing training emphasizing both new business and renewal development,
supports lead  generation and provides sales personnel with  computerized  sales
support and data base systems.

Each year the  Company  solicits  renewals  from  licensees.  Each year  renewal
accounts must pass elements of the research and rating  process and every second
year they must pass the entire research and rating process.

At June 30,  1998 the  Company  had 12  marketing,  sales and  field  consultant
persons  engaged in making  sales to new service  providers  and  promoting  the
Company's services and brand.

Competition
Although  the  Company  is not aware of a directly  competitive  mark or service
targeted  for a broad range of service  industries,  competitive  offerings  are
expected  to develop in the  future.  The  Company  currently  competes  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 than
the Company.

The Internet is new,  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  consumers  and greater  informational  content  including  service
business  listings  and  information.  Therefore  the Company  expects  Internet
competition to develop and intensify in the future.

The Company  believes that it provides value to licensees by providing them with
a  performance  rating  they  can  use  to  distinguish  themselves  from  their
competitors.  The  Company  also  believes  that  ValueStar  Certified  provides
consumers a convenient and easy-to-use  method of selecting  service  businesses
and  improving  their  shopping  decisions.  The Company  believes the principal
competitive  factors  affecting its market include the quality and nature of its
content,   ease  of  consumer  use,   marketing  and  sales  methods  and  brand
recognition. Although the Company believes it is establishing a market awareness
and  brand  recognition  in  Northern  California,  barriers  to  entry  by  new
competitors are not significant and any such new competitors, in addition to the
direct effects of  competition,  may cause  marketplace  confusion  making sales
efforts more difficult and may result in adverse pricing pressure.  There can be
no assurance that the Company can maintain its  competitive  position or will be
able to continue to compete  against  existing or new competitors in the future.
Furthermore,  as a strategic response to changes in the competitive environment,
the Company may make certain  pricing,  service or marketing  decisions or enter
into new ventures or arrangements  that could have a material  adverse effect on
the Company's business, financial condition and results of operations.

Trademarks, Service Marks and Other Proprietary Rights
The Company owns a U.S. federally  registered  certification mark on "ValueStar"
and the "ValueStar Certified" symbol and has applied for protection on ValueStar
in Canada.  The Company has also received a registration for "Only the Best Pass
the Test" as a service mark in the U.S. The Company considers its trademarks and
symbol to be material to the  business of the  Company.  The Company  vigorously
seeks to protect and intends to defend its trademarks  against  infringement and
other  unauthorized use. The Company is unaware of any significant  infringement
or other  unauthorized use of its trademarks  since  inception.  There can be no
assurance  the  Company  can protect  its  trademarks  and  symbol.  The loss or
infringement  of the ValueStar  trademark and symbol or the inability to protect
the mark  adequately  would have a

                                       9
<PAGE>

material  adverse  effect on the business and  operations of the Company.  It is
possible  that  competitors  or others  will  adopt  service  names  similar  to
"ValueStar"  thereby impeding the Company's  ability to build brand identity and
possibly leading to customer and consumer confusion.

The Company  copyrights  its  materials and  publications  and seeks to maintain
certain  aspects of its business  operations as trade  secrets.  The Company has
developed  consumer  and  business  databases,  training  systems,  software and
systems that are proprietary to the Company.

Government Regulation and Legal Issues
The Company is not currently subject to direct regulation other than federal and
state regulation applicable to businesses generally.

The Company's  operations  require that its  certification  mark only be used by
qualifying companies and that its use be discontinued if a business ceases to be
a licensee.  The Company vigorously defends its contract rights including taking
legal action as required.  However when and as the Company  expands to new areas
and  the  certification   becomes  more  recognized  and  valuable  it  will  be
increasingly  difficult to police  unauthorized use of its certification mark or
confusing marks.

Although  the  Company is not a direct  referral  service,  it may be subject to
claims by consumers for the actions of licensees.  Although the Company does not
believe  such  a  claim  would  have  merit,  the  costs  of  defense  could  be
substantial.  The Company does not currently  carry specific  insurance  against
such  claims and there is no  assurance  that the  Company's  general  liability
coverage  would cover such  claims.  To date the Company has not been subject to
any material claims by customers of licensees.

Employees
As of June 30,  1998,  the Company  employed 44  full-time  persons.  Two are in
senior  management,  20 in marketing and sales, 19 in research and rating, and 5
in accounting and  administration.  The Company employs part-time personnel from
time to time and uses outside contractors for various marketing  services.  None
of  the  Company's   employees  are  represented  by  a  collective   bargaining
arrangement  and the  Company has  experienced  no work  stoppages.  The Company
considers its relations with employees to be favorable.

The  Company's  future  success will depend in large  measure upon the continued
contributions of its President and CEO, James Stein and the Company's ability to
attract and retain quality sales personnel.  The Company experiences competition
for qualified sales personnel who are in demand by many  competitors,  many with
more  resources  than the  Company.  The loss of the services of Mr. Stein could
have a material  adverse effect on the Company's  business.  The Company entered
into a new three year employment  contract with Mr. Stein effective July 1, 1998
and has a $2 million "key man" insurance policy on Mr. Stein.

Item 2. Description of Property

The Company's corporate and operating offices are located in approximately 4,800
square feet of improved  office space  located at 1120 and 1150 Ballena Blvd. in
Alameda,  California.  This  facility  accommodates  administration,  sales  and
marketing and research and rating personnel. This facility is leased pursuant to
a month to month lease  re-negotiated  effective  July 1998 at a monthly rate of
approximately  $5,700. The Company or the landlord is required to provide 90 day
notice  prior to any  termination  or  vacating  of the  premises.  The  Company
believes this facility is adequate for present operations but should the Company
continue to expand into new market regions  management  expects additional space
will be  required  during  the next  twelve  months.  Management  believes  that
additional  office  space  is  available  in the  greater  Oakland  area  should
expansion  be  required  or should the Company be required to vacate the current
premises.

Item 3. Legal Proceedings

The Company is 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.

                                       10
<PAGE>

                                     PART II

Item 5. Market for Common Equity and Related Stockholder Matters

Market Information
On May 28, 1997 the Company's  Common Stock  commenced  trading and is quoted on
the National  Association of Securities  Dealers,  Inc.  ("NASD") OTC Electronic
Bulletin Board (symbol  "VSTR").  The market for the Company's  Common Stock has
often been sporadic and limited.

The following  table sets forth the high and low bid  quotations  for the Common
Stock for the fiscal years ended June 30, 1998 and 1997 as provided by the NASD.

                                                            Bid Quotations
                                                       High              Low
                                                       ----              ---
Fiscal Year Ending June 30, 1997
  Fourth Quarter (May 28, 1997 to June 30, 1997)      $1.25            $1.0625
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

The  above  quotations  reflect  inter-dealer  prices,  without  retail  markup,
markdown or  commission  and may not  represent  actual  transactions.  Prior to
initiation  of trading  there was no public  trading  market  for the  Company's
Common Stock since the Company's inception in 1987.

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, the Company's
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 the 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 the Company or its competitors, quarterly variations in
operating results,  announcements of technological or service  innovations,  the
introduction  of new  products or services,  changes in pricing  policies by the
Company 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 the 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.

The  Company's  Common Stock is currently  defined as "penny  stocks"  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 such
penny stock rules  generally  impose  additional  sales  practice and disclosure
requirements upon  broker-dealers  who sell the Company's  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 

                                       11
<PAGE>

$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 the Company's
shares and thus may also  affect the ability of  purchasers  of shares to resell
those shares in the public markets.

The  Company  had 142  holders of record of its Common  Stock at June 30,  1998,
which the Company believes  represents  approximately 300 beneficial owners. The
Company has never paid a cash  dividend on its Common  Stock and does not expect
to pay dividends in the foreseeable future.

Recent Sales of Unregistered Securities
The following is a description of equity  securities  sold by the Company during
the year ended June 30, 1998 that were not  registered  under the Securities Act
and not previously reported in prior quarterly filings:

         On May 15, 1998 the Company completed the private offering and sale for
         cash  of  an  aggregate   of  $525,000  of  unsecured  6%   Convertible
         Subordinated  Promissory  Notes  due June 30,  2001  ("Notes")  to four
         investors.  The principal  and interest  amount of each Note may at the
         election of the Note  holder be  converted,  in whole or in part,  into
         fully paid and nonassessable shares of common stock, $.00025 par value,
         of the Company, at a conversion price of $1.00 per share. The Notes may
         be called by the Company for conversion if the closing bid price of the
         Company's  common  stock  equals  or  exceeds  $2.00  per share for ten
         consecutive trading days and certain other conditions are met.

         The Note purchasers  were granted  warrants to purchase an aggregate of
         262,500  common shares of the Company at an exercise price of $1.25 per
         share  ("A-Warrants")  and warrants to purchase an aggregate of 262,500
         common  shares of the Company at an  exercise  price of $2.00 per share
         ("B-Warrants") until April 30, 2003 (collectively the "Warrants").  The
         A-Warrants  are  redeemable  by the  Company  at $.01 per  share if the
         closing bid price of the Company's common stock equals or exceeds $3.00
         per  share  for  twenty  consecutive  trading  days and  certain  other
         conditions are met. The  B-Warrants are also  redeemable by the Company
         at $.01 per  share if the  closing  bid price of the  Company's  common
         stock equals or exceeds $4.50 per share for twenty consecutive  trading
         days and certain other conditions are met.

         These securities were offered and sold without  registration  under the
         Securities  Act of 1933,  as amended (the "Act"),  in reliance upon the
         exemption provided by Regulation D thereunder and an appropriate legend
         was placed on the Notes and  Warrants  and will be placed on the shares
         issuable  upon  conversion  of the Notes or  exercise  of the  Warrants
         unless registered under the Act prior to issuance.  The securities were
         sold by the Company without an  underwriter.  The Company has agreed to
         file  a  registration   statement  on  the  common  stock  obtained  on
         conversion  of  the  Notes  and  Warrants  and  to  certain  piggy-back
         registration rights, subject to certain limitations.

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

Overview
The  Company's  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 the Company's  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 license agreement specifying the conditions and limitations
on using the certification.  Research and rating fee revenue,  ranging from $470
to  $570,  is  deferred  until  the  research  report  is  delivered.  Sales  of
information  materials  and other  services  are  recognized  as  materials  are
delivered  or  shipped  or  services  rendered.  The  Company  from time to time
provides discounts,  incentives 

                                       12
<PAGE>

from  basic  pricing  and may  provide  satisfaction  guarantees  to first  time
applicants and also from time to time extends payment terms on the certification
fee.

The Company  expenses  research and rating costs as incurred.  Costs incurred in
printing and distributing the Company's CVR publication for consumers, currently
published  in January and July,  and any related  revenues are  recognized  upon
publication.  Accordingly,  the  revenues and costs in the  Company's  first and
third  fiscal  quarters  are  impacted  by the costs and  revenues  from the CVR
publication.

Effective  July 1,  1994,  with the  adoption  by the  Company of  Statement  of
Position  No.  93-7  (SOP  93-7),   Reporting  on  Advertising  Costs,   certain
direct-response advertising costs are deferred and amortized over a twelve month
period on a straight-line method. These costs, which relate directly to targeted
new  licensee   solicitations,   primarily   include  targeted   direct-response
advertising  programs consisting primarily of telephone sales 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.

The net effect of capitalizing and amortizing  deferred costs was an increase in
costs and  expenses  of $3,000  for the fiscal  year  ended June 30,  1998 and a
reduction  in costs and  expenses  of $65,000 for the fiscal year ended June 30,
1997.

The Company  estimates new licensees  have an average life  exceeding four years
based on historical  renewal rates.  Accordingly,  the Company believes deferred
costs (which are  amortized  over twelve  months)  will be realized  from future
operations.   Deferred  costs  are   periodically   evaluated  to  determine  if
adjustments for impairment are necessary.

Since inception the Company has been growing and developing its business and has
incurred  losses  in each  year  since  inception  and at June  30,  1998 had an
accumulated  deficit  of  $5,418,665.  There  can  be  no  assurance  of  future
profitability.

Effect of Growth in New Licensees and License Renewals
The  Company's  business  revenue  model,  similar  to  other  membership  based
organizations  or recurring  revenue  businesses,  is  predicated on growing new
members  (certification  licensees)  and  maintaining  high renewal  rates.  The
Company's renewal licensees  contribute higher gross margins than new applicants
due to  reduced  sales and  rating  costs.  Also a growing  and  larger  base of
licensees  reduces the costs (relative to revenues)  associated with maintaining
the  VALUESTAR.COM  Internet site,  marketing and promoting the Company's  brand
including   printing  and  distributing  the  Company's  CVR  publication,   and
maintaining  general  and  administrative  support.  The  marginal  fixed  costs
associated with more licensees is minimal compared to base marketing,  printing,
distribution and general and administrative costs.

Since a considerable portion of the Company's operations are engaged towards the
solicitation  of new service and  professional  business  applicants in order to
expand the base of licensees,  the Company incurs substantial costs towards this
activity.  Currently the Company is only deferring  direct telephone sales costs
and amortizing them over twelve months. Other costs are expensed as incurred.

At June 30, 1998, the Company had 1,188 licensees,  compared to 319 licensees on
June 30, 1996 an increase of 272%. The following  table  illustrates the changes
in licensees and renewal rates for the fiscal years ended June 30, 1998 and 1997
in one market region, Northern California:

                                                  Fiscal Year Ended June 30,
                                                     1998            1997
                                                     ----            ----

         Licensees - beginning of period              745            319
         Adjustments (1)                              (20)            (4)
         Licensees up for renewal                     725            315
         Renewals                                     532            235
         Renewal Percentage                            73%            75%
         New licensees                                619            510
         Licensees - end of period                  1,188            745

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

                                       13

<PAGE>

The Company  believes as a market region  matures,  and the Company has a larger
base of  licensees,  fixed and indirect  costs will  decline as a percentage  of
revenues. The Company also believes that the opening of new markets will provide
additional  revenues to cover certain fixed selling,  marketing,  administration
and overhead costs. With the establishment of the new Southern California region
(Los Angeles  area) in July 1998,  the Company  intends to monitor each region's
operating results and their contribution to corporate  administration and costs.
Management  believes that the Northern California market has achieved a licensee
base  sufficient  to  provide  positive  regional  operating  margins  (prior to
allocation of corporate administration and overhead) in future periods, although
there can be no  assurance  thereof.  Management  also  estimates  that it could
reduce costs to achieve break-even  operations on the current level of new sales
and the existing base of renewing licensees.

Future  operations  are impacted by changes in the cost  structure and elections
regarding  advertising,  promotions  and growth rates (due to the lower  margins
associated with first year licensees).  Management intends, subject to financial
resources, to continue to expand the business geographically requiring increased
numbers of sales, marketing and support personnel, the exact number which is not
currently  estimable and is dependent on decisions  regarding  expansion.  Rapid
growth, due to the nature of the Company's operations, is expected to contribute
to continued operating losses in the foreseeable future.

Effective  January 1, 1997 the Company  changed its business  marketing focus to
telephone  sales from a field sales  force.  This has resulted in an increase in
applicants  for ratings  and  reduced  unit sales  costs.  In December  1997 the
Company  made a  change  from  using  an  outside  vendor  to  perform  customer
satisfaction research on applicants to in-house employees.  The Company expensed
approximately  $40,000 in startup  costs for this change in the third quarter of
fiscal 1998 related to setting up the in-house  research  call center and hiring
and training employees. This change has reduced unit rating costs and management
believes it has improved  quality  control over the research and rating process.
However the change  resulted in a delay in  completing  pending  ratings  during
fiscal 1998 thereby reducing reported  revenues.  Management expects to complete
any delayed ratings in the first six months of fiscal 1999.

Because of the  changes,  at June 30,  1998 the  Company had 410 (349 new and 61
renewal)  prospective  licensees in the application and rating phase. At current
new sales  rates the normal  number of pending  prospective  licensees  would be
approximately  345.  Generally  there is a 60 day  period  between  the  initial
sign-up of an applicant and the execution of a license  agreement for successful
applicants.  Based on management's  experience,  these 410 prospective licensees
are expected to represent over $330,000 of revenues that should be recognized in
the first quarter of fiscal 1999 (generally analogous to backlog).

Results of Operations
Revenues.  Revenues consist of certification  fees from new and renewal business
licensees,  rating fees from new and renewal business applicants,  sale proceeds
from information  materials and premium listings,  and other ancillary revenues.
The Company reported total revenues of $1,601,406 for the fiscal year ended June
30, 1998, a 52% increase over revenues of $1,054,530  for the prior fiscal year.
During fiscal 1998 certification license fees accounted for 76% of revenue (also
76% for the prior  year).  The growth in revenues is the result of improved  new
sales  velocity  and the impact of a larger  base of business  member  renewals.
Revenues  for the  fourth  fiscal  quarter  ended  June 30,  1998 were  $508,829
compared to $476,355  for the prior year  comparable  quarter or a 7%  increase.
Management  believes this limited increase is the direct result of June 30, 1998
pending  prospective  licensees.   The  higher  number  of  pending  prospective
licensees at June 30, 1998 over normal levels represents an estimated $60,000 of
pending  revenue  expected to be realized in the first six months of fiscal 1999
rather than the fourth  quarter of fiscal  1998 due to this  timing  difference.
Management  expects  by the end of the  second  fiscal  quarter of 1999 that the
number of pending  licensees  will  represent  approximately  60 days or less of
licensable sales.

Revenues can vary from quarter to quarter due to the impact of distributing  the
semi-annual   Consumer  ValueStar  Report  ("CVR")   publication  to  consumers,
seasonality,   effectiveness   of  sales  methods  and  promotions,   levels  of
expenditures  targeted at prospective  licensees,  the numbers of  certification
licensees up for renewal, renewal rates, pricing policies,  timing of completion
of research and ratings and other factors,  some of which are beyond the control
of management.

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 and licensing materials. During December 1997,
the  Company  made a change  from  using an outside  vendor to perform  customer
satisfaction  research on applicants to in-house  employees and related facility
and operating  costs.  This change has reduced  rating costs on a per unit basis
and as a  percentage  of  revenues.  Included  in cost 

                                       14
<PAGE>

of  revenues  in the  third  fiscal  quarter  of  1998  were  startup  costs  of
approximately  $40,000.  Cost of revenues  represented  36% of sales  during the
fiscal year ended June 30, 1998 (33% in the fourth  quarter),  a reduction  from
50% for the fiscal year ended June 30, 1997 (45% for the fourth quarter). During
the current  year,  the Company made changes to make ratings more  efficient and
more  economical.  The  increased  volume of revenues  in the current  year also
reduces the percentage of revenues  associated  with certain fixed rating costs.
Cost of revenues may vary  significantly  from quarter to quarter both in amount
and as a percentage of sales.

Sales Costs.  Sales costs for the fiscal year ended June 30, 1998 were $902,320,
or 56% of revenues, compared to $749,100, or 71% of revenues for the prior year.
In the prior year,  the Company  relied on a direct  sales  force  supported  by
direct mail to generate  sales. In the current year, the Company had implemented
the telephone sales  approach,  also supported by direct mail. This has resulted
in reduced unit selling  costs.  Also in the current year  approximately  37% of
certification license fees came from renewals with limited sales costs, compared
to approximately 12% of license fees coming from renewals in the prior year. The
Company  expects  sales 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 and other
factors, some beyond the control of management.

Marketing and Promotion  Expenses.  Marketing and promotion expenses  aggregated
$746,639  during fiscal 1998  comparable  to $739,455  incurred for fiscal 1997.
Included in  marketing  and  selling  expenses  in each year were  printing  and
distribution  costs of the  Company's  CVR  publication  targeted at  consumers.
Printing and  distribution  costs of $232,000 in fiscal 1998 were  comparable to
the fiscal  1997 total of  $233,000,  however  the company was able to print and
distribute  more  copies with  additional  pages due to better  pricing.  During
fiscal  1998 the  Company  expended  $310,000  on paid  advertising  targeted at
expanding  consumer  awareness  of  ValueStar  Certified.  Paid  advertising  of
$170,000 was employed in the prior year. During fiscal 1998 the Company expended
$77,000  less  on  general  marketing  and  staff  costs  and  $65,000  less  on
communications staffing and production, electing to focus on paid advertising to
build  brand and  consumer  awareness.  Generally  the  first  and third  fiscal
quarters  have  increased  costs  because  the CVR  publication  is printed  and
distributed  during these  quarters.  Also, the Company  generally  expends less
advertising  in the second  fiscal  quarter  due to higher  media  costs in this
calendar fourth quarter.

Marketing and promotion expenses are subject to significant variability based on
decisions  regarding  the timing and size of  distribution  of CVR and decisions
regarding  paid  advertising,  public  relations and market and brand  awareness
efforts. The Company anticipates continuing to make significant  expenditures in
marketing and promotion  efforts as the Company supports a growing licensee base
but anticipates 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
management activities,  including legal, accounting and other professional fees.
They  totaled  $827,955  for the fiscal  year ended June 30,  1998,  compared to
$523,854  for the  comparable  prior year,  an increase of  $304,101.  The major
increases  include a $47,000  increase  due to costs of increased  personnel,  a
$22,000 increase in occupancy costs due to additional  personnel and the startup
of in-house  research,  a $32,000  increase in guarantees  and allowance for bad
debts due to increased  volumes,  a $90,000  increase in corporate costs (legal,
accounting,  filing,  and consulting) due to the public trading of common shares
of the Company and the incurrence of $112,000 of non-cash  compensation expenses
related to consulting and guarantees on financings  during the 1998 fiscal year.
Management  anticipates that general and  administrative  costs will continue to
exceed prior period  levels due to increased  personnel,  added  facilities  and
related expenses and corporate costs as a publicly traded company.

To date,  development  expenses  associated  with the  design,  development  and
testing of the  Company's  programs and services  have not been material and are
included in sales and  marketing  or general  and  administrative  expenses  (if
performed by executive  management).  In the future, as the Company develops new
programs or services,  it anticipates that it may segregate development expenses
as an expense category.

The Company incurred interest expense in fiscal 1998 of $119,023, an increase of
$110,023 from the prior year,  resulting  from the use of debt financing to fund
operations.  The $119,023 included $12,532 of non-cash  interest  resulting from
the amortization of the discount  attributable to the value assigned to warrants
issued with debt.

Net Loss.  The  Company had a net loss of  $1,577,181  for the fiscal year ended
June 30, 1998,  compared to a net loss of  $1,497,812  for the fiscal year ended
June 30, 1997. The Company anticipates it will continue to experience  operating

                                       15
<PAGE>

losses  until it  achieves  a critical  mass base of  renewing  licensees  as it
pursues aggressive growth in new licensees. As the Company is rapidly increasing
its business volume (new and renewal) immediate future quarterly results will be
greatly   impacted  by  decisions   regarding  new  markets  and  growth  rates.
Achievement of positive  operating  results will require  obtaining a sufficient
base of new licensees and renewal  licensees to support  operating and corporate
costs.  There can be no  assurance  the  Company can  sustain  renewal  rates or
achieve a profitable base of operations.

Liquidity and Capital Resources
Since the Company  commenced  operations,  it has had significant  negative cash
flow from operating activities. The negative cash flow from operating activities
was  $1,629,721  for the fiscal year ended June 30, 1998, and $1,519,799 for the
fiscal  year ended June 30,  1997.  At June 30,  1998 the  Company  had  working
capital of $168,396.  For the fiscal year ended June 30, 1998 the negative  cash
flow from operating  activities was due to the continued operating losses, heavy
investment  in  new  licensee  growth  and  startup  of  the  in-house  research
department.  Included  in  working  capital  at June  30,  1998 is net  accounts
receivable of $361,369,  representing  approximately  82 days of revenues and an
annualized turnover ratio of approximately 4.4 times. This compares favorably to
approximately  102 days of revenues and turnover of  approximately  3.6 times at
June 30, 1997.  The  improved  turnover and reduced  accounts  receivable  level
results from increased revenues and concentrated collection efforts.  Management
believes  that 60 to 90 days sales in  receivables  is  reasonable  based on the
nature of the Company's  business and the terms it provides  licensees.  At June
30, 1998 the Company has not experienced and does not anticipate any significant
accounts receivable recoverability problems.

The Company has financed  its  operations  primarily  through the sale of common
equity,  shareholder  loans  subsequently  converted  to  common  stock and debt
financing.  During fiscal year ended June 30, 1998 the Company obtained $250,000
from a bank line of credit,  $1,000,000 in a 12% Note financing,  $525,000 in 6%
Convertible  Subordinated Promissory Notes and $227,500 from common stock sales.
The bank line of credit is  guaranteed  by  certain  officers,  directors  and a
shareholder.  Other than the credit line,  there are no  commitments  for future
investments  and there can be no  assurance  that the  Company  can  continue to
finance its operations through these or other sources.

Other than cash on hand of $398,604 at June 30, 1998 and net accounts receivable
of  $361,369,  the Company has no material  unused  sources of liquidity at this
time, and the Company  expects to incur  additional  operating  losses in future
fiscal quarters as a result of continued  operations and investments in licensee
growth. The timing and amounts of these expenditures and the extent of operating
losses  will  depend on many  factors,  some of which are beyond  the  Company's
control.

The  Company  has plans to expand  into new  markets  and  expects  that it will
require,  in  addition to  refinancing  or repaying  the  $250,000  bank line of
credit, a minimum of $750,000 to finance planned expanded  operations during the
next twelve  months.  This estimate is based on  anticipated  renewal  revenues,
anticipated sales levels,  licensee growth and expected operating costs. However
actual results could differ significantly from management's plans, and therefore
the Company may require  substantially  greater  additional  operating funds. In
such an event,  should  additional funds not be available or planned  operations
not meet  management's  expectations,  the Company may be required to curtail or
scale back staffing,  advertising and other marketing  expenditures  and general
operations in more reliance on higher profitable renewals and limit new licensee
growth.  There can be no assurance that additional  funding will be available or
on what terms.  Potential  sources of such funds include exercise of outstanding
warrants and options,  loans from existing  shareholders or other debt financing
or additional equity offerings.

Tax Loss Carryforwards
As of June 30, 1998,  the Company had  approximately  $4,839,300  of federal tax
loss carryforwards. A valuation allowance has been recorded for the net deferred
tax asset of $1,452,000 arising primarily from tax loss  carryforwards  because,
in the  Company's  assessment,  it is more likely than not that the deferred tax
asset will not be realized.

New Accounting Pronouncements
The  Financial  Accounting  Standards  Board  ("FASB")  has issued  SFAS No. 130
"Reporting Comprehensive Income", SFAS No. 131 "Disclosures About Segments of an
Enterprise and Related Information", SFAS No. 132, "Employers' Disclosures about
Pensions and Other  Postretirement  Benefits" and SFAS No. 133  "Accounting  for
Derivative  Instruments  and  Hedging  Activities."  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 that is displayed with
the same prominence as other financial

                                       16
<PAGE>

statements.  SFAS No.  131  supersedes  SFAS No.  14  "Financial  Reporting  for
Segments of a Business  Enterprise."  SFAS No. 131 establishes  standards on the
way that public companies report financial  information about operating segments
in annual financial  statements and requires  reporting of selected  information
about operating  segments in interim financial  statements issued to the public.
It also establishes  standards for disclosure  regarding  products and services,
geographic areas and major customers. SFAS No. 131 defines operating segments as
components of a company about which separate financial  information is available
that is evaluated  regularly by the chief  operating  decision maker in deciding
how  to  allocate  resources  and  in  assessing   performance.   SFAS  No.  132
standardizes the disclosure  requirements for pensions and other  postretirement
benefits  and  requires  additional   information  on  changes  in  the  benefit
obligations  and fair  values  of plan  assets  that will  facilitate  financial
analysis.  SFAS No. 133  establishes  accounting  and  reporting  standards  for
derivative  instruments,  including  derivative  instruments  embedded  in other
contracts, and for hedging activities.

SFAS No. 130 and No. 131 are  effective  for  financial  statements  for periods
beginning  after  December  15, 1997 and  require  comparative  information  for
earlier  years to be  restated.  SFAS No. 132 is effective  for years  beginning
after December 15, 1997 and requires  comparative  information for earlier years
to be restated,  unless such information is not readily available.  SFAS No. 133
is effective for all fiscal  quarters of fiscal years  beginning  after June 15,
1999.  The  adoption of these  statements  will have no  material  impact on the
Company's  consolidated  financial  statements and the results of operations and
financial position will be unaffected by their implementation.

Year 2000 Compliance
The  Company  is 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
sensitive  information  when  the year  changes  to  2000.  Systems  that do not
properly  recognize such  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.

The Company,  like most owners of computer software,  will be required to modify
significant  potions of its  software so that it will  function  properly in the
Year  2000.  Preliminary  estimates  of the total  costs to be  incurred  by the
Company to resolve this problem  range from $10,000 to $20,000.  Maintenance  or
modification costs will be expensed as incurred, while the costs of new software
will be capitalized and amortized over the software's useful life.

Since the Company mainly uses third party "off-the-shelf"  software, it does not
anticipate a problem in resolving the Year 2000 problem in a timely manner.  The
Company is  currently  taking  steps to ensure  that its  computer  systems  and
services will continue to operate on and after January 1, 2000.  However,  there
can be no assurance  that Year 2000  problems will not occur with respect to the
Company's computer systems.  Furthermore, the Year 2000 problem may impact other
entities  with which the Company  transacts  business,  and the  Company  cannot
predict the effect of the Year 2000  problem on such  entities or the  resulting
effect on the Company. As a result, if preventative and/or corrective actions by
the Company and those the Company  does  business  with are not made in a timely
manner,  the Year  2000  issue  could  have a  material  adverse  effect  on the
Company's business,  financial condition and results of operations.  The Company
has not yet  developed  a  contingency  plan to  operate  in the event  that any
noncompliant  critical  systems  are not  remedied  by January 1, 2000,  but the
Company intends to develop such a plan in the near future.

Business Risks
This quarterly  report  contains a number of  forward-looking  statements  which
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 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 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.

         Absence of Profitable Operations and Possible  Insufficiency of Capital
         -  The  Company  has  incurred   significant   operating  losses  since
         inception.  The Company  incurred an operating loss of $1.5 million for
         the fiscal  year ended June 30,  1997 and $1.5  million  for the fiscal
         year ended June 30, 1998. The Company has had limited financial results
         upon which investors may base an assessment of its potential.  Further,
         the  Company's  operating  results have  fluctuated in the past and are
         expected to fluctuate in the future due to a number of factors, many of

                                       17
<PAGE>

         which are outside the Company's control. There can be no assurance that
         profitable  operations can be achieved,  and additional capital will be
         required to maintain growth.

         Possible  Inability  to Continue  as a Going  Concern - The Company has
         suffered recurring losses from operations.  This factor, in combination
         with (i)  reliance  upon debt and equity  financing to fund losses from
         operations  and cash flow  deficits,  (ii) material net losses and cash
         flow  deficits  from  operations  and  (iii) the  possibility  that the
         Company  may be unable to meet its debts as they come due,  raise doubt
         about  the  Company's  ability  to  continue  as a going  concern.  The
         Company's  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,  as to  which  no
         assurance can be given.

         Competition and  Technological  Change - The possibility  exists that a
         business   rating  service  and   certification   mark  similar  to  or
         competitive  with that of the  Company  will be  developed.  It is also
         possible  that future  competition  will try to duplicate the Company's
         concept.  The Company 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 the  Company's  business.  As a
         provider  of consumer  information  through  the  Internet  and various
         media,  the  Company  will be  required  to adapt  to new and  changing
         technologies.  There can be no assurance  that the  Company's  services
         will remain viable or competitive in the face of technological change.

         Dependence  on Officers  and  Directors - The Company is  substantially
         dependent  upon  the  experience  and  knowledge  of its  officers  and
         directors.  The loss to the Company of such persons,  particularly  Mr.
         James  Stein,  could  be  detrimental  to  the  Company's  development,
         especially since it may not have the funds to hire management personnel
         with the requisite expertise. The Company has a $2 million key-man life
         insurance policy on Mr. Stein.

         Reliance on Other Third Parties - The Company's  operations depend on a
         number of third  parties.  The Company has limited  control  over these
         third parties and other than PRI, has no long-term  relationships  with
         them. The Company does not own a gateway onto the Internet, but instead
         relies on an Internet  service  provider to connect the  Company's  Web
         site to the Internet.  Disruption,  temporary or prolonged,  of its Web
         site could have a material  adverse  effect on the Company's  business.
         The Company is dependent on third parties for printing and distribution
         of its CVR report.  Failure to maintain  satisfactory  relationships on
         acceptable  commercial  terms with such third  parties could affect the
         timing and quality of the Company's services to customers and adversely
         affect its operating results.

         Developing Market; Uncertain Acceptance - Although the Company believes
         that the  factors  driving  its  business  acceptance  in the  Northern
         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.  The Company  believes that the evolution of its
         business  will  depend  in  part  on  increasing   brand   recognition.
         Development and awareness of the Company's  rating brand will depend on
         the  co-branding  efforts  of the  Company  and its  licensees  and the
         success in maintaining  its position as a leader in the rating of local
         service businesses.

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

         Reliance on and  Protection of Trademarks and  Intellectual  Property -
         The  Company  regards its  trademarks,  copyrights,  trade  secrets and
         similar  intellectual  property  as  critical  to its  success  and the
         Company relies 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  its
         proprietary  rights.  There can be no assurance 

                                       18
<PAGE>

         that  third  parties  will  not  infringe  upon or  misappropriate  the
         Company's  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 the Company's operations. A number of companies claim
         proprietary rights to certain aspects of Internet operations.  Although
         the  Company  is not  aware of any  aspect of its  operations  that may
         infringe on the rights of other  companies,  there is no assurance such
         claims will not arise in the future.  Although  the Company has limited
         resources to protect its rights, the Company intends to take aggressive
         actions to protect its certification mark.

         Government  Regulation  and Legal  Uncertainties  - The  Company is 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 the Company's  operations  may be impacted by such  litigation  and
         regulation in the future.  The Company may also be subject to uninsured
         claims by consumers  for actions of licensees or other claims  incident
         to its business operations.

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

Item 7. Financial Statements

The consolidated  financial statements of the Company 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 27.

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

On July 25, 1997 the Company  engaged  Moss Adams LLP to serve as the  Company's
independent  accountants  to report on the fiscal year ended June 30, 1997.  The
firm of Mohler, Nixon & Williams,  which had reported on the Company's financial
statements  for the fiscal  years ended June 30, 1996 and 1995 was  dismissed by
the Company on July 25, 1997. The change of independent accountants for the 1997
fiscal year was initiated and made by the Board of Directors.  The report of the
former  accountants  for the prior two fiscal  years did not  contain an adverse
opinion or disclaimer of opinion but included a modifying  paragraph  describing
that the  statements  were  prepared  assuming  a going  concern.  There were no
disagreements  on any matters of accounting  principles or practices,  financial
statement   disclosures,   or  auditing  scope  or  procedure  with  the  former
accountants  in  connection  with the audit of fiscal  1995 and 1996 nor through
July 25, 1997.  The Company did not consult the new firm on any  application  of
accounting principles or the type of audit opinion that might be rendered.

                                    PART III

Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
With Section 16(a) of the Exchange Act

Identification of Directors and Executive Officers
The  present  directors  and  executive  officers  of the  Company,  their ages,
positions held in the Company and duration as director, are as follows:

    Name              Age      Position and Offices               Director Since
  James Stein         40      Director, President and CEO              1992
  James A. Barnes     43      Director, Treasurer and Secretary        1995
  Jerry E. Polis      66      Director                                 1995
  Robert J. Muller    44      Chief Information Officer                n/a
  Michael J. Kelly    28      Controller                               n/a

The  terms of all  directors  will  expire  at the next  annual  meeting  of the
Company's  shareholders,  or when their  successors  are elected and  qualified.
Directors  are  elected  each year,  and all  directors  serve  one-year  terms.
Officers  serve  at the  pleasure  of  the  Board  of  Directors.  There  are no
arrangements or understandings between the Company and any other person pursuant
to which he was or is to be selected as a director, executive officer or nominee
therefor.

                                       19
<PAGE>

Biographical Information

James Stein has been a director and  President and CEO of the Company since 1992
and was a director and executive officer of ValueStar,  Inc. since its inception
in  September,  1991.  Prior to commencing  the  ValueStar  operations as a sole
proprietorship  in 1990, Mr. Stein served as President and CEO from 1983 to 1990
of Direct Language,  Inc., a San Francisco based publisher of Asian and Hispanic
Yellow Pages and El Mensajero, a Spanish-language weekly newspaper.

James  A.  Barnes  was  elected  as  a  director  in  July  1995  and  appointed
Secretary/Treasurer. In March 1997 he resigned as Secretary but was re-appointed
in August 1998.  Since 1984 he has been  President of Sunrise  Capital,  Inc., a
wholly-owned  venture capital and consulting firm. He previously  practiced as a
certified  public  accountant  and  management  consultant  with  Ernst  & Ernst
(1976-1977),  Touche Ross & Co.  (1977-1980) and as a principal in J. McDonald &
Co. Ltd.,  Phoenix,  Arizona  (1980-1984).  He graduated  from the University of
Nebraska  with a B.A.  Degree in Business  Administration  in 1976.  Mr.  Barnes
devotes only part-time services to the Company.

Jerry E. Polis was  elected as a director  in July 1995.  Since 1963 he has been
self-employed primarily in real estate investments,  and since 1964 he has owned
and operated Polis Realty. From 1968 to sale of his ownership in January,  1997,
he was active as 50% owner of the Taco Bell  franchises  for the State of Nevada
(operated  under  privately-owned  Las Cal  Corporation).  In 1994 he co-founded
Commercial Bank of Nevada (CBN), an unlisted  publicly owned bank located in Las
Vegas, Nevada which was sold through a merger in June 1998. He was a director of
CBN from 1994 and Chairman  from May, 1996 until its sale.  Mr. Polis  graduated
from Penn State University with a B.A. Degree in Commerce in 1953.

Robert J. Muller was appointed  Chief  Information  Officer in August 1998. From
July 1995 to August 1998 he was founder  and a partner in Poesys  Associates,  a
San Francisco systems and software consultancy company. Also from September 1997
to August 1998 he served as Senior  Software  Engineer and  Engineering  Project
Manager for Aurigin Systems Inc., an intellectual  property  management company.
From  July  1993 to July  1995 he served  as  Product  Development  Manager  and
Technical  Documentation  Manager for Blyth  Software,  Inc. Mr.  Muller's prior
experience includes positions as Engineering  Manager for Symantec  Corporation,
Product Manager and Customer Service  Representative  for Oracle Corporation and
Statistical Computing Consultant for the Massachusetts  Institute of Technology.
Mr. Muller has an A.B. in Political  Science from the  University of California,
Berkeley (1976) and an S.M. in Political Science (1978) and a Ph.D. in Political
Science (1983) from the  Massachusetts  Institute of Technology.  He is also the
author or  co-author of seven books and other  publications  on Oracle and other
database systems and project management.

Michael J. Kelly was appointed  controller in August 1998.  From October 1995 to
August 1998 he was  Operations  Manager and  Network  Administrator  for Silicon
Valley Shelving, San Jose, California,  a privately held distributor of material
handling  equipment and static  control  products.  From October 1994 to October
1995 he was a sales  representative  for  Innerspace  Engineering  of San Mateo,
California  and from June 1992 to October  1994 he was  Operations  Manager  and
Controller for James A. Old & Son of Hayward,  California,  both companies being
distributors  of  material  handling  equipment.  Mr.  Kelly  obtained a B.A. in
Economics  and a B.A. in Russian  Studies from the  University  of Notre Dame in
1992.

Mr. Stein and Mr.  Barnes serve as the  Compensation  Committee for the 1996 and
1997 Stock  Plans,  otherwise  the  Company  does not have any  standing  audit,
nominating or other compensation committees of the Board of Directors.

Advisory Board
In 1993 the  Company  established  an  advisory  board to  provide  guidance  to
management on the Company's  program for consumers and  businesses.  The current
advisory board members have served since 1993. They are:

Commissioner  Jessie Knight - is one of the five commissioners of the California
Public  Utilities  Commission.  He is responsible for setting policy and tariffs
for utilities and  telecommunications  industries in California.  His background
includes  positions as Vice  President of the San Francisco  Chamber of Commerce
and Vice President of Marketing at the San Francisco Newspaper Agency (Chronicle
and Examiner newspapers). He was formerly a Marketing Director at Dole Foods Co.
He is experienced in marketing, finance and strategic planning.

                                       20
<PAGE>

L.M.  Ashmore  - is a  Senior  Vice  President  of  the  consulting  firm  Omega
Performance.  Ms. Ashmore was formerly  Director,  Corporate Service Quality for
Charles  Schwab,  Co. and  Director of Service  Quality for Citibank CA. She has
extensive experience in human resources, ethics, customer satisfaction,  service
quality and customer loyalty.

Jack McSorley - has extensive business experience in the broadcast industry.  As
a partner in BayCom Partners he has been active in the acquisition,  finance and
management of broadcast  properties.  He is  experienced  in  marketing,  media,
finance and corporate issues.

Advisory board members are compensated in the form of stock options.

Compliance With Section 16(a) of the Exchange Act
Section 16(a) of the Exchange Act requires the Company's officers, directors and
persons who own more than 10% of a class of the Company's securities  registered
under Section 12(g) of the Exchange Act to file reports of ownership and changes
in ownership  with the  Securities and Exchange  Commission  ("SEC").  Officers,
directors and greater than 10%  shareholders  are required by SEC  regulation to
furnish the Company with copies of all Section 16(a) forms they file.

Based solely on a review of copies of such reports  furnished to the Company and
written  representations  that no other reports were required  during the fiscal
year ended June 30, 1998, the Company  believes that all persons  subject to the
reporting requirements pursuant to Section 16(a) filed the required reports on a
timely  basis with the SEC,  except as follows:  Mr.  Polis filed in July 1998 a
late Form 4 reporting one market purchase transaction effected in June 1998, and
Mr.  Barnes  amended  and filed in  January  1998 a Form 4  previously  filed in
December 1997 to report two previously unreported purchase transactions from the
Company effected in December 1997.

Item 10. Executive Compensation.
<TABLE>

There is shown below  information  concerning the  compensation of the Company's
chief  executive  officer (a Named  Officer) for the fiscal years ended June 30,
1998,  1997 and 1996. No other  executive  officer's  salary and bonus  exceeded
$100,000 during the fiscal year ended June 30, 1998.
<CAPTION>

                                              Summary Compensation Table
                                              --------------------------

                                                  Annual Compensation              Long Term Compensation
                                                  -------------------              -----------------------
Name and                           Fiscal                                 Other             Options         All Other
Principal Position                  Year       Salary         Bonus       Annual          (# of Shares)    Compensation
------------------------------------------------------------------------------------------------------------------------
<S>                                 <C>       <C>               <C>         <C>              <C>                 <C>
James Stein, Chief Executive        1998      $90,000          -0-         -0-               50,000             -0-
Officer and President               1997      $90,000          -0-         -0-                  -0-             -0-
                                    1996      $90,000          -0-         -0-               15,000             -0-
</TABLE>

Option Grants
Shown  below is  further  information  on grants of stock  options  to the Named
Officer reflected in the Summary  Compensation  Table shown above for the fiscal
year ended June 30, 1998.

             Option Grants Table for Fiscal Year Ended June 30, 1998
             -------------------------------------------------------

                                    Percent of Total
             Number of               Options Granted       Exercise  Expiration
 Name        Options Granted  to Employees in Fiscal Year   Price      Date
 ----        ---------------  ---------------------------   -----      ----

 James Stein     50,000                26.2%                 $1.00    3/3/2003


Aggregated Option Exercises and Fiscal Year-End Values
There were no options  exercised  by the Named  Officer  during the fiscal  year
ended June 30, 1998.  The following  table  provides  information on unexercised
options at June 30, 1998:

                                       21
<PAGE>

                          Fiscal Year-End Option Values
                          -----------------------------
                   Number of Unexercised               Value of Unexercised
                     Options Held At                  In-The-Money Options At
                      June 30, 1998                      June 30, 1998 (1)
                      -------------                      -----------------
Name                   Exercisable                          Exercisable
                       -----------                          -----------
James Stein              315,000                              $66,406

        (1) At June 30, 1998 the last sale price was $0.65625 per share.

The Company does not have any stock appreciation  rights plans in effect and has
no  long-term  incentive  plans,  as those terms are defined in  Securities  and
Exchange Commission regulations. During the fiscal year ended June 30, 1998, the
Company did not adjust or amend the exercise  price of stock options  awarded to
the Named Officer nor other persons,  and the Company has no defined  benefit or
actuarial plans covering any person.


Compensation of Directors
The Company has no standard  arrangements for direct or indirect remuneration to
the  directors in their  capacity as directors  other than the granting of stock
options.  No  direct  or  indirect  remuneration  other  than  in  the  form  of
reimbursement of expenses of attending directors' meetings was paid to directors
during the fiscal  year ended June 30,  1998 other than the grant of a five year
stock option on 50,000 common shares  exercisable  at $1.00 per share granted to
each of the Company's three  directors.  It is anticipated  that during the next
twelve  months the Company will not pay any direct or indirect  remuneration  to
any  directors of the Company in their  capacity as directors  other than in the
form of reimbursement of expenses of attending  directors' or committee meetings
and the granting of stock options from time to time.

Employment Contract
Mr. Stein is employed and compensated through the Company's  subsidiary pursuant
to a contract with the Company.  Effective July 1, 1998 the Company entered into
a new employment  agreement with Mr. Stein for a term of three years.  The terms
of the  agreement  include Mr. Stein  serving as President  and CEO and includes
termination,   confidentiality,   indemnification  and  non-competition  clauses
customary in such agreements.  The contract provides for compensation of $10,000
per  month  with  bonuses  and  increases  at the  discretion  of the  Board  of
Directors.  The Company may terminate the employment  with or without good cause
(as  defined),  but  termination  without good cause (other than  disability  or
death) results in a severance payment equal to twelve months of the then monthly
base salary and prorated  earned bonus payable in one lump sum.  Likewise upon a
change in control, as defined in the agreement, Mr. Stein may elect to terminate
employment  and obtain a payment equal to the remaining  months of the agreement
multiplied  by the base  salary and any earned but unpaid  bonus  payable in one
lump sum.

Stock Option and Compensation Plans
During 1992 the Company adopted and the shareholders approved the 1992 Incentive
Stock Option Plan, as amended, for key employees,  (the "1992 ISO Plan") and the
1992 Non-Statutory Stock Option Plan, as amended,  for employees,  directors and
consultants  (the "1992 NSO  Plan").  Both  plans  expire on May 29,  2002.  The
Company has  reserved a maximum of 250,000  common  shares to be issued upon the
exercise  of  options  granted  under each plan (a maximum of a total of 500,000
common shares).

The Board of  Directors  adopted on January 19, 1996 the 1996 Stock  Option Plan
covering an aggregate of 400,000 shares of the Company's  common stock. On March
20, 1997 the Board of  Directors  amended and  restated the 1996 Stock Plan (the
"1996 Stock Plan") to reduce the aggregate number of shares to 300,000. On March
20, 1997 the Board of  Directors  adopted the 1997 Stock  Option Plan (the "1997
Stock Plan")  covering an aggregate of 200,000  shares of the  Company's  common
stock.  The 1996  Stock  Plan and the  1997  Stock  Plan  were  approved  by the
shareholders  on April  16,  1997  and have  substantially  the same  terms  and
provisions except that the 1996 Stock Plan is available for non-qualified option
grants only.  On March 31, 1998 the Board of Directors  increased  the number of
shares  authorized  for issue pursuant to the 1997 Stock Plan to an aggregate of
500,000 shares of common stock, subject to shareholder approval.

On March 14, 1997 the Company adopted the 1997 Employee Stock  Compensation Plan
providing  for the  issuance  of up to  4,000  common  shares  to  non-executive
employees.

                                       22
<PAGE>

Item 11. Security Ownership of Certain Beneficial Owners and Management

The following  table sets forth,  as of August 31, 1998, the stock  ownership of
each officer and director of the Company,  of all officers and  directors of the
Company as a group,  and of each person  known by the Company to be a beneficial
owner of 5% or more of its Common Stock.  Except as otherwise noted, each person
listed below is the sole beneficial  owner of the shares and has sole investment
and voting  power as to such  shares.  No person  listed  below has any  option,
warrant or other right to acquire  additional  securities of the Company  within
sixty days, except as noted.

               Name and Address              Amount & Nature
 Title           of Beneficial                of Beneficial           Percent
of Class            Owner                     Ownership (1)         of Class (1)
--------       ----------------               -------------         ------------
Common stock   James Stein                    1,619,276  (2)             17.9%
par value      1120A Ballena Blvd.
$.00025        Alameda, California 94501

SAME           James A. Barnes                1,267,198  (3)             14.3%
               9029 Opus Drive
               Las Vegas, Nevada 89117

SAME           Jerry E. Polis                   820,417  (4)              9.2%
               925 E. Desert Inn Road
               Las Vegas, Nevada 89109

SAME           Bryant I. Pickering              554,496  (5)              6.4%
               9012 Opus Drive
               Las Vegas, Nevada 89117

SAME           Robert M. Brennan              1,333,333  (6)             15.4%
               6446 Shearwater Ct.
               Avila Beach, California

SAME           Canusa Trading Ltd.              768,172  (7)              8.6%
               37 Reid Street
               Hamilton, Bermuda

               All directors & officers       3,706,891  (8)             39.1%
               as a group (5 persons)

         (1) Number of shares and percentage  ownership  include shares issuable
             pursuant  to options  and  warrants  held by the person in question
             within 60 days after  August  31,  1998.  Percentages  are based on
             8,682,496 shares outstanding as of August 31, 1998.
         (2) Includes  315,000  common  shares  issuable  upon the  exercise  of
             outstanding  stock options and 62,500  common shares  issuable upon
             the exercise of a stock  purchase  warrant.  Includes  3,000 common
             shares held by his wife and minor children.
         (3) Represents  363,510 shares held of record by Sunrise Capital,  Inc.
             ("SCI"),  595,225  shares  held of  record by  Tiffany  Investments
             ("TI"), 97,629 shares held of record by Tiffany Investments Limited
             Partnership  ("TILP"),  13,334  shares  held of record  by  Sunrise
             Management,  Inc.  Profit  Sharing Plan  ("SMIPS"),  115,000 shares
             issuable upon the exercise of outstanding  stock options and 82,500
             common  shares   issuable  upon  the  exercise  of  stock  purchase
             warrants. Mr. Barnes is President and owner of SCI, General Partner
             of TI and TILP and Trustee of SMIPS and has  investment  and voting
             power over these shares.
         (4) Includes  366,667  shares  held of  record  by the  Jerry E.  Polis
             Family   Trust  and  150,000   shares  held  by  record  by  Davric
             Corporation  over which Mr. Polis  exercises  voting and investment
             power.  Also includes  100,000 shares issuable upon the exercise of
             outstanding  stock options and 127,500 common shares  issuable upon
             the exercise of a stock purchase warrant.
         (5) Includes  544,496 shares held by Odne Limited  Partnership all such
             shares of which  Dr.  Pickering  exercises  voting  and  investment
             power.

                                       23
<PAGE>

         (6) As reported to the Company by Mr.  Brennan who has  represented  to
             the  Company  that he has sole  voting  and  investment  power with
             respect to 1,263,333  shares and shares voting and investment power
             with his spouse with respect to 70,000 shares.
         (7) As reported to the Company by Canusa Trading Ltd.  Includes 295,000
             common  shares   issuable  upon  the  exercise  of  stock  purchase
             warrants.
         (8) Includes  2,904,391 shares issued and  outstanding,  530,000 shares
             issuable upon exercise of stock options and 272,500 shares issuable
             upon the exercise of stock purchase warrants.

The Company is aware of no arrangements  which may result in a change in control
of the Company.

Item 12. Certain Relationships and Related Transactions

During  the last two fiscal  years  there has not been,  nor is there  currently
proposed, any transaction or series of similar transactions to which the Company
was or is to be a party in which the  amount  involved  exceeds  $60,000  and in
which any  director,  executive  officer or holder of more than 5% of the common
stock of the  Company had or will have a direct or  indirect  material  interest
other than (i) compensation arrangements that are described in Item 10 above and
(ii) the transactions described below.

Certain of the Company's  shareholders,  including officers and directors,  have
from time to time, provided short-term interest bearing advances to the Company.
At June 30, 1998,  no such advances  were  outstanding.  On December 9, 1997 the
Company granted Stock Purchase  Warrants to four persons for a bank guarantee of
the Company's  $250,000 credit line. The Stock Purchase Warrants are exercisable
into an aggregate of 250,000  common  shares at $1.25 per share until  September
30, 2002 (62,500  shares to each  individual).  Among the four  guarantors  were
officers/directors  James Stein and James A. Barnes and director Jerry E. Polis.
The  Company  believes  it would  have been  unable to obtain the line of credit
without  the  inducement  of  the  personal  guarantees  by  such  officers  and
directors.

On March 31, 1998 the Company  issued  91,250  shares for services in connection
with the Company's debt financing valued at $88,398.  A total of 76,250 of these
shares were issued to Mr. Polis, a director, and 5,000 shares issued to Mr.
Barnes, an officer and director.

In July 1998,  in connection  with a new three year  employment  agreement,  the
Company  granted Mr. Stein  options on 100,000  shares  which become  vested and
exercisable  after January 7, 1999 and then only upon the achievement of certain
future  common  share  prices  commencing  at $2.50  per  share.  In July  1998,
directors  Polis and Barnes were each granted  similar  options on 50,000 common
shares, as directors.

In July 1998 the Company  restructured the due date on $100,000 of 12% notes due
September  30, 1998 and  extended the date to March 31, 2001 and granted the two
holders an aggregate of 50,000 non-detachable  warrants to purchase common stock
at $1.25 per share.  One holder of a $50,000  note and  25,000  warrants  is the
spouse of Mr. Polis, a director of the Company.

In August 1998 the Company  obtained an $85,000  five year term loan  secured by
certain  equipment and software  from a Company  affiliated  with Mr.  Polis,  a
director.  The Company  believes the terms of the loan are  comparable  to those
that could have been obtained from an independent party.

Certain  conflicts of interest may arise  between the Company and its  directors
due to the fact that they have other  employment or business  interests to which
they devote  attention,  and they are expected to continue to do so. The Company
has not  established  policies or  procedures  for the  resolution of current or
potential  conflicts  of interest  between the  Company  and its  management  or
management-affiliated  entities.  There  can be no  assurance  that  members  of
management  will resolve all conflicts of interest in the Company's  favor.  The
officers and  directors are  accountable  to the Company as  fiduciaries,  which
means that they are legally  obligated to exercise  good faith and  integrity in
handling  the  Company's  affairs.  Failure  by them to  conduct  the  Company's
business in its best  interests  may result in liability to them.  The Company's
Articles of Incorporation provide that directors have the right to contract with
the Company if any financial interest is disclosed or the transaction is fair or
reasonable to the Company.

                                       24
<PAGE>

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
the Company 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

     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)

     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

     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

                                       25
<PAGE>

     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)

     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

     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*(1)Employment  Agreement  between the Company and James Stein dated as
             of July 1, 1998

     10.6    Property Lease Agreement between Ballena Isle Marina and ValueStar,
             Inc.  dated July 14,  1995 filed as  Exhibit  6.6 to the  Company's
             Registration Statement on Form 10-SB, as amended

     10.6.1* Amendments to Property Lease Agreement  between Ballena Isle Marina
             and ValueStar, Inc. dated as of July 1 and August 1, 1998

     10.7(1) 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

                                       26
<PAGE>


             Statement on Form 10-SB, as amended

     10.8(1) 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*(1) First Amendment to 1997 Stock Option Plan dated March 31, 1998

     10.9(1) 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)

     10.11*  Promissory  Note between the Company and Davric  Corporation  dated
             August 14, 1998.


     16.1    Letter  on  Change  in  Accountant  filed  as  Exhibit  16.1 to the
             Company's Registration Statement on Form 10-SB, as amended

     21.1*   Subsidiary of the Company

     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, 1998. The report dated May 21, 1998 reported an Item 5 event
related to the  placement of $525,000 of unsecured 6%  Convertible  Subordinated
Promissory Notes due June 30, 2001.

                                       27


<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, 1998,  and the related  consolidated  statements of
operations,  stockholders'  deficit, and cash flows for the years ended June 30,
1998  and  1997.  These  financial  statements  are  the  responsibility  of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
financial statements based on our audit.

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

In our opinion,  the  consolidated  financial  statements as of and for the year
ended June 30, 1998,  present fairly,  in all material  respects,  the financial
position of the Company as of June 30, 1998,  and the results of its  operations
and cash flows for the years ended June 30, 1998 and 1997,  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  from  operations  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 20, 1998




                                                                             F-1
<PAGE>


                                                           VALUESTAR CORPORATION
                                                      CONSOLIDATED BALANCE SHEET
                                                                   June 30, 1998
--------------------------------------------------------------------------------

                                     ASSETS

CURRENT ASSETS
     Cash                                                           $   398,604
     Receivables                                                        361,369
     Inventory                                                           24,396
     Prepaid expenses                                                     3,902
                                                                    -----------

          Total current assets                                          788,271

PROPERTY AND EQUIPMENT                                                   56,697

DEFERRED COSTS                                                          130,930
                                                                    -----------

          Total assets                                              $   975,898
                                                                    ===========

                     LIABILITIES AND STOCKHOLDERS' DEFICIT

CURRENT LIABILITIES
     Bank line of credit                                            $   250,000
     Accounts payable                                                   197,410
     Accrued liabilities and other payables                             145,445
     Deferred revenues                                                   27,020
                                                                    -----------

          Total current liabilities                                     619,875
                                                                    -----------

LONG-TERM DEBT                                                        1,525,357
                                                                    -----------
STOCKHOLDERS' DEFICIT
     Common stock, $.00025 par value; 20,000,000 shares
          authorized, 8,682,496 shares issued and outstanding             2,171
     Additional paid-in capital                                       4,247,160
     Accumulated deficit                                             (5,418,665)
                                                                    -----------

          Total stockholders' deficit                                (1,169,334)
                                                                    -----------

          Total liabilities and stockholders' deficit               $   975,898
                                                                    ===========


The accompanying notes are an integral part of these financial statements
--------------------------------------------------------------------------------
                                                                             F-2

<PAGE>

                                                           VALUESTAR CORPORATION
                                           CONSOLIDATED STATEMENTS OF OPERATIONS
                                              Years Ended June 30, 1998 and 1997
--------------------------------------------------------------------------------

                                                     1998             1997
                                                ------------     ------------- 

REVENUES                                        $  1,601,406     $  1,054,530
                                                ------------     ------------- 
OPERATING EXPENSES
     Cost of revenues                                580,041          532,133
     Selling                                         902,320          749,100
     Marketing and promotion                         746,639          739,455
     General and administrative                      827,955          523,854
                                                ------------     ------------

                                                   3,056,955        2,544,542
                                                ------------     ------------- 

LOSS FROM OPERATIONS                              (1,455,549)      (1,490,012)
                                                ------------     ------------
OTHER INCOME (EXPENSE)
     Interest expense                               (119,023)          (9,000)
     Miscellaneous                                    (2,609)           1,200
                                                ------------     ------------

                                                    (121,632)          (7,800)
                                                ------------     ------------

NET LOSS                                        $ (1,577,181)    $ (1,497,812)
                                                ============     ============

LOSS PER COMMON SHARE                           $      (0.19)    $      (0.20)
                                                ============     ============
WEIGHTED AVERAGE OF COMMON SHARES
     OUTSTANDING                                   8,500,228        7,330,831
                                                ============     ============


The accompanying notes are an integral part of these financial statements
--------------------------------------------------------------------------------
                                                                             F-3

<PAGE>

<TABLE>
                                                                                                           VALUESTAR CORPORATION
                                                                                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
                                                                                              Years Ended June 30, 1998 and 1997
--------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
                                                         Common Stock            Additional
                                                   -----------------------        Paid-in         Accumulated
                                                      Shares       Amount         Capital           Deficit          Total
                                                   -----------    --------     ------------      -------------   ------------
<S>                                                <C>            <C>          <C>               <C>             <C>  
Balance, June 30, 1996                               7,026,818    $  1,757     $  2,735,105      $ (2,343,672)   $    393,190 


Sale of stock at $.75 per share                      1,000,000         250          749,750               --          750,000 
Conversion of debt to stock
     at $.75 per share                                  43,195          11           32,385               --           32,396 
Sale of stock at $.75 per share                         53,333          13           39,987               --           40,000 
Stock issued to employees                                2,900           1            2,174               --            2,175 
Sale of stock at $1.00 per share                       200,000          50          199,950               --          200,000 
Net loss                                                   --          --               --         (1,497,812)     (1,497,812)
                                                   -----------    --------     ------------      ------------    ------------ 

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)
                                                   ===========    ========     ============      ============    ============ 
</TABLE>


The accompanying notes are an integral part of these financial statements
--------------------------------------------------------------------------------
                                                                             F-4

<PAGE>

<TABLE>
                                                                      VALUESTAR CORPORATION
                                                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                         Years Ended June 30, 1998 and 1997
------------------------------------------------------------------------------------------
<CAPTION>
                                                                   1998           1997
                                                                -----------    -----------
<S>                                                             <C>            <C>         
CASH FLOWS FROM OPERATING ACTIVITES
     Net Loss                                                   $(1,577,181)   $(1,497,812)
     Adjustments to reconcile net loss to net
          cash used by operating activities:
               Depereciation                                         11,125          9,885
               Change in allowance for doubtful accounts             45,000         23,207
               Warrants issued for services                          24,000           --
               Common stock issued for services                      88,398           --
               Amortization of bond discount                         12,532           --
          Changes in:
               Receivables                                         (110,827)      (218,829)
               Inventory                                              3,467        (12,533)
               Prepaid expenses                                       3,133         (3,927)
               Deferred costs                                         3,155        (64,923)
               Accounts payable                                    (175,816)       215,698
               Accrued liabilities and other payables                38,993         57,454
               Deferred revenues                                      4,300        (28,019)
                                                                -----------    -----------

                    Net cash used by operating activities        (1,629,721)    (1,519,799)
                                                                -----------    -----------

CASH FLOWS FROM INVESTING ACTIVITIES
     Property and equipment acquisitions                            (18,400)       (12,960)
                                                                -----------    -----------
CASH FLOWS FROM FINANCING ACTIVITIES
     Proceeds from sale of stock                                    227,500        992,175
     Net borrowings under line of credit                            250,000           --
     Proceeds from debt                                           1,525,000        130,000
                                                                -----------    -----------
                    Net cash provided by financing activities     2,002,500      1,122,175
                                                                -----------    -----------
NET INCREASE (DECREASE) IN CASH                                     354,379       (410,584)

CASH, beginning of year                                              44,225        454,809
                                                                -----------    -----------

CASH, end of year                                               $   398,604    $    44,225
                                                                ===========    ===========
SUPPLEMENTAL CASH-FLOW INFORMATION:
     Cash paid during the year for:
          Interest                                              $    89,666    $     9,000
          Income taxes                                          $       800    $       800
     Non-cash investing and financing activities:
          Conversion of debt to equity                          $    30,000    $    32,396
          Issuance of warrants with debt                        $   118,000    $      --

-------------------------------------------------------------------------------------------
                                                                                   Page F-5
</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(R))  - -
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 150
industries;  licensing the certification  mark to highly rated  businesses;  and
selling ancillary materials and services. The Company's activities are currently
concentrated within one industry segment in California.

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 five
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  annual
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, 1998.

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

                                                           VALUESTAR CORPORATION
                           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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


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

Loss per common  share - The  Company has  implemented  Statement  of  Financial
Accounting  Standards  ("SFAS")  No. 128,  "Earnings  Per  Share."  SFAS No. 128
provides  for the  calculation  of  "Basic"  and  "Diluted"  earnings  per share
("EPS").  Basic EPS  includes  no dilution  and is  computed by dividing  income
available  to  common  stockholders,   after  deduction  for  cumulative  unpaid
dividends,  by the weighted average number of common shares  outstanding for the
period.  Diluted EPS reflects the potential  dilution of  securities  that could
share in the earnings of an entity, similar to fully diluted earnings per share.
The Company's losses for the periods  presented cause the inclusion of potential
common stock  instruments  outstanding to be  antidilutive  and,  therefore,  in
accordance  with SFAS No. 128,  the Company is not required to present a diluted
EPS. Stock options,  warrants and convertible  notes  exercisable into 3,337,550
shares of common stock were  outstanding as of June 30, 1998.  These  securities
were not included in the  computation of diluted EPS because of the losses,  but
could potentially dilute EPS 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.

Recent  accounting  pronouncements  - The Financial  Accounting  Standards Board
("FASB") has issued SFAS No. 130,  "Reporting  Comprehensive  Income";  SFAS No.
131, "Disclosures About Segments of an Enterprise and Related Information"; SFAS
No.  132,  "Employers'  Disclosures  about  Pensions  and  Other  Postretirement
Benefits";  and SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities."  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  that is  displayed  with  the  same  prominence  as  other
financial statements.  SFAS No. 131 supersedes SFAS No. 14, "Financial Reporting
for Segments of a Business  Enterprise."  SFAS No. 131 establishes  standards on
the way that public  companies  report  financial  information  about  operating
segments in annual  financial  statements,  and  requires  reporting of selected
information about operating  segments in interim financial  statements issued to
the public. It also establishes  standards for disclosure regarding products and
services,  geographic areas and major customers.  SFAS No. 131 defines operating
segments as components of a company about which separate  financial  information
is available that is evaluated  regularly by the chief operating  decision maker
in deciding how to allocate resources and in assessing performance. SFAS No. 132
standardizes the disclosure  requirements for pensions and other  postretirement
benefits  and  requires  additional   information  on  changes  in  the  benefit
obligations  and fair  values  of plan  assets  that will  facilitate  financial
analysis.  SFAS No. 133  establishes  accounting  and  reporting  standards  for
derivative  instruments,  including  derivative  instruments  embedded  in other
contracts, and for hedging activities.


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

                                                           VALUESTAR CORPORATION
                           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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


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

SFAS No. 130 and No. 131 are  effective  for  financial  statements  for periods
beginning  after  December 15, 1997,  and require  comparative  information  for
earlier  years to be  restated.  SFAS No. 132 is effective  for years  beginning
after December 15, 1997, and requires comparative  information for earlier years
to be restated,  unless such information is not readily available.  SFAS No. 133
is effective for all fiscal  quarters of fiscal years  beginning  after June 15,
1999.  The  adoption of these  statements  will have no  material  impact on the
Company's  consolidated  financial  statements and the results of operations and
financial position will be unaffected by their implementation.

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.

Reclassifications  -  Certain  reclassifications  have been made to the June 30,
1997, financial statements to conform to the current year's presentation.


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. 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                                        $436,369
        Less allowance for doubtful accounts                       75,000
                                                                 --------

                                                                 $361,369
                                                                 ========


--------------------------------------------------------------------------------
                                                                             F-8

<PAGE>

                                                           VALUESTAR CORPORATION
                           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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


NOTE  4 -     PROPERTY AND EQUIPMENT

        Computer equipment                                $40,979
        Fixtures and equipment                             21,162
        Office equipment                                   12,237
        Logo design                                         4,949
                                                          -------
                                                           79,327
        Less accumulated depreciation                      22,630
                                                          -------
                                                          $56,697
                                                          =======

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 twelve  month  period.  At June  30,  1998,  $130,930  of
direct-response  advertising  costs were  capitalized  and reported as an asset.
Advertising  and  promotion  costs charged to expense were $964,500 and $567,000
for the years ended June 30, 1998 and 1997, respectively.


NOTE  6 -     BANK LINE OF CREDIT

The Company has a $250,000 revolving bank line of credit, with interest at prime
plus 2%. At June 30, 1998, the Company had no credit  available  under this line
of credit.  The bank's  commitment under this agreement  matures on November 25,
1998.  The line of credit is  guaranteed  by  certain  officers,  directors  and
shareholders  of the Company who were granted an  aggregate of 250,000  warrants
for their  guarantee.  The Company  calculated the fair value of the warrants at
the date of issuance and expensed the guarantee cost.


NOTE  7 -     ACCRUED LIABILITIES AND OTHER PAYABLES

        Payroll and payroll taxes                            $ 83,301
        Accrued vacation costs                                 30,338
        Accrued interest                                       11,000
        Other                                                  20,806
                                                             --------
                                                             $145,445
                                                             ========


--------------------------------------------------------------------------------
                                                                             F-9

<PAGE>

                                                           VALUESTAR CORPORATION
                           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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


NOTE  8 -     LONG-TERM DEBT

The  principal  amount of long-term  debt  outstanding  at June 30, 1998,  is as
follows:

         12% Notes  Payable - Notes  payable with interest at 12%
         payable  monthly;  with all  principal  due on March 31,
         2001, or sooner at the Company's discretion; unsecured     $  100,000

         12%  Subordinated  Notes  Payable -  Subordinated  notes
         payable with interest at 12% payable  monthly;  with all
         principal  due  on  June  30,  2000,  or  sooner  at the
         Company's discretion; unsecured. Net of unamoritzed bond
         discount of $53,793                                           946,207

         6% Convertible Notes Payable - Subordinated  convertible
         notes  payable  with  interest  at 6% payable in kind on
         conversion   or  at  maturity  on  June  30,  2001;   no
         prepayment is allowed;  unsecured;  convertible at $1.00
         per common share.  Net of  unamortized  bond discount of
         $51,675.  Includes  accrued  interest  of $5,825  due at
         maturity                                                      479,150
                                                                    ----------
                                                                    $1,525,357
                                                                    ==========

The 12% Notes Payable were due on September 30, 1998, but subsequent to year end
were  restructured  and restated  with a new maturity date of March 31, 2001. In
connection  with the  restructuring,  the  Company  granted the  noteholders  an
aggregate of 50,000  warrants (see Note 13). A total of $50,000 of the 12% Notes
Payable is 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.

At June 30, 1998, the 6% Convertible  Notes Payable and accrued interest thereon
would have been convertible into 530,824 common shares.

Maturities of long-term debt for succeeding years are as follows:

                  Year Ending June 30,
                  --------------------

                        2000                               $1,000,000
                        2001                                  625,000
                                                          -----------

                                                           $1,625,000
                                                          ===========

In connection  with the issuance of the 12% Notes Payable and the 6% Convertible
Notes  Payable,  the Company  granted the holders  certain  warrants to purchase
common  stock  (see Note  11).  The  Company  calculated  the fair  value of the
warrants  at the date of  issuance  and is  amortizing  this  amount as interest
expense over the life of the debt.


--------------------------------------------------------------------------------
                                                                            F-10

<PAGE>

                                                           VALUESTAR CORPORATION
                           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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

NOTE  9 -     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 of various  reserves and deferring
the deduction, for tax purposes, of various 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:

                                                     1998                1997
                                                     ----                ----

Federal tax loss carryforward                     $1,156,000          $1,040,000
State tax loss carryforward                          215,000             187,000
Reserves and allowances                               48,000              39,000
Unamortized bond discount                             33,000                --
                                                  ----------          ----------

                                                   1,452,000           1,266,000
Less valuation allowance                           1,452,000           1,266,000
                                                  ----------          ----------

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

                  Date of Expiration          Federal                 California
                  ------------------          -------                 ----------
                        1999                $     --                  $  178,000
                        2000                      --                     736,000
                        2001                      --                     763,000
                        2002                      --                     761,400
                        2007                    98,900                      --
                        2008                   410,500                      --
                        2009                   365,700                      --
                        2010                   178,600                      --
                        2011                   736,900                      --
                        2012                 1,525,000                      --
                        2013                 1,523,700                      --
                                            ----------                ----------

                                            $4,839,300                $2,438,400
                                            ==========                ==========



--------------------------------------------------------------------------------
                                                                            F-11

<PAGE>

                                                           VALUESTAR CORPORATION
                           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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

NOTE 10 -     PREFERRED 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, 1998.


NOTE 11 -     STOCK OPTIONS AND WARRANTS

In  1995,   the  FASB  issued  SFAS  No.  123,   "Accounting   for   Stock-based
Compensation".  This  standard  requires  expanded  disclosures  of  stock-based
compensation  arrangements with employees and encourages application of the fair
value recognition provisions in the statement.

SFAS No.  123 does not  rescind  the  existing  accounting  rules  for  employee
stock-based  compensation.   Companies  may  continue  following  the  rules  to
recognize and measure  compensation as provided by Accounting  Principles  Board
Opinion  Number 25 (APB No. 25), but companies  will now be required to disclose
the pro forma  amounts of net income and earnings per share that would have been
reported had the Company elected to follow the fair value recognition provisions
of SFAS No. 123.  The Company  continues  to measure  its  employee  stock-based
compensation arrangements under the provisions of APB No. 25.

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:

                                                  1998                1997
                                                  ----                ----

      Loss for the year                       $(1,577,181)         $(1,497,812)
      Compensation expense                        (50,000)             (12,500)
                                              -----------          -----------
      Pro forma net loss                      $(1,627,181)         $(1,510,312)
                                              ===========          ===========
      
      Pro forma loss per common share         $     (0.19)         $     (0.21)
                                              ===========          ===========

The fair  value of each  option  and  warrant  granted  during  1998 and 1997 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
25% in 1998 and -0-% in 1997,  (3) risk  free  interest  rate of 7%,  and (4) an
expected  life of the options of from 3 to 5 years.  Options  issued during 1998
and 1997 have an  estimated  weighted  average  fair  value of $0.30 and  $0.22,
respectively.

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.


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


                                                           VALUESTAR CORPORATION
                           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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

NOTE 11 -     STOCK OPTIONS AND WARRANTS (Continued)

In 1997 the  stockholders  approved the 1997 Stock Option Plan. The plan expires
in 2007 and reserves 200,000 shares of common stock for Incentive Stock Options.
Options  under the plan  expire  over a period  not to exceed ten years from the
date of grant. On March 31, 1998, the Board of Directors  amended the 1997 Stock
Option  Plan  increasing  the number of shares  issuable  thereunder  by 300,000
shares to an aggregate of 500,000 shares of common stock, subject to shareholder
approval.

The following table summarizes common stock option activity:

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

Balance July 1, 1996                           840,000             $   0.45
Granted                                         74,000             $   0.75
Canceled                                      (210,000)            $   0.50
Exercised                                         --                --
Expired                                           --                --

Balance June 30, 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
                                              ========             ========

Exercisable at June 30, 1998                   775,666             $   0.56
                                              ========             ========

<TABLE>
The following  table  summarizes  the number of options  exercisable at June 30,
1998, and the weighted average exercise prices and remaining  contractual  lives
of the options:
<CAPTION>
                                                                                            Weighted      Weighted average
                                                                                            average        exercise price
       Range of               Number               Number               Weighted           remaining         of options
       exercise           outstanding at       exerciseable at          average           contractual      exercisable at
        prices             June 30, 1998        June 30, 1998        exercise price           life          June 30, 1998
----------------------------------------------------------------------------------------------------------------------------
<S>                           <C>                  <C>                   <C>                  <C>               <C>
     $0.40-$0.50              615,000              591,665               $0.44                1.87              $0.44
        $0.75                  72,000               34,001               $0.75                2.31              $0.75
        $1.00                 190,550              150,000               $1.00                4.37              $1.00
                              -------              -------               -----                ----              -----

                              877,550              775,666               $0.59                2.45              $0.56
                              =======              =======               =====                ====              =====
</TABLE>

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


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


                                                           VALUESTAR CORPORATION
                           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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

NOTE 11 -     STOCK OPTIONS AND WARRANTS (Continued)

At June  30,  1998,  the  Company  had the  following  stock  purchase  warrants
outstanding, each exercisable into one common share:

                   Number            Exercise Price            Expiration Date
                   ------            --------------            ---------------

                    150,000               $0.75                April, 2002
                     10,000               $0.75                September, 1998
                    200,000               $1.25                June, 2002
                    300,000               $1.25                September, 2002
                    200,000               $1.25                December, 2002
                    500,000               $1.25                December, 2000
                    262,500               $1.25                April, 2003
                    262,500               $2.00                April, 2003
                     50,000               $1.75                May, 2003
                 ----------

                  1,935,000
                 ==========

An aggregate of 247,500 of the above warrants are held by officers and directors
of the  Company.  Certain of the  warrants  are callable by the Company at stock
prices  ranging from $3.00 to $5.00 and subject to certain other  prerequisites.
Some warrants contain certain registration rights.


NOTE 12 -     COMMITMENTS AND CONTINGENCIES

The Company,  like most owners of computer software,  will be required to modify
significant  potions of its  software so that it will  function  properly in the
year  2000.  Preliminary  estimates  of the total  costs to be  incurred  by the
Company to resolve this problem range from $10,000 to $20,000. Since the Company
mainly uses third  party  "off-the-shelf"  software,  it does not  anticipate  a
problem in resolving the year 2000 problem in a timely  manner.  Maintenance  or
modification costs will be expensed as incurred, while the costs of new software
will be capitalized and amortized over the software's useful life.

The Company  rents  office space under a  month-to-month  operating  lease.  The
monthly lease payments are currently $5,700.  The Company is responsible for its
pro-rata  share of common  area  maintenance  fees,  which  includes  utilities,
maintenance  and  insurance.  Rent expense for the years ended June 30, 1998 and
1997, was $48,000 and $33,000, respectively.


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


                                                           VALUESTAR CORPORATION
                           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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

NOTE 13 -     SUBSEQUENT EVENTS

In July 1998, the Company  entered into a three year  employment  agreement with
its  President  and Chief  Executive  Officer  providing  for a minimum  salary,
incentive compensation and severance benefits,  among other items. In connection
with this agreement, and to also provide compensation for the future services of
the  Company's   directors,   the  Company   granted  an  aggregate  of  200,000
non-qualified  stock options exercisable at $1.25 per share for a period of five
years,  vesting only on the  achievement  of certain future stock prices ranging
from $2.50 per share to $7.50 per share.

In connection with  restructuring  of the 12% Notes Payable (see Note 8) in July
1998, the Company granted warrants on an aggregate of 50,000 shares at $1.25 per
share until March 2001.

Subsequent  to  year  end,  the  Company   granted  options  on  67,800  shares,
exercisable at $1.00 per share, to employees pursuant to its stock option plans.

In August  1998,  the Company  obtained  $85,000 of secured  five year term debt
financing  for the  purchase of certain  software and  equipment  from a company
affiliated with a director of the Company.


--------------------------------------------------------------------------------
                                                                            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 21, 1998
<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 21, 1998
    -----------                     and Director                        
    James Stein                     (principal executive officer)               
                                            

/s/ MICHAEL J. KELLY                Controller                                  September 21, 1998
    ----------------                (principal accounting officer)
    Michael J. Kelly                

/s/ JAMES A. BARNES                 Treasurer, Secretary and Director           September 21, 1998
    ---------------                 (principal financial officer)
    James A. Barnes                 

/s/ JERRY E. POLIS                  Director                                    September 21, 1998
    --------------
    Jerry E. Polis
</TABLE>