UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

(Mark One)

[X]      Quarterly report pursuant to Section 13 or 15(d) of the Securities
         Exchange Act of 1934

         For the quarterly period ended July 31, 1997

                                       or

[ ]      Transition report under Section 13 or 15(d) of the Securities
         Exchange Act of 1934

         For the transition period from _____  to  _____

                         Commission file number: 0-24346

                               VIDEO UPDATE, INC.
             (Exact Name of Registrant as Specified in its Charter)

                       Delaware                        41-1461110
         (State or Other Jurisdiction of             (I.R.S. Employer
         Incorporation or Organization)             Identification No.)

                             3100 World Trade Center
                               30 East 7th Street
                            St. Paul, Minnesota 55101
                    (Address of Principal Executive Offices)
                                   (Zip Code)

                                 (612) 222-0006
              (Registrant's Telephone Number, Including Area Code)

                                 Not Applicable
         (Former name, former address and former fiscal year, if changed
                               since last report)

         Indicate by check mark whether the Registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or 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  ___

         The number of shares of Class A Common Stock, $.01 par value,
outstanding at September 11, 1997 is 18,104,591 and the number of shares of
Class B Common Stock, $.01 par value, outstanding is 2,000,000.


<PAGE>


<TABLE>
<CAPTION>
                               VIDEO UPDATE, INC.

                                      INDEX

PART I - FINANCIAL INFORMATION                                                  PAGE NO.
------------------------------                                                  --------

ITEM 1.  Financial Statements

<S>                                                                              <C>
         Consolidated Balance Sheets - April 30, 1997, and July 31, 1997........  3

         Consolidated Statements of Income - Three Months ended July 31,
              1996 and July 31, 1997............................................  4

         Consolidated Statements of Cash Flows - Three Months ended
              July 31, 1996 and July 31, 1997...................................  5

         Notes to Consolidated Financial Statements - July 31, 1997.............  6

ITEM 2.  Management's Discussion and Analysis of Financial
              Condition and Results of Operations ..............................  7

PART II - OTHER INFORMATION

ITEM 1.  Legal Information...................................................... 13

ITEM 6.  Exhibits and Reports on Form 8-K ...................................... 13

SIGNATURES ..................................................................... 15

</TABLE>

<PAGE>


PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS


                               VIDEO UPDATE, INC.
                           CONSOLIDATED BALANCE SHEETS
               (In thousands, except share and per share amounts)


<TABLE>
<CAPTION>
                                                  ASSETS
                                                                      April 30, 1997          July 31, 1997
                                                                      ------------            --------------
                                                                                               (UNAUDITED)
<S>                                                                 <C>                     <C>            
Cash and cash equivalents                                           $       2,424           $         3,039
Accounts receivable                                                         3,776                     3,838
Notes receivable from related parties                                       1,394                     1,451
Inventory                                                                   7,318                     8,921
Videocassette rental inventory -- net                                      45,479                    50,866
Property and equipment -- net                                              33,069                    37,164
Prepaid expenses                                                              783                     1,559
Goodwill -- net                                                            37,716                    36,752
Other assets                                                                1,648                     1,634
                                                                      ------------            --------------
Total assets                                                        $     133,607           $       145,224
                                                                      ============            ==============

                                   LIABILITIES AND STOCKHOLDERS' EQUITY

Notes payable                                                       $      20,564           $        28,544
Accounts payable                                                           12,196                    15,625
Accrued expenses                                                            2,415                     2,851
Accrued rent                                                                2,238                     2,782
Accrued compensation                                                        1,779                     1,983
Income taxes payable                                                        1,096                       103
Deferred income taxes                                                       2,327                     2,485

Commitments and contingencies

Stockholders' equity:
Preferred Stock, par value $.01 per share:
    Authorized shares -- 5,000,000
    Issued shares -- none                                                       -                         -
Class A Common Stock, par value $.01 per share:
    Authorized shares -- 60,000,000
    Issued and outstanding shares -- 18,170,341 at April 30,
      1997 and 18,104,591 at July 31, 1997                                    182                       181
Class B Common Stock, par value $.01 per share:
    Authorized, issued and outstanding shares -- 
      2,000,000  at April 30, 1997 and July 31, 1997                           20                        20
    Additional paid-in capital                                             86,085                    85,585
    Retained earnings                                                       6,806                     6,916
    Foreign currency translation                                             (421)                     (171)
                                                                      ------------            --------------
                                                                           92,672                    92,531
    Notes receivable from officers for the exercise of options             (1,680)                   (1,680)
                                                                      ------------            --------------
Total stockholders' equity                                                 90,992                    90,851
                                                                      ------------            --------------
Total liabilities and stockholders' equity                          $     133,607           $       145,224
                                                                      ============            ==============

</TABLE>

                             SEE ACCOMPANYING NOTES.

Note: The balance sheet at April 30, 1997 has been derived from the audited
financial statements at that date but does not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements.

<PAGE>

                               VIDEO UPDATE, INC.
                        CONSOLIDATED STATEMENTS OF INCOME
                                   (UNAUDITED)
                    (In thousands, except per share amounts)



<TABLE>
<CAPTION>
                                                                              Three Months Ended July 31,
                                                                                1996             1997
                                                                            -------------     ------------
<S>                                                                       <C>               <C>          
Revenues:
    Rental revenue                                                        $       17,184    $      27,813
    Service fees                                                                     119              150
    Product sales                                                                  1,260            2,843
                                                                            -------------     ------------
                                                                                  18,563           30,806

Costs and expenses:
    Store operating expenses                                                      14,472           25,399
    Selling, general and administrative                                            1,978            2,674
    Cost of product sales                                                            680            1,489
    Amortization of goodwill                                                         371              520
                                                                            -------------     ------------
                                                                                  17,501           30,082
                                                                            -------------     ------------

Operating income                                                                   1,062              724
Interest expense                                                                    (165)            (507)
Other income                                                                          61              106
                                                                            -------------     ------------
                                                                                    (104)            (401)
                                                                            -------------     ------------

Income before income taxes                                                           958              323
Income tax expense                                                                   395              213
                                                                            -------------     ------------
Net income                                                                $          563    $         110
                                                                            =============     ============

Net income per share                                                      $          .05    $         .01
                                                                            =============     ============

</TABLE>

                                SEE ACCOMPANYING NOTES.
                         


<PAGE>


                               VIDEO UPDATE, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                     Three Months Ended July 31,
                                                                      1996                 1997
                                                                   ------------        -------------
OPERATING ACTIVITIES
<S>                                                              <C>                 <C>           
    Net income                                                     $       563         $        110
    Adjustments to reconcile net income to net cash
     provided by operating activities:
        Depreciation and amortization                                    5,701                9,311
        Accrued rent                                                       202                  544
        Deferred income taxes                                              (44)                 158
        Changes in operating assets and liabilities, net
          of acquisitions of businesses:
            Accounts receivable                                           (132)                 (63)
            Inventory                                                     (384)              (1,604)
            Other assets                                                  (531)                (863)
            Accounts payable                                             1,560                3,430
            Income taxes payable                                          (282)                (993)
            Other liabilities                                              198                  891
                                                                   ------------        -------------
Net cash provided by operating activities                                6,851               10,921

INVESTING ACTIVITIES

    Purchase of videocassette rental inventory                          (7,910)             (12,775)
    Purchase of property and equipment                                  (3,062)              (5,396)
    Investment in businesses, net of cash acquired                           -                  (57)
    Notes receivable from officers                                         (53)                 (60)
    Payments on notes receivable                                             -                    2
                                                                   ------------        -------------
Net cash used in investing activities                                  (11,025)             (18,286)

FINANCING ACTIVITIES

    Proceeds from notes payable                                          4,628               10,000
    Payments on notes payable                                              (68)              (2,020)
                                                                   ------------        -------------
Net cash provided by financing activities                                4,560                7,980
                                                                   ------------        -------------

Increase in cash and cash equivalents                                      386                  615
Cash and cash equivalents at beginning of the period                       676                2,424
                                                                   ------------        -------------
Cash and cash equivalents at end of the period                     $     1,062         $      3,039
                                                                   ============        =============



</TABLE>


                             SEE ACCOMPANYING NOTES.


<PAGE>


                               VIDEO UPDATE, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JULY 31, 1997
                                   (UNAUDITED)

1.        GENERAL

         The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three months ended July 31, 1997 are
not necessarily indicative of the results that may be expected for the year
ending April 30, 1998. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's annual
report on Form 10-K for the year ended April 30, 1997.


         RECLASSIFICATION

         Certain prior year items have been reclassified to conform with the
fiscal 1998 presentation.

2.       NET INCOME PER COMMON SHARE

         Net income per share under the treasury stock method is computed by
dividing net income for the year by the weighted average number of shares of
common stock and common stock equivalents, if dilutive, outstanding during the
year. If the number of shares of common stock obtainable on exercise of
outstanding options and warrants in the aggregate exceeds 20% of the number of
common shares outstanding at the end of the period for which the computation is
being made, the treasury stock method shall be modified in determining the
dilutive effect of the options and warrants. The "treasury stock method -
modified" is presented if it is found to be dilutive. The weighted average
number of shares used in the net income per share calculation was reduced by the
common shares placed in escrow in connection with the Company's initial public
offering.


<TABLE>
<CAPTION>
                                                                THREE MONTHS ENDED JULY 31,
                                                                ---------------------------
                                                                    1996         1997
                                                                  --------     --------
                                                           (In thousands, except per share amount)
<S>                                                               <C>          <C>     
EARNINGS PER SHARE

Net income                                                        $    563     $    110
                                                                  ========     ========

Weighted average shares outstanding:
    Class A common shares outstanding at quarter end                11,018       18,105
    Class B common shares outstanding at quarter end                 2,000        2,000
    Less:  Class B common shares placed in escrow in
        connection with the initial public offering                 (1,300)      (1,300)
    Effect of shares issuable under stock options and 
        warrants based on the treasury stock method                    629          177
                                                                  --------     --------
                                                                    12,347       18,982
                                                                  ========     ========
Net income per common and common
    equivalent share                                              $    .05     $    .01
                                                                  ========     ========

</TABLE>


<PAGE>


         In February, 1997 the Financial Accounting Standards Board issued
Statement No. 128, Earnings per Share, which is required to be adopted on April
30, 1998. At that time, the Company will be required to change the method
currently used to compute earnings per share and to restate all prior periods.
Under the new requirements for calculating primary earnings per share, the
dilutive effect of stock options will be excluded. The impact is expected to
result in no change in primary earnings per share for the first quarter ended
July 31, 1997 and 1996. The impact of Statement 128 on the calculation of fully
diluted earnings per share for these quarters is not expected to be material.

3.        DEFICIENCY OBLIGATIONS - ACQUISITIONS

         In connection with three acquisitions in which the Company has issued
an aggregate of 584,506 shares of Class A Common Stock in fiscal 1996 and 1997,
the Company may be obligated to make deficiency payments to such sellers equal
to the difference between the guaranteed price of $7.00 to $15.00 for each share
issued, and the actual market price obtained for such shares as of specified
dates between July 1996 and October 1998. The remaining deficiency payments are
estimated to be approximately $2,576,000 based on the closing stock price of
$3.625 at July 31, 1997. The Company has the option of satisfying approximately
$1,220,000 of this liability at July 31, 1997 through the issuance of additional
shares of Class A Common Stock. The Company is currently disputing whether any
deficiency payment is due with respect to 239,163 shares held by a seller in one
of the acquisitions; the seller is claiming a deficiency payment based on
proceeds from the sale of Class A Common Stock during the six month period of
March 1996 to September 1996.

         During June 1997, a cash deficiency payment was made with regard to one
acquisition in the cash amount of $57,200.

4.        STOCKHOLDER'S EQUITY

         On October 2, 1996, the Company announced the closing of its public
offering of 6.1 million shares of Class A Common Stock. The net proceeds from
the offering were approximately $21,628,000 and were used to provide working
capital, make acquisitions, reduce outstanding debt, open additional stores and
meet other general corporate purposes. On October 9, 1996, the Company announced
the closing of the over-allotment option of 915,000 shares of Class A Common
Stock providing approximately $3,404,000 in additional net proceeds.

         The Company canceled 65,750 shares of Class A Common Stock issued to a
seller (reducing paid in capital and goodwill by approximately $500,000) as part
of a purchase price adjustment related to one of the Company's Canadian
acquisitions.

ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
          RESULTS OF OPERATIONS.

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

OVERVIEW

         The Company franchised its first store in January 1983 and opened its
first Company-owned store in September 1989. By July 1994, when the Company
completed its initial public offering, the Company had grown to 15 Company-owned
stores and 30 franchised stores. Subsequently, the Company substantially
accelerated its growth and as of July 31, 1997 operated 361 Company-owned stores
in 18 states and six provinces in Canada, and has 35 franchised stores
predominantly in the United States. The majority of the Company's stores located
in the United States are superstores. Superstores are video specialty stores
that carry more than 7,500 rental units.


<PAGE>


         As a result of the acquisitions completed during fiscal 1995, 1996 and
1997, the Company anticipates that its results of operations will be reduced by
the amortization of goodwill of approximately $36,752,000, with anticipated
quarterly non-cash charges of approximately $507,000. The Company anticipates
that future acquisitions will involve the recording of additional significant
amounts of goodwill and deferred charges on its balance sheet.

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


                                       THREE MONTHS ENDED JULY 31,
                                      ----------------------------
                                        1996                1997
                                      --------            --------
                                             (In thousands)

Rental revenue                        $ 17,184            $ 27,813
Service fees                               119                 150
Product sales                            1,260               2,843
                                      --------            --------
                                      $ 18,563            $ 30,806
                                      ========            ========

OPERATING RESULTS

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


                                       THREE MONTHS ENDED JULY 31,
                                       ---------------------------
                                            1996        1997
                                           -------    -------

Revenues:

    Rental revenue                            92.6%      90.3%
    Service fees                               0.6        0.5
    Product sales                              6.8        9.2
                                           -------    -------
Total revenues                               100.0      100.0

Costs and expenses:

    Store operating expenses                  78.0       82.4
    Selling, general and administrative       10.6        8.7
    Cost of product sales                      3.7        4.8
    Amortization of goodwill                   2.0        1.7
                                           -------    -------
Total cost and expenses                       94.3       97.6
                                           -------    -------
Operating income                               5.7        2.4

Other income (expense):

    Interest expense                          (0.9)      (1.6)
    Other income                               0.3        0.3
                                           -------    -------
Total other income                            (0.6)      (1.3)
                                           -------    -------
Income before income taxes                     5.1        1.1
Income tax expense                             2.1        0.7
                                           -------    -------
Net income                                     3.0%       0.4%
                                           =======    =======


<PAGE>


THREE MONTHS ENDED JULY 31, 1997 COMPARED TO THREE MONTHS ENDED JULY 31, 1996

         RENTAL REVENUE. Rental revenue was approximately $27,813,000 and
$17,184,000, or 90.3% and 92.6% of total revenues for the three months ended
July 31, 1997 and 1996, respectively. The increase in rental revenue of
$10,629,000 was derived primarily from video stores acquired during fiscal 1997,
from the opening of 70 new Company-owned stores, net of closings, since the
first quarter of fiscal 1997, and from a 2% increase in same store revenues.

         SERVICE FEES. Service fees were approximately $150,000 and $119,000, or
0.5% and 0.6% of total revenues for the three months ended July 31, 1997 and
1996, respectively. Continuing service fees and royalties from franchisees
accounted for 100.0% and 97.0% of total service fees, respectively. The decrease
in service fees as a percentage of total revenues was due to a significant
increase in the number of Company-owned stores without a corresponding increase
in the number of franchised stores.

         PRODUCT SALES. Product sales were approximately $2,843,000 and
$1,260,000, or 9.2% and 6.8% of total revenues for the three months ended July
31, 1997 and 1996, respectively. The increase in product sales of $1,583,000 was
primarily a result of product sales by the video stores acquired during fiscal
1997, from the opening of 70 Company-owned video stores, net of closings, since
the first quarter of fiscal 1997 and from the increase in sales of fixed assets
to franchisees. The increase as a percentage of total revenues was primarily due
to a difference in product mix in the stores acquired.

         STORE OPERATING EXPENSES. Store operating expenses consist primarily of
compensation and related expenses including regional management expenses,
occupancy expenses, and depreciation and amortization expenses. Operating
expenses were approximately $25,399,000 and $14,472,000, or 82.4% and 78.0% of
total revenues for the three months ended July 31, 1997 and 1996, respectively.
The increase in store operating expenses of $10,927,000, was primarily the
result of video stores acquired during fiscal 1997 and the opening of 70
Company-owned video stores, net of closings, since the first quarter of fiscal
1997.

         Compensation and related expenses were approximately $7,099,000 and
$4,298,000, or 23.0% and 23.2% of total revenues for the three months ended July
31, 1997 and 1996, respectively. The increase of $2,801,000 was primarily due to
video stores acquired during fiscal 1997 and from the opening of 70
Company-owned video stores, net of closings, since the first quarter of fiscal
1997.

         Occupancy expenses were approximately $7,677,000 and $4,041,000, or
24.9% and 21.8% of total revenues for the three months ended July 31, 1997 and
1996, respectively. The increase of approximately $3,636,000 was primarily due
to video stores acquired during fiscal 1997 and from the opening of 70
Company-owned stores, net of closings, since the first quarter of fiscal 1997.
The increase as a percentage of total revenues was primarily due to higher costs
associated with the opening of new video stores prior to revenue reaching
maturity during the first year of operations.

         Depreciation and amortization expenses were approximately $8,481,000
and $5,144,000, or 27.5% and 27.7% of total revenues for the three months ended
July 31, 1997 and 1996, respectively. Depreciation and amortization expense
reflects the depreciation of store equipment and fixtures and the amortization
of videocassettes. The increase of $3,337,000 was primarily attributable to the
addition of new release videocassette inventory for new, existing, and acquired
stores. Amortization expense as a percentage of revenues for future periods may
vary based on the Company's purchase of videocassette inventory, which is
subject to change based on the Company's rate of expansion, studio release
schedules and anticipated market demand.

         SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses were approximately $2,674,000 and $1,978,000, or 8.7%
and 10.6% of total revenues for the three months ended July 31, 1997 and 1996,
respectively. The increase of approximately $696,000 was primarily due to adding
management personnel and administrative staff to support the Company's growth
and related


<PAGE>


expenditures. The decrease as a percentage of total revenues was due to the
increase in total revenues without a proportional increase in corporate
overhead.

         COST OF PRODUCT SALES. Cost of product sales was approximately
$1,489,000 and $680,000, or 4.8% and 3.7% of total revenues for the three months
ended July 31, 1997 and 1996. The cost of product sales as a percentage of total
product sales revenue was approximately 52.4% and 54.0% for fiscal 1997 and
1996, respectively. The decrease in the cost of product sales as a percentage of
total product sales was primarily the result of a different mix of products
sold.

         AMORTIZATION OF GOODWILL. Amortization of goodwill was approximately
$520,000 and $371,000 or 1.7% and 2.0% of total revenues for the three months
ended July 31, 1997 and 1996, respectively. The decrease as a percentage of
total sales was primarily attributable to an increase in sales from new store
openings without a proportional increase in the amortization of certain
intangible assets resulting from the video stores acquired.

         INTEREST EXPENSE. Interest expense was approximately $507,000 and
$165,000, or 1.6% and 0.9% of total revenues for the three months ended July 31,
1997 and 1996, respectively. The increase of $342,000 was primarily attributable
to interest on increased borrowings under the Company's bank line of credit.

         OTHER INCOME. Other income was approximately $106,000 and $61,000, or
0.3% and 0.3% of total revenues for the three months ended July 31, 1997 and
1996, respectively. The increase of $45,000 was primarily due to an increase in
interest earned on notes receivable from officers.

LIQUIDITY AND CAPITAL RESOURCES

         The Company has funded its operations to date through cash from
operations, the proceeds of prior equity and debt offerings, borrowings under
bank facilities, trade credit and equipment leases. The Company's principal
capital requirements are for the opening of new superstores, the purchase of
videocassette rental inventory, and the acquisition of existing stores each of
which varies based on market conditions and expansion plans.

         At July 31, 1997, the Company had cash and cash equivalents of
approximately $3,039,000. The Company uses an unclassified balance sheet in its
financial statements, and as a result, does not classify its assets or
liabilities as current or noncurrent. If the Company were to use a classified
balance sheet, a portion of videocassette rental inventories would be classified
as noncurrent because they are not assets that are reasonably expected to be
completely realized in cash or sold in one year. The acquisition cost of these
inventories, however, would be reflected in current liabilities. The Company
believes that classification of videocassette rental inventories as noncurrent
assets would be misleading because it would not indicate the level of assets
expected to be converted into cash in the next year as a result of rentals or
sales of these videocassettes.

         For the three months ended July 31, 1997 net cash provided by operating
activities was approximately $10,921,000. Net cash used in investment activities
was approximately $18,286,000 consisting primarily of approximately $5,396,000
for new and remodeled stores, and conversion costs associated with acquired
stores, and approximately $12,775,000 for the purchase of videocassette
inventory for existing and new stores. Net cash generated from financing
activities was approximately $7,980,000 resulting primarily from proceeds under
the Company's bank line of credit.

         In February 1997, a syndicate led by Bank of America National Trust and
Savings Association (successor by merger to "Bank of America Illinois") extended
a $60 million revolving credit facility (the "Line of Credit") to the Company,
with amounts borrowed thereunder bearing interest at variable rates based on the
Federal Funds rate or the Eurodollar rate. The Line of Credit is convertible
into a two-year term loan if it is not renewed. As of July 31, 1997,
approximately $28,000,000 was outstanding under the


<PAGE>


Line of Credit, bearing interest at 7.5% to 8.5%. During the term of the Line of
Credit and thereafter to the extent any amounts are outstanding under the Line
of Credit, the Company is subject to various restrictive covenants, including
limitations on further indebtedness, other than trade credit and capital or
operating leases, and requirements that the Company obtain written consent for
certain acquisitions of new businesses or their assets (excluding new superstore
openings) or entering into business combinations, including mergers, syndicates
or joint ventures. The Line of Credit also restricts the amount and terms of
debt that may be issued to sellers of acquired businesses and requires that the
Company maintain certain cash flow ratios as well as certain ratios of total
liabilities to tangible net worth.

         The Company funds its short-term working capital needs, including the
purchase of videocassette rental inventory, primarily through cash from
operations and borrowings under the Line of Credit. The Company expects that
cash from operations and borrowings under the Line of Credit will be sufficient
to fund cash requirements for ongoing existing operations for the remainder of
the fiscal year, although no assurances can be given as to unanticipated
expenses or revenue shortfalls, which may cause the Company to require
additional financing. No assurances can be given that additional financing will
be available, or if available, that it will be on terms and conditions
satisfactory to the Company.

         In addition, in July 1997, the Company announced it had entered into an
agreement ("Merger Agreement") to acquire Moovies, Inc. ("Moovies") in a
stock-for-stock merger transaction (the "Merger"). The Merger is subject to
stockholder approval of both companies, and is anticipated to be completed some
time in late calendar 1997.

         The obligations of the Company and Moovies to consummate the Merger are
subject to the satisfaction of certain conditions, including, but not limited
to, obtaining requisite approvals of the stockholders of the Company and
Moovies, obtaining consents under their respective bank credit agreements (for
the Company, a consent under and/or a modification of the Line of Credit),
obtaining adequate financing, obtaining requisite regulatory approvals
(including under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as
amended), and the continuing accuracy, in all material respects, as of the
effective time of the Merger of the representations and warranties made by the
Company and Moovies in the Merger Agreement. Each party has the right to waive
certain of the closing conditions referred to above. No assurance can be given
that these conditions will be satisfied or waived or that the Merger will be
consummated on a timely basis, if at all.

         The Company has promissory notes (the "Recourse Notes") from the
Company's Chief Executive Officer and from the President for approximately
$1,966,000 and $1,092,000, respectively, including accrued interest through July
31, 1997. The Recourse Notes were issued by the executives upon their exercise
in August 1995 of 420,000 options granted to them under the Stock Option Plans
in May 1995 at an exercise price of $4.3125, the fair market value of the stock
on the date options were granted. The Recourse Notes represent the total
exercise price of such options plus amounts advanced by the Company to such
executives to satisfy then anticipated tax liabilities. The Recourse Notes,
which provide for full recourse against the respective officer's personal assets
and Company stockholdings, are due and payable in October 1999, and accrue
interest at 8% per annum. In the event that the obligors sell shares of the
Company's stock, the net proceeds thereof will be applied to payment, in part or
in full, of the Recourse Notes.

         In addition, as of July 31, 1997, the Company has a note receivable
from the President of the Company for approximately $31,000 which accrues
interest at 8% per annum and is due November 1997. The note represents advances
from the Company to the President from January 1994 to April 1994, together with
accrued interest.

         In connection with three acquisitions in which the Company has issued
an aggregate of 584,506 shares of Class A Common Stock in fiscal 1996 and 1997,
the Company may be obligated to make deficiency payments to such sellers equal
to the difference between the guaranteed price of $7.00 to $15.00 for each share
issued, and the actual market price obtained for such shares as of specified
dates between


<PAGE>


July 1996 and October 1998. As of July 31, 1997, the remaining deficiency
payments are estimated to be approximately $2,576,000 based on the closing stock
price of $3.625 at July 31, 1997. The Company has the option of satisfying
approximately $1,220,000 of this liability at July 31, 1997 through the issuance
of additional shares of Class A Common Stock. The Company is currently disputing
whether any deficiency payment is due with respect to 239,163 shares held by a
seller in one of the acquisitions; the seller is claiming a deficiency payment
based on proceeds from the sale of Class A Common Stock during the six month
period of March 1996 to September 1996.

         The Company generally does not offer lines of credit or guarantees for
the obligations of its franchisees, although on occasion, the Company has made
short term loans to current franchisees. The Company intends to evaluate the
possibility of providing loans or limited guarantees for certain franchisee
obligations, which in the aggregate are not expected to be material to the
Company's financial condition.

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

         Reference to Private Securities Litigation Reform Act: Statements made
by the Company that are not historical facts are forward looking statements that
involve risks and uncertainties. Actual results could differ materially from
those expressed or implied in forward looking statements. All such forward
looking statements are subject to the safe harbor created by the Private
Securities Litigation Reform Act of 1995. Important factors that could cause
financial performance to differ materially from past results and from those
expressed or implied in this document include, without limitation, the risks of
acquisition of businesses (including limited knowledge of the businesses
acquired and misrepresentations by sellers), including the proposed acquisition
of Moovies, changes in business strategy or development plans, new store
openings, availability of products, availability of financing, competition,
management, ability to manage growth, loss of customers, weather (particularly
on weekends and holidays), consumer acceptance of new release videocassette
titles, and a variety of other factors. The obligations of the Company and
Moovies to consummate the Merger are subject to the satisfaction of certain
conditions, including, but not limited to, obtaining requisite approvals of the
stockholders of the Company and Moovies, obtaining consents under the respective
bank credit agreements of the Company and Moovies, obtaining adequate financing,
obtaining requisite regulatory approvals and the continuing accuracy, in all
material respects, as of the effective time of the Merger, of the
representations and warranties made by the Company and Moovies in the Merger
Agreement. No assurance can be given that these conditions will be satisfied or
waived or that the Merger will be consummated on a timely basis, if at all.
Further information on these and other risks is included in the Company's Annual
Report on Form 10-K for the year ended April 30, 1997, as well as the Company's
other filings with the Securities and Exchange Commission.

INFLATION

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

SEASONALITY AND QUARTERLY FLUCTUATIONS

         The video rental industry generally experiences revenue declines in
April and May, due in part to the change to Daylight Savings Time and to
improved weather, and in September and October, due in part to school openings
and the introduction of new network and cable television programs.

         The Company's video rental business may be affected by other factors,
including acquisitions by the Company of existing video stores, additional and
existing competition, marketing programs, weather, special or unusual events,
variations in the number of superstore openings, the quality of new release
titles available for rental and sale, and other factors that may affect
retailers in general.
<PAGE>

PART II - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

         In connection with the acquisition of the assets of Videoland, Inc.
("Videoland") in November 1995, the Company issued 239,163 shares of its Class A
Common Stock (the "Videoland Shares") to the sellers of the assets of Videoland
(the "Videoland Sellers"). With respect to the Videoland Shares, the Company
agreed to make a deficiency payment in October 1996 to the Videoland Sellers if
the gross proceeds received by such sellers from the sale of the Videoland
Shares during the six months from March 1996 through September 1996 is not equal
to the number of shares of Videoland Shares sold multiplied by $12.00. The
Videoland Sellers were subject to certain "lockup" or sale restrictions as a
condition to any deficiency payment. Although the Videoland Sellers have now
requested a deficiency payment of approximately $1,220,000 in October 1996 based
on a sale of all of the Videoland Shares, the Company believes that the
Videoland Sellers have violated the contractual lockup and sale restrictions.
Accordingly, the Company has initiated an action in federal district court in
Minnesota for a declaratory judgment that the Videoland Sellers are not entitled
to any deficiency payment. Discovery on this matter is proceeding. Although no
assurances can be given as to the outcome of such action, the Company intends to
vigorously pursue the matter.

         On January 23, 1997, the Company filed an action (the "Minnesota
Action") for breach of contract, breach of warranty, and negligence against
Kieffer & Co. Inc., a sign manufacturer, ("Kieffer") seeking damages that
resulted from Kieffer's manufacture and installation of signs on the Company's
stores in several states in the United States. Kieffer filed counterclaims
against the Company for breach of contract, seeking $317,341.76 in damages. On
January 24, 1997, Kieffer commenced a separate action for breach of contract
(the "Wisconsin Action") against the Company in Sheboygan County (Wisconsin)
Circuit Court seeking the same damages alleged in their counterclaim in the
Minnesota Action. The Company removed the Wisconsin Action to the United States
District Court for the Eastern District of Wisconsin. That court has stayed the
Wisconsin Action pending the resolution of the Minnesota Action. Although no
assurances can be given as to the outcome of such action, the Company is
vigorously pursuing the matter.

         The Company has been in litigation with CHJ Associates ("CHJ"), a
Washington limited partnership, over a lease agreement. The matter has been
resolved by the execution of an executory settlement agreement (the
"Agreement"), under which CHJ will develop one or more Video Update stores for
the Company in Washington state. Although no assurance can be given as to
whether CHJ will comply with the terms of the Agreement, the Company does not
believe that the resolution of the matter will materially adversely impact the
Company's financial position or results of operations.

ITEM 6.           EXHIBITS AND REPORTS ON FORM 8-K

         A.       Exhibits.  The following exhibits are filed herewith:

                  Exhibit No.               Title

                      27              Financial Data Schedule

         B. Reports on Form 8-K. Listed below are all Current Reports or
amendments on Form 8-K that were filed during the fiscal quarter covered by this
report, listing the items reported, any financial statements filed, and the
dates of such reports.

                  1. Current Report on Form 8-K/A filed June 12, 1997, amending
                  the Company's Form 8-K filed on April 17, 1997 and containing
                  the following financial statements:

                           (a)      The audited financial statements for Hill
                                    and Cassidy Retail Corp. for the year ended
                                    November 30, 1996.


<PAGE>


                           (b)      The pro forma financial information for the
                                    Company for the year ended April 30, 1996
                                    and for the nine months ended January 31,
                                    1997.

                  2. Current Report on Form 8-K filed July 10, 1997, reporting
                  the Agreement and Plan of Merger by and among Video Update,
                  Inc., VUI Merger Corp. and Moovies, Inc., dated as of July 9,
                  1997.


<PAGE>


                                   SIGNATURES

         Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

                                    VIDEO UPDATE, INC.

Date:  September 15, 1997:          By: /s/ Daniel A. Potter
                                            DANIEL A. POTTER,
                                            Chief Executive Officer and
                                            Chairman of the Board of Directors

Date:  September 15, 1997:          By: /s/ Christopher J. Gondeck
                                            CHRISTOPHER J. GONDECK,
                                            Chief Financial Officer