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 October 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 December 12, 1997 is 18,104,591 and the number of shares of Class
B Common Stock, $.01 par value, outstanding is 2,000,000.

<PAGE>


                               VIDEO UPDATE, INC.

                                      INDEX

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

ITEM 1.  Financial Statements

         Consolidated Balance Sheets - April 30, 1997, and
           October 31, 1997                                                  3

         Consolidated Statements of Income - Three Months and
           Six Months Ended October 31, 1996 and October 31, 1997            4

         Consolidated Statements of Cash Flows - Three Months
           and Six Months Ended October 31, 1996 and October 31, 1997        5

         Notes to Consolidated Financial Statements - October 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 Proceedings                                                  13

ITEM 6.  Exhibits and Reports on Form 8-K                                   14

SIGNATURES                                                                  15


<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,  October 31,
                                                                     1997        1997
                                                                 ---------    ---------
                                                                             (UNAUDITED)
<S>                                                              <C>          <C>      
Cash and cash equivalents                                        $   2,424    $      96
Accounts receivable                                                  3,776        3,593
Notes receivable from related parties                                1,394        1,470
Inventory                                                            7,318        9,119
Videocassette rental inventory -- net                               45,479       56,785
Property and equipment -- net                                       33,069       41,750
Prepaid expenses                                                       783        1,875
Recoverable income taxes                                              --          1,502
Goodwill -- net                                                     37,716       36,612
Other assets                                                         1,648        1,752
                                                                 ---------    ---------
Total assets                                                     $ 133,607    $ 154,554
                                                                 =========    =========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Notes payable                                                    $  20,564    $  32,534
Accounts payable                                                    12,196       21,712
Accrued expenses                                                     2,415        2,884
Accrued rent                                                         2,238        3,450
Accrued compensation                                                 1,779        1,548
Income taxes payable                                                 1,096         --
Deferred income taxes                                                2,327        3,021

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 October 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 October 31, 1997                  20           20
    Additional paid-in capital                                      86,085       85,585
    Retained earnings                                                6,806        5,909
    Foreign currency translation                                      (421)        (610)
                                                                 ---------    ---------
                                                                    92,672       91,085
    Notes receivable from officers for the exercise of options      (1,680)      (1,680)
                                                                 ---------    ---------
Total stockholders' equity                                          90,992       89,405
                                                                 ---------    ---------
Total liabilities and stockholders' equity                       $ 133,607    $ 154,554
                                                                 =========    =========
</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        Six Months Ended
                                              October 31,              October 31,
                                            1996        1997        1996        1997
                                          --------    --------    --------    --------
<S>                                       <C>         <C>         <C>         <C>     
Revenues:
    Rental revenue                        $ 18,444    $ 29,152    $ 35,628    $ 56,964
    Service fees                               165         193         284         343
    Product sales                            1,515       3,786       2,775       6,630
                                          --------    --------    --------    --------
                                            20,124      33,131      38,687      63,937

Costs and expenses:
    Store operating expenses                15,868      27,973      30,286      53,372
    Selling, general and administrative      2,044       3,167       4,022       5,841
    Cost of product sales                      956       2,362       1,636       3,852
    Amortization of goodwill                   371         502         743       1,022
                                          --------    --------    --------    --------
                                            19,239      34,004      36,687      64,087
                                          --------    --------    --------    --------

Operating income (loss)                        885        (873)      2,000        (150)

Interest expense                              (152)       (670)       (318)     (1,176)
Other income                                   119          74         129         180
                                          --------    --------    --------    --------
                                               (33)       (596)       (189)       (996)
                                          --------    --------    --------    --------

Income (loss) before income taxes              852      (1,469)      1,811      (1,146)
Income tax expense (benefit)                   382        (462)        778        (249)
                                          ========    ========    ========    ========
Net income (loss)                         $    470    $ (1,007)   $  1,033    $   (897)
                                          ========    ========    ========    ========

Net income (loss) per share               $   0.03    $  (0.05)   $   0.08    $  (0.05)
                                          ========    ========    ========    ========
</TABLE>

                             SEE ACCOMPANYING NOTES.

<PAGE>


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


                                                    Six Months Ended October 31,
                                                             1996        1997
                                                           --------    --------

OPERATING ACTIVITIES
    Net income (loss)                                      $  1,033    $   (897)
    Adjustments to reconcile net income (loss) to net
      cash provided by operating activities:
        Depreciation and amortization                        11,409      19,670
        Accrued rent                                            700       1,212
        Deferred income taxes                                   131         694
        Changes in operating assets and liabilities, net
           of acquisitions of businesses:
            Accounts receivable                                (976)        179
            Inventory                                           946      (1,801)
            Other assets                                       (722)     (1,414)
            Accounts payable                                  2,643       9,516
            Income taxes payable                               (168)     (2,598)
            Other liabilities                                   529           9
                                                           --------    --------
Net cash provided by operating activities                    15,525      24,570

INVESTING ACTIVITIES
    Purchase of videocassette rental inventory              (17,169)    (26,799)
    Purchase of property and equipment                       (6,329)    (11,343)
    Investment in businesses, net of cash acquired             (166)       (610)
    Notes receivable from officers                             --          (160)
    Payments on notes receivable                                420          43
                                                           --------    --------
Net cash used in investing activities                       (23,244)    (38,869)

FINANCING ACTIVITIES
    Proceeds from notes payable                               5,326      14,000
    Payments on notes payable                                (9,525)     (2,029)
    Proceeds from issuance of common stock, net              25,032        --
                                                           --------    --------
Net cash provided by financing activities                    20,833      11,971
                                                           --------    --------

Increase (decrease) in cash and cash equivalents             13,114      (2,328)
Cash and cash equivalents at beginning of the period            676       2,424
                                                           --------    --------
Cash and cash equivalents at end of the period             $ 13,790    $     96
                                                           ========    ========

                             SEE ACCOMPANYING NOTES.

<PAGE>


                               VIDEO UPDATE, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                OCTOBER 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 six months ended October 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 (loss) per share under the treasury stock method is computed
by dividing net income (loss) 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 (loss) 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             SIX MONTHS
                                                           ENDED OCTOBER 31,       ENDED OCTOBER 31,
                                                         --------------------    --------------------
                                                           1996        1997        1996        1997
                                                         --------    --------    --------    --------
                                                            (In thousands, except per share amount)
<S>                                                      <C>         <C>         <C>         <C>      
EARNINGS PER SHARE
Net income (loss)                                        $    470    $ (1,007)   $  1,033    $   (897)
                                                         ========    ========    ========    ========

Weighted average shares outstanding:
    Class A common shares outstanding at quarter end       18,018      18,105      18,018      18,105
    Class B common shares outstanding at quarter end        2,000       2,000       2,000       2,000
    Less:  Class B common shares placed in escrow in
           connection with the initial public offering     (1,300)     (1,300)     (1,300)     (1,300)
    Effect of using weighted average common shares
        outstanding                                        (4,465)       --        (5,740)       --
    Effect of shares issuable under stock options and
        warrants based on the treasury stock method           348         177         483         177
                                                         --------    --------    --------    --------
                                                           14,601      18,982      13,461      18,982
                                                         ========    ========    ========    ========
Net income (loss) per common and common
  equivalent share                                       $   0.03    $  (0.05)   $   0.08    $  (0.05)
                                                         ========    ========    ========    ========

</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 three months and six
months ended October 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 574,506 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 $2,680,000 based on the closing stock price of
$3.125 at October 31, 1997. The Company has the option of satisfying
approximately $1,220,000 of this liability at October 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 October 1997, a cash deficiency payment was made with regard to
an acquisition in the cash amount of $68,562.

4.       STOCKHOLDER'S EQUITY

         In the first quarter of fiscal 1998, 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 October 31, 1997 operated 387 Company-owned
stores in 20 states and six provinces in Canada, and has 34 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.

         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 $36,612,000, with anticipated
quarterly non-cash charges of approximately $504,000. The Company anticipates
that future acquisitions will involve the recording of additional significant
amounts of goodwill and deferred charges on its balance sheet.

<PAGE>


         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         SIX MONTHS ENDED
                         OCTOBER 31,              OCTOBER 31,
                    --------------------      --------------------
                      1996         1997        1996          1997
                    -------      -------      -------      -------
                        (In thousands)          (In thousands)

Rental revenue      $18,444      $29,152      $35,628      $56,964
Service fees            165          193          284          343
Product sales         1,515        3,786        2,775        6,630
                    -------      -------      -------      -------
                    $20,124      $33,131      $38,687      $63,937
                    =======      =======      =======      =======


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.


                                         SIX MONTHS ENDED OCTOBER 31,
                                         ----------------------------
                                             1996         1997
                                             -----       -----

Revenues:
    Rental revenue                            92.1 %      89.1 %
    Service fees                               0.7         0.5
    Product sales                              7.2        10.4
                                             -----       -----
Total revenues                               100.0       100.0

Costs and expenses:
    Store operating expenses                  78.3        83.5
    Selling, general and administrative       10.4         9.1
    Cost of product sales                      4.2         6.0
    Amortization of goodwill                   1.9         1.6
                                             -----       -----
Total cost and expenses                       94.8       100.2
                                             -----       -----
Operating income (loss)                        5.2        (0.2)

Other income (expense):
    Interest expense                          (0.8)       (1.9)
    Other income                               0.3         0.3
                                             -----       -----
Total other income (expense)                  (0.5)       (1.6)
                                             -----       -----
Income (loss) before income taxes              4.7        (1.8)
Income tax expense (benefit)                   2.0        (0.4)
                                             -----       -----
Net income (loss)                              2.7 %      (1.4)%
                                             =====       =====

<PAGE>


SIX MONTHS ENDED OCTOBER 31, 1997 COMPARED TO SIX MONTHS ENDED OCTOBER 31, 1996

         RENTAL REVENUE. Rental revenue was approximately $56,964,000 and
$35,628,000, or 89.1% and 92.1% of total revenues for the six months ended
October 31, 1997 and 1996, respectively. The increase in rental revenue of
$21,336,000 was derived primarily from video stores acquired during fiscal 1997,
from the opening of 79 Company-owned stores, net of closings, since the second
quarter of fiscal 1997, and from a 3% increase in same store revenues.

         SERVICE FEES. Service fees were approximately $343,000 and $284,000, or
0.5% and 0.7% of total revenues for the six months ended October 31, 1997 and
1996, respectively. Continuing service fees and royalties from franchisees
accounted for 91.3% and 89.4% of total service fees, respectively.

         PRODUCT SALES. Product sales were approximately $6,630,000 and
$2,775,000, or 10.4% and 7.2% of total revenues for the six months ended October
31, 1997 and 1996, respectively. The increase in product sales of $3,855,000 was
primarily a result of product sales by the video stores acquired during fiscal
1997, from the opening of 79 Company-owned video stores, net of closings, since
the second 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.

         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 $53,372,000 and $30,286,000, or 83.5% and 78.3% of
total revenues for the six months ended October 31, 1997 and 1996, respectively.
The increase in store operating expenses of $23,086,000 was primarily the result
of video stores acquired during fiscal 1997 and the opening of 79 Company-owned
video stores, net of closings, since the second quarter of fiscal 1997.

         Compensation and related expenses were approximately $14,817,000 and
$8,935,000, or 23.2% and 23.1% of total revenues for the six months ended
October 31, 1997 and 1996, respectively. The increase of $5,882,000 was
primarily due to video stores acquired during fiscal 1997 and from the opening
of 79 Company-owned video stores, net of closings, since the second quarter of
fiscal 1997.

         Occupancy expenses were approximately $15,967,000 and $8,917,000, or
25.0% and 23.0% of total revenues for the six months ended October 31, 1997 and
1996, respectively. The increase of approximately $7,050,000 was primarily due
to video stores acquired during fiscal 1997 and from the opening of 79
Company-owned stores, net of closings, since the second quarter of fiscal 1997.
The increase as a percentage of total revenues was primarily due to revenues of
new and acquired stores not meeting management's expectations due primarily
(management believes) to lack of public acceptance of new release titles and
higher costs associated with the opening of new video stores prior to revenue
reaching maturity during the first two years of operation.

         Depreciation and amortization expenses were approximately $17,967,000
and $10,267,000, or 28.1% and 26.5% of total revenues for the six months ended
October 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 $7,700,000 was primarily attributable to the
addition of new release videocassette inventory for new, existing, and acquired
stores. The increase as a percentage of total revenues was primarily due to
revenues of new and acquired stores not meeting management's expectations due
primarily (management believes) to lack of public acceptance of new release
titles and higher costs associated with the opening of new video stores prior to
revenue reaching maturity during the first two years of operation. 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 $5,841,000 and $4,022,000, or 9.1%
and 10.4% of total revenues for the six months ended October 31, 1997 and 1996,
respectively. The increase of approximately $1,819,000 was primarily due to

<PAGE>


adding management personnel and administrative staff to support the Company's
growth and related 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
$3,852,000 and $1,636,000, or 6.0% and 4.2% of total revenues for the six months
ended October 31, 1997 and 1996. The cost of product sales as a percentage of
total product sales revenue was approximately 58.1% and 59.0% for fiscal 1997
and 1996, respectively. The decrease in the cost of product sales as a
percentage of total product sales was primarily due to a difference in product
mix.

         AMORTIZATION OF GOODWILL. Amortization of goodwill was approximately
$1,022,000 and $743,000 or 1.6% and 1.9% of total revenues for the six months
ended October 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 $1,176,000 and
$318,000, or 1.9% and 0.8% of total revenues for the six months ended October
31, 1997 and 1996, respectively. The increase of $858,000 was primarily
attributable to interest on increased borrowings under the Company's bank line
of credit.

         OTHER INCOME. Other income was approximately $180,000 and $129,000, or
0.3% of total revenues for the six months ended October 31, 1997 and 1996. The
increase of $51,000 was primarily due to an increase in interest 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 and build out 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 October 31, 1997, the Company had cash and cash equivalents of
approximately $96,000. 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 six months ended October 31, 1997 net cash provided by
operating activities was approximately $24,570,000. Net cash used in investment
activities was approximately $38,869,000 consisting primarily of approximately
$11,343,000 for new and remodeled stores, and conversion costs associated with
acquired stores, and approximately $26,799,000 for the purchase of videocassette
inventory for existing and new stores. Net cash generated from financing
activities was approximately $11,971,000 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 (as amended, 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 or restructured on or
before February 1998. As of October 31, 1997, approximately $32,000,000 was

<PAGE>


outstanding under the Line of Credit, bearing interest at 8.4% to 9.3%. 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.

         For the remainder of the current fiscal year, management currently
expects to focus on maximizing the operating efficiencies of its existing and
previously acquired locations and on completing the build out of new stores in
locations for which the Company has signed lease commitments, rather than on
aggressively expanding with new superstores in additional metropolitan areas
where it does not presently have locations. The Company expects to fund its
short-term capital needs, including the purchase of videocassette rental
inventory and the build out of new stores, primarily through cash from
operations, trade credit, and borrowings under the Line of Credit, if available
(subject to the Company's maintenance of certain cash flow and tangible net
worth ratios). No assurances can be given that the Company will not require
additional sources of financing as a result of store openings or build outs
currently in progress, disappointing operating results, unavailability under or
non-renewal of the Line of Credit as a result of such operating results, or
unanticipated cash needs or opportunities. Moreover, no assurances can be given
that such additional funds will be available on satisfactory terms, if at all.
If the Company is unable to obtain such additional financing, the Company may be
required to reduce its overall expenditures and the Company's ability to
maintain or expand its current level of operations could be materially and
adversely affected.

         In addition, in July 1997, the Company announced it had entered into an
Agreement and Plan of Merger (the "Agreement") to acquire Moovies, Inc.
("Moovies") in a stock-for-stock merger transaction (the "Merger"). In October
1997, the Company announced that it had entered into an Amendment (the
"Amendment") to the Agreement (collectively, the Amendment and the Agreement are
referred to as the "Merger Agreement"). The Merger Agreement provides that each
stockholder of Moovies will receive .75 shares of Video Update Class A Common
Stock for each share of Moovies Common Stock. The Merger is subject to
stockholder approval of both companies, and is currently anticipated to be
completed some time in the first calendar quarter of 1998.

         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, the "HSR Act" and the effectiveness under the securities laws of a
registration statement which has not yet been filed), 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. Additionally, the Company intends to seek a restructuring/renewal of
its current bank line of credit in connection with (and to satisfy conditions
to) the consummation of the Merger Agreement, of which no assurance can be
given. 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 filed the Notification and Report Form required by the HSR
Act on November 13, 1997, and early termination of the waiting period
established by the HSR Act was granted on or about November 18, 1997. Although
such early termination has been granted, no assurances can be given that
governmental action under the antitrust laws will not be taken before or after
consummation of the Merger.

         The Company has promissory notes (the "Recourse Notes") from the
Company's Chief Executive Officer and from the President for approximately
$2,004,000 and $1,114,000, respectively, including accrued interest through
October 31, 1997. The Recourse Notes were issued by the executives upon their

<PAGE>


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 October 31, 1997, the Company has a note receivable
from the President of the Company for approximately $32,000 which accrues
interest at 8% per annum and is expected to be due November 1998, subject to
board approval. 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 574,506 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 $2,680,000 based on the closing stock price of
$3.125 at October 31, 1997. The Company has the option of satisfying
approximately $1,220,000 of this liability at October 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.

<PAGE>


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, and other factors that may
affect retailers in general.

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

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 in this matter has been completed and
cross-motions for summary judgment are now pending before the court. 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. On December 3,
1997, the parties settled their dispute pursuant to a confidential settlement
agreement containing mutual releases (the "Kieffer Settlement Agreement").
Although the parties have executed the Kieffer Settlement Agreement, all steps
necessary to consummate such agreement will not take place until

<PAGE>


December 31, 1997. The parties will then execute and file with both the
Minnesota and Wisconsin courts the appropriate stipulations to dismiss both
cases with prejudice. Although no assurance can be given as to whether all
necessary steps to consummate the Kieffer Settlement Agreement will take place,
the Company does not believe that the resolution of the matter will materially
adversely impact the Company's financial position or results of operations.

         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 "CHJ
Settlement 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 CHJ Settlement 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
                     -----------        -----
                         10             Amended and Restated Voting Agreement
                                         executed in connection with the
                                         proposed merger with Moovies Inc.
                         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 filed October 31, 1997,
                  reporting the Amendment to the Agreement and Plan of Merger by
                  and among Video Update, Inc., VUI Merger Corp. and Moovies,
                  Inc., dated as of October 27, 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:  December 15, 1997:             By: /s/Daniel A. Potter
                                              DANIEL A. POTTER,
                                              Chief Executive Officer and
                                              Chairman of the Board of Directors

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