<PAGE>


                                    UNITED STATES
                          SECURITIES AND EXCHANGE COMMISSION
                               WASHINGTON, D.C.  20549
                                           
                                     FORM 10-QSB
                                           
                                           
                                           
[X]  Quarterly report under Section 13 or 15(d) of the Securities Exchange Act
     of 1934

     For the quarterly period ended October 31, 1996

[ ]  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 Small Business Issuer 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)
                                           
                                    (612) 222-0006
                --------------------------------------------------------
                   (Issuer's Telephone Number, Including Area Code)
                                           
                                           
                                             
     Check whether the Issuer: (1) filed all reports required to be filed by 
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for 
such shorter period that the registrant was required to file such reports), 
and (2) has been subject to such filing requirements for the past 90 days.

Yes   X      No
    -----       -----

     On December 9, 1996, the Issuer had 18,017,735 outstanding shares of Class
A Common Stock, $.01 par value, and 2,000,000 outstanding shares of Class B
Common Stock, $.01 par value.

<PAGE>

                                  VIDEO UPDATE, INC.
                                           
                                        INDEX
                                           
PART 1 - FINANCIAL INFORMATION                                         PAGE NO.
------------------------------                                         --------

ITEM 1.  Financial Statements 

         Consolidated Balance Sheets - April 30, 1996, and 
              October 31, 1996........................................    3

         Consolidated Statements of Income - Three Months and Six 
              Months ended October 31, 1995 and October 31, 1996......    4

         Consolidated Statements of Cash Flows - Six Months ended
               October 31, 1995 and October 31, 1996..................    5

         Notes to Consolidated Financial Statements - October 31, 
               1996...................................................    6

ITEM 2.  Management's Discussion and Analysis of Financial
               Condition and Results of Operations....................    9

PART II - OTHER INFORMATION
---------------------------

ITEM 1.  Legal Information............................................   15

ITEM 5.  Other Information............................................   15

ITEM 6.  Exhibits and Reports on Form 8-K.............................   15

SIGNATURES............................................................   16
----------





                                    2 of 16

<PAGE>

PART 1 - FINANCIAL INFORMATION
------------------------------
ITEM 1.  FINANCIAL STATEMENTS

                                  VIDEO UPDATE, INC.
                             CONSOLIDATED BALANCE SHEETS
                  (In thousands, except share and per share amounts)
                                           
                                        ASSETS
                                                       April 30,    October 31,
                                                          1996         1996
                                                       ---------    -----------
                                                                    (UNAUDITED)
Cash and cash equivalents                               $   676       $ 13,790
Accounts receivable                                         558          1,534
Notes receivable from related parties                     1,555          1,265
Inventory                                                 4,545          3,599
Videocassette rental inventory -- net                    25,701         33,974
Property and equipment -- net                            18,988         23,706
Prepaid expenses                                            682          1,153
Goodwill -- net                                          25,973         25,402
Other assets                                                840            932
                                                       ---------    -----------
Total assets                                            $79,518       $105,355
                                                       ---------    -----------
                                                       ---------    -----------

                          LIABILITIES AND STOCKHOLDERS' EQUITY

Notes payable                                           $ 4,859       $    660
Accounts payable                                          8,692         11,335
Accrued compensation                                      1,334          1,250
Accrued expenses                                            977          1,460
Accrued rent expense                                        228            271
Income tax payable                                          593            425
Deferred income taxes                                       841            972
Other liabilities                                           494          1,152

Commitments and contingnecies

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 -- 50,000,000
    Issued and outstanding shares -- 11,017,735 at 
      April 30, 1996 and 18,017,735 at October 31, 1996     110            180
Class B Common Stock, par value $.01 per share:
    Authorized, issued and outstanding shares -- 
      2,000,000  at April 30, 1996 and October 31, 1996      20             20
    Additional paid-in capital                           61,029         85,991
    Retained earnings                                     2,186          3,219
    Foreign currency translation                            (34)           100
                                                       ---------    -----------
                                                         63,311         89,510
    Notes receivable from officers for the exercise of 
      options                                            (1,811)        (1,680)
                                                       ---------    -----------
Total stockholders' equity                               61,500         87,830
                                                       ---------    -----------
Total liabilities and stockholders' equity              $79,518       $105,355
                                                       ---------    -----------
                                                       ---------    -----------

                               SEE ACCOMPANYING NOTES.
                                           
Note:  The balance sheet at April 30, 1996 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.


                                       3 of 16
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                                  VIDEO UPDATE, INC.
                          CONSOLIDATED STATEMENTS OF INCOME
                                     (UNAUDITED)
                       (In thousands, except per share amounts)
                                           
                                        Three Months Ended   Six Months Ended
                                            October 31,         October 31,
                                           1995      1996      1995      1996
                                         --------   -------   -------  -------
Revenues:
    Rental revenue                        $ 9,810   $18,444   $14,612   $35,628
    Service fees                               77       165       203       284
    Product sales                             784     1,515     1,028     2,775
                                          -------   -------   -------   -------
                                           10,671    20,124    15,843    38,687

Costs and expenses:
    Store operating expenses                7,962    15,890    11,510    30,426
    Selling, general and administrative     1,173     2,044     2,004     4,022
    Cost of product sales                     491       956       658     1,636
    Amortization of goodwill                  227       371       346       743
                                          -------   -------   -------   -------
                                            9,853    19,261    14,518    36,827
                                          -------   -------   -------   -------

Operating income                              818       863     1,325     1,860

Interest expense                             (101)     (152)     (152)     (318)
Other income                                  148       141       223       269
                                          -------   -------   -------   -------
                                               47       (11)       71       (49)
                                          -------   -------   -------   -------

Income before income taxes                    865       852     1,396     1,811
Income tax expense                            379       382       610       778
                                          -------   -------   -------   -------
Net income                                $   486   $   470   $   786   $ 1,033
                                          -------   -------   -------   -------
                                          -------   -------   -------   -------

Net income per share, primary             $  0.05   $  0.03   $  0.10   $  0.08
                                          -------   -------   -------   -------
                                          -------   -------   -------   -------

Net income per share, fully diluted       $  0.05   $  0.03   $  0.09   $  0.08
                                          -------   -------   -------   -------
                                          -------   -------   -------   -------

                               SEE ACCOMPANYING NOTES.



                                       4 of 16
<PAGE>

                                  VIDEO UPDATE, INC.
                        CONSOLIDATED STATEMENTS OF CASH FLOWS
                                     (UNAUDITED)
                                    (In thousands)
                                           
                                                  Six Months Ended October 31,
                                                  ----------------------------
                                                     1995              1996
                                                  ----------        ----------
OPERATING ACTIVITIES
    Net income                                     $    786          $  1,033
    Adjustments to reconcile net income to net 
      cash provided by operating activities:
        Depreciation and amortization                 3,703            11,409
        Deferred rent and other liabilities             256               700
        Deferred income taxes                           192               131
        Changes in operating assets and 
          liabilities, net of acquisitions 
          of businesses:
            Accounts receivable                        (103)             (976)
            Notes receivable                             (1)              420
            Inventory                                (2,116)              946
            Other assets                               (252)             (722)
            Accounts payable                          3,552             2,643
            Income taxes payable                        419              (168)
            Other liabilities                          (921)              529
                                                  ----------        ----------
Net cash provided by operating activities             5,515            15,945

INVESTING ACTIVITIES
    Purchase of videocassette rental inventory       (7,911)          (17,169)
    Purchase of property and equipment               (5,899)           (6,329)
    Investment in businesses, net of cash acquired  (14,568)             (166)
    Loan advance to executives                       (1,252)                -
                                                  ----------        ----------
Net cash used in investing activities               (29,630)          (23,664)

FINANCING ACTIVITIES
    Proceeds from bank line                               -             5,300
    Proceeds from notes payable                           -                26
    Payments on bank line                                 -            (9,400)
    Payments on notes payable                        (3,200)             (125)
    Proceeds from exercise of employee options            2                 -
    Proceeds from exercise of Class A warrants, 
      net                                            28,414                 -
    Proceeds from issuance of common stock, net         992            25,032
                                                  ----------        ----------
Net cash provided by financing activities            26,208            20,833
                                                  ----------        ----------

Increase in cash and cash equivalents                 2,093            13,114
Cash and cash equivalents at beginning of the 
  period                                              5,573               676
                                                  ----------        ----------
Cash and cash equivalents at end of the period     $  7,666          $ 13,790
                                                  ----------        ----------
                                                  ----------        ----------

                               SEE ACCOMPANYING NOTES.



                                       5 of 16
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                                  VIDEO UPDATE, INC.
                      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   OCTOBER 31, 1996
                                     (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, 1996 are
not necessarily indicative of the results that may be expected for the year
ending April 30, 1997.  For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's annual
report on Form 10-KSB for the year ended April 30, 1996.

     RECLASSIFICATION

     Certain prior year items have been reclassified to conform with the fiscal
1997 presentation. 

2.   NET INCOME PER COMMON SHARE

     Net income per share 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.  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.

                                        THREE MONTHS ENDED   SIX MONTHS ENDED
                                            OCTOBER 31,         OCTOBER 31,
                                        ------------------   ----------------
                                          1995      1996      1995     1996
                                        --------  --------  -------- --------
                                       (In thousands, except per share amounts)

Net income                              $   486   $   470    $   786  $ 1,033
                                        --------  --------  -------- --------
                                        --------  --------  -------- --------

Weighted average shares outstanding:
    Class A common shares outstanding 
      at quarter end                     10,775    18,018     10,775   18,018
    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          (2,206)   (4,465)    (4,159)  (5,740)
    Effect of shares issuable under stock
      options and warrants based on the
      treasury stock method               1,249       348        915      483
                                        --------  --------  -------- --------
                                         10,518    14,601      8,231   13,461
                                        --------  --------  -------- --------
                                        --------  --------  -------- --------

Net income per common and common
  equivalent share, primary             $  0.05   $  0.03    $  0.10  $  0.08
                                        --------  --------  -------- --------
                                        --------  --------  -------- --------


                                       6 of 16
<PAGE>

                                        THREE MONTHS ENDED   SIX MONTHS ENDED
                                            OCTOBER 31,         OCTOBER 31,
                                        ------------------   ----------------
                                          1995      1996      1995     1996
                                        --------  --------  -------- --------
                                       (In thousands, except per share amounts)

Net income                               $   486  $   470    $   786  $ 1,033

Weighted average shares outstanding:
    Class A common shares outstanding 
      at quarter end                      10,775   18,018     10,775   18,018
    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           (2,206)  (4,465)    (4,159)  (5,740)
    Effect of shares issuable under stock
      options and warrants based on the
      treasury stock method                1,249      348      1,336      483
                                        --------  --------  -------- --------
                                          10,518   14,601      8,652   13,461
                                        --------  --------  -------- --------
                                        --------  --------  -------- --------

Net income per common and common
  equivalent share, fully diluted        $  0.05  $  0.03    $  0.09  $  0.08
                                        --------  --------  -------- --------
                                        --------  --------  -------- --------

3.   CHANGE IN AMORTIZATION METHOD FOR VIDEOCASSETTE RENTAL INVENTORY

     Effective February 1, 1996, videocassettes that are considered base stock
(including copies one through three of new releases) are amortized over 36
months on a straight-line basis to a salvage value of $6.00 per videocassette. 
New release videocassettes are amortized as follows: the fourth through ninth
copies of each title per store are amortized on a straight-line basis during
their first six months to a net book value of $6.00 and then on a straight-line
basis over 30 months with no salvage value; and the tenth and any succeeding
copies of each title per store are amortized on a straight-line basis during
their first six months to a net book value of $6.00 and then on a straight-line
basis over three months with no salvage value.  The changes, which represent in
part a change in accounting principle and a change in accounting estimate, were
reflected in the Company's consolidated financial statements in total as a
change in an accounting estimate in the fourth quarter of fiscal 1996. 

     Prior to February 1, 1996, base stock videocassettes were amortized over 36
months on a straight-line basis with no salvage value.  Prior to May 1, 1995,
new release videocassettes were amortized as follows: copies one through three
of each title per store were amortized as base stock; the fourth through ninth
copies of each title per store were amortized 40% in the first year and 30% in
each of the second and third years; and the tenth and any succeeding copies of
each title per store were amortized over nine months on a straight-line basis. 

     The new method of amortization was adopted because the Company believes
accelerating expense recognition for new release videocassettes (copies four and
greater) during the first six months more closely matches the typically higher
revenue generated following a title's release, and believes that $6.00
represents a reasonable salvage value for base stock videocassettes after 36
months. 

                                       7 of 16

<PAGE>

     The effect of the application of the new method of amortizing 
videocassettes during the first half of fiscal 1996 (six months ended October 
31, 1995) would have increased amortization expense by approximately 
$1,024,000 and decreased net income by approximately $577,000, or $.07 per 
share, for the period.

4.   ACQUISITIONS

     In connection with six acquisitions in which the Company has issued an
aggregate of 650,613 shares of Class A Common Stock in fiscal 1996, 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 of such shares as of specified dates between
July 1996 and October 1998.  During October 1996, a deficiency payment was made
with regard to one acquisition in the cash amount of $87,135.  As of October 31,
1996, the remaining deficiency payments are estimated to be approximately
$2,600,000 based on the closing stock price at October 31, 1996.  In two of
these acquisitions, the Company has the option of satisfying approximately
$1,300,000 of this liability at October 31, 1996 through the issuance of
approximately 192,000 additional shares of Class A Common Stock.

5.   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 will be 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.

     In June 1996, the Board of Directors approved an additional stock option
plan (the "1996 Plan").  The 1996 Plan provides for the granting of up to
820,000 options to eligible individuals to purchase shares of Class A Common
Stock of the Company.  Options under the 1996 Plan may be incentive stock
options or non-qualified options. 



                                       8 of 16

<PAGE>

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, 1996 operates 237 Company-owned stores in 13
states and in Canada, and has 28 franchised stores predominantly in the United
States. All 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 and fiscal 
1996, the Company anticipates that its results of operations will be reduced 
by the amortization of goodwill of approximately $25,402,000, with anticipated
quarterly non-cash charges of approximately $372,000 for goodwill.  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   SIX MONTHS ENDED
                                            OCTOBER 31,         OCTOBER 31,
                                        ------------------   ----------------
                                          1995      1996      1995     1996
                                        --------  --------  -------- --------
                                           (In thousands)     (In thousands)

Rental revenue                          $  9,810  $ 18,444  $ 14,612 $ 35,628
Service fees                                  77       165       203      284
Product sales                                784     1,515     1,028    2,775
                                        --------  --------  -------- --------
                                        $ 10,671  $ 20,124  $ 15,843 $ 38,687
                                        --------  --------  -------- --------

     Effective February 1, 1996, videocassettes that are considered base stock
(including copies one through three of new releases) are amortized over 36
months on a straight-line basis to a salvage value of $6.00 per videocassette.
New release videocassettes are amortized as follows: the fourth through ninth
copies of each title per store are amortized on a straight-line basis during
their first six months to a net book value of $6.00 and then on a straight-line
basis over 30 months with no salvage value; and the tenth and any succeeding
copies of each title per store are amortized on a straight-line basis during
their first six months to a net book value of $6.00 and then on a straight-line
basis over three months with no salvage value. 

     Amortization expense as a percentage of revenue 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.

                                       9 of 16

<PAGE>

OPERATING RESULTS

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

                                            Six months ended October 31,
                                            ----------------------------
                                               1995             1996
                                            -----------      -----------
Revenues:
    Rental revenue                              92.2 %           92.1 %
    Service fees                                 1.3              0.7 
    Product sales                                6.5              7.2 
                                            -----------      -----------
Total revenues                                 100.0            100.0

Costs and expenses:
    Store operating expenses                    72.6             78.7
    Selling, general and administrative         12.6             10.4
    Cost of product sales                        4.2              4.2
    Amortization of goodwill                     2.2              1.9
                                            -----------      -----------
Total cost and expenses                         91.6             95.2
                                            -----------      -----------
Operating income                                 8.4              4.8

Other income (expense):
    Interest expense                            (1.0)            (0.8)
    Other income                                 1.4              0.7
                                            -----------      -----------
Total other income (expense)                     0.4             (0.1)
                                            -----------      -----------
Income from operations before income taxes       8.8              4.7
Income tax expense                               3.8              2.0
                                            -----------      -----------
Net income                                       5.0 %            2.7 %
                                            -----------      -----------
                                            -----------      -----------


SIX MONTHS ENDED OCTOBER 31, 1996 COMPARED TO SIX MONTHS ENDED OCTOBER 31, 1995

     RENTAL REVENUE.  Rental revenue was approximately $35,628,000 and 
$14,612,000, or 92.1% and 92.2% of total revenues for the six months ended 
October 31, 1996 and 1995, respectively. The increase in rental revenue of 
$21,016,000 was derived primarily from video stores acquired after the first 
quarter of fiscal 1996 which accounted for approximately $11,289,000 or 53.7% 
of the increase, from the opening of 60 new Company-owned stores since the 
second quarter of fiscal 1996 which accounted for approximately $6,661,000 or 
31.7% of the increase, and from a 7% increase in same store revenues. 

     SERVICE FEES.  Service fees were approximately $284,000 and $203,000, or
 .7% and 1.3% of total revenues for the six months ended October 31, 1996 and
1995, respectively. Continuing service fees and royalties from franchisees
accounted for 89.4% and 100.0% 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. 

                                       10 of 16

<PAGE>

     PRODUCT SALES.  Product sales were approximately $2,775,000 and 
$1,028,000, or 7.2% and 6.5% of total revenues for the six months ended 
October 31, 1996 and 1995, respectively. The increase in product sales of 
$1,747,000 was primarily a result of product sales by the video stores 
acquired after the first quarter of fiscal 1996 which accounted for 
approximately $743,000 or 42.5% of the increase, from the opening of 60 
Company-owned video stores since the second quarter of fiscal 1996 which 
accounted for approximately $294,000 or 16.8% of the increase and from the 
increase in sales of fixed assets to franchisees which accounted for 
approximately $262,000 or 15.0% of the increase.

     STORE OPERATING EXPENSES.  Store operating expenses consist primarily of
compensation and related expenses, occupancy expenses, depreciation and
amortization expenses and regional management expenses. Operating expenses were
approximately $30,426,000 and $11,510,000, or 78.7% and 72.6% of total revenues
for the six months ended October 31, 1996 and 1995, respectively. The increase
in store operating expenses of $18,916,000, was primarily the result of video
stores acquired after the first quarter of fiscal 1996, the opening of 60
Company-owned video stores since the second quarter of fiscal 1996, and an
increase in amortization expense related to videocassettes. The increase in
store operating expenses as a percentage of total revenues was primarily due to
the application of the old amortization method in fiscal 1996 which accounted
for 6.5% of the change, higher initial expenses related to new store openings
prior to revenue reaching maturity during the first year of operations and
additional regional expenses related to developing new markets. 

     Compensation and related expenses were approximately $8,256,000 and
$3,502,000, or 21.3% and 22.1% of total revenues for the six months ended
October 31, 1996 and 1995, respectively. The increase of $4,754,000 was
primarily due to video stores acquired after the first quarter of fiscal 1996
which accounted for approximately $2,582,000 or 54.3% of the increase and from
the opening of 60 Company-owned video stores since the second quarter of fiscal
1996 which accounted for approximately $1,596,000 or 33.6% of the increase. 

     Occupancy expenses were approximately $8,917,000 and $3,378,000, or 23.0%
and 21.3% of total revenues for the six months ended October 31, 1996 and 1995,
respectively. The increase of approximately $5,539,000 was primarily due to
video stores acquired after the first quarter of fiscal 1996, which accounted
for approximately $2,311,000 or 41.7% of the increase and from the opening of
60 Company-owned stores since the second quarter of fiscal 1996 which accounted
for approximately $2,422,000 or 43.7% of the increase. 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 $10,267,000 
and $3,280,000, or 26.5% and 20.7% of total revenues for the six months ended 
October 31, 1996 and 1995, respectively. Depreciation and amortization 
expense reflects the depreciation of store equipment and fixtures and the 
amortization of videocassettes. The increase of $6,987,000 was primarily 
attributable to the addition of new release videocassette inventory for new, 
existing, and acquired stores.  The effect of the application of the new 
method of amortizing videocassettes during the first six months of fiscal 
1996 (six months ended October 31, 1995) would have increased amortization 
expense to approximately $4,304,000 or 27.2% of total revenues.  Amortization 
expense also increased as a percentage of sales in the first six months of 
fiscal 1997 (six months ended October 31, 1996) due to additional tape 
purchases as a percentage of sales for new store openings prior to reaching 
maturity during the first year of operations.  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 $4,022,000 and $2,004,000, or 10.4% and 12.6% of
total revenues for the six months ended October 31, 1996 and 1995, respectively.
The increase of approximately $2,018,000 was primarily due to 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. 

                                       11 of 16

<PAGE>

     COST OF PRODUCT SALES.  Cost of product sales was approximately $1,636,000
and $658,000, or 4.2% of total revenues for the six months ended October 31,
1996 and 1995. The cost of product sales as a percentage of total product sales
revenue was approximately 59.0% and 64.0% for fiscal 1996 and 1995,
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
$743,000 and $346,000 or 1.9% and 2.2% of total revenues for the six months
ended October 31, 1996 and 1995, 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 in fiscal 1996. 

     INTEREST EXPENSE.  Interest expense was approximately $318,000 and
$152,000, or .8% and 1.0% of total revenues for the six months ended October 31,
1996 and 1995, respectively. The increase of $166,000 was primarily attributable
to interest on increased borrowings under the Company's bank line of credit. 

     OTHER INCOME.  Other income was approximately $269,000 and $223,000, or .7%
and 1.4% of total revenues for the six months ended October 31, 1996 and 1995,
respectively. The increase of $46,000 was primarily due to 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 acquisition of existing stores, the opening 
of new superstores, and the purchase of videocassette rental inventory, each 
of which varies based on market conditions and expansion plans.

     At October 31, 1996, the Company had cash and cash equivalents of
approximately $13,790,000.  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, 1996 net cash provided by operating 
activities was approximately $15,945,000. Net cash used in investment 
activities was approximately $23,664,000 consisting primarily of 
approximately $6,329,000 for new and remodeled stores, and approximately 
$17,169,000 for the purchase of videocassette inventory for existing and new 
stores.  Net cash generated from financing activities was approximately 
$20,833,000 resulting primarily from the proceeds of the Company's subsequent 
public offering which was completed in October 1996 and from payments net of 
borrowings on the bank line of credit of approximately $4,100,000. 

     The Company has promissory notes (the "Recourse Notes") from the Company's
Chief Executive Officer and from the President for approximately $1,853,000 and
$1,029,000, respectively, including accrued interest through October 31, 1996. 
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

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<PAGE>

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, 1996, the Company has a note receivable 
from the President of the Company for $30,000 which accrues interest at 8% 
per annum and is due November 1996.  The note represents advances from the 
Company to the President form January 1994 to April 1994, together with 
accrued interest.

     In April 1996, the Company entered into a one-year revolving credit 
facility with Bank of America Illinois (the "Line of Credit") under which the 
Company may borrow up to $10,000,000, with amounts borrowed thereunder 
bearing interest at variable rates based on the federal funds rate, prime 
rate or the interbank Eurodollar rate. The Line of Credit is convertible into 
a two-year term loan if it is not renewed. 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 the 
written consent of Bank of America Illinois (the "Bank") 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.  In August 1996, 
the Bank and the Company entered into an amendment to the Line of Credit, 
effective upon the closing of the Company's subsequent public offering (the 
"Amendment").  The Amendment modified certain net worth covenants relating to 
mergers, acquisitions and purchases and provides that during the term of the 
Line of Credit, the Bank's consent is required for (i) any one transaction or 
series of substantially contemporaneous related transactions involving 
$25,000,000 in consideration and (ii) all transactions in the aggregate 
involving consideration equal to the lessor of $25,000,000 or the net 
proceeds received by the Company from the Company's subsequent public 
offering.  In October, 1996 the Company paid off its line of credit borrowing 
of approximately $9,400,000 with proceeds from the subsequent public offering.

     To the extent that the Company pursues any future acquisitions, the Company
expects to finance such acquisitions from the net proceeds of debt and equity
offerings, with cash from operations, and from borrowings under credit
facilities.

     In connection with six acquisitions in which the Company has issued an
aggregate of 650,613 shares of Class A Common Stock in fiscal 1996, 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 of such shares as of specified dates between
July 1996 and October 1998.  During October 1996, a deficiency payment was made
with regard to one acquisition in the cash amount of $87,135.  As of October 31,
1996, the remaining deficiency payments are estimated to be approximately
$2,600,000 based on the closing stock price at October 31, 1996.  In two of
these acquisitions, the Company has the option of satisfying approximately
$1,300,000 of this liability at October 31, 1996 through the issuance of
approximately 192,000 additional shares of Class A Common Stock.

     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 will be 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.

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<PAGE>

     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.

     The Company believes that the net proceeds of its recent equity offering,
together with its current cash from operations and borrowing capabilities, will
be sufficient to meet its anticipated cash requirements and anticipated growth
over the next twelve months.

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.
























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<PAGE>

PART II - OTHER INFORMATION
---------------------------

ITEM 1.   LEGAL PROCEEDINGS

     A.   In connection with the acquisition of the assets of Talerico
          Enterprises, Inc. and Michael Talerico ("TEI") in October 1995, the
          Company advised TEI of what it believed to be various breaches of
          representations and warranties made by TEI in its asset purchase
          agreement with the Company.  Accordingly, the Company withheld a
          portion of the purchase price, including 55,000 shares of Class A
          Common Stock.  In December 1995, TEI filed an action against the
          Company in Arizona state court for breach of contract (the "Action"). 
          In August 1996, the Company and TEI agreed to settle the disputes
          underlying the Action.  Under the terms of the settlement, the Company
          agreed to pay TEI $225,000 and to issue 40,000 shares of Class A
          Common Stock (the "TEI Common Stock").  TEI has agreed not to sell,
          pledge or encumber any of the TEI Common Stock until April 1997, and
          thereafter not more than 10,000 shares of TEI Common Stock within any
          six month period through August 1998.  The Company has agreed to make
          deficiency payments to TEI (payable in either cash or stock at the
          Company's option) if the aggregate sale proceeds of the TEI Common
          Stock do not equal or exceed $500,000 through arms-length sales at
          different intervals through September 1998.
          
     B.   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.  Although no assurances can be
          given as to the outcome of such action, the Company intends to
          vigorously pursue the matter.

ITEM 5.   OTHER INFORMATION

          None.

ITEM 6.   EXHIBITS AND REPORTS ON FORM 8-K

          A. The following Exhibit is filed herewith:

             Exhibit                    
               No.                     Title
             -------                   -----
               27                 Financial Data Schedule

          B. The Company filed a Current Report on 8-K dated October 22, 
             1996, to report the closing of a public offering.





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<PAGE>

                                      SIGNATURES

     In accordance with the requirements of the Exchange Act, the Registrant 
caused this report to be signed on its behalf by the undersigned, thereunto 
duly authorized.

                                       VIDEO UPDATE, INC.

Date:  December 9, 1996                By:  /S/ DANIEL A. POTTER
                                           -----------------------------------
                                                   DANIEL A. POTTER, 
                                                   Chief Executive Officer and
                                                   Chairman of the Board of 
                                                   Directors


Date:  December 9, 1996                By:  /S/ CHRISTOPHER J. GONDECK
                                           -----------------------------------
                                                   CHRISTOPHER J. GONDECK, 
                                                   Principal Accounting Officer



















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