<PAGE>
 
                                 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 January 31, 1999
 
                                      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)

                                (651) 312-2222
                     ------------------------------------
             (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 March 15, 1999 is 29,278,457.
<PAGE>
 
                              VIDEO UPDATE, INC.

                                     INDEX
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION                                                  PAGE NO.
------------------------------                                                  --------
<S>                                                                             <C>
Item 1.   Financial Statements
 
          Consolidated Balance Sheets - April 30, 1998 and January 31, 1999         3
 
          Consolidated Statements of Operations - Three Months
             and Nine Months Ended January 31, 1998 and January 31, 1999            4
 
          Consolidated Statements of Cash Flows - Nine Months Ended
             January 31, 1998 and January 31, 1999                                  5
 
          Notes to Consolidated Financial Statements - January 31, 1999             6
 
Item 2.   Management's Discussion and Analysis of Financial
             Condition and Results of Operations                                    7
 
PART II - OTHER INFORMATION
---------------------------
 
Item 1.   Legal Proceedings                                                        14
 
Item 6.   Exhibits and Reports on Form 8-K                                         16
 
SIGNATURES                                                                         16
----------
</TABLE>


                                    2 of 16
<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,                           January 31,
                                                                               1998                                 1999
                                                                           -------------                       ---------------
<S>                                                                        <C>                                 <C>
                                                                                                                 (Unaudited)
Cash and cash equivalents                                                      $  1,433                              $    696   
Accounts receivable                                                               4,737                                 4,098   
Inventory                                                                         9,167                                14,043   
Video and game rental inventory -- net                                           97,734                                96,009   
Property and equipment -- net                                                    69,720                                67,138   
Prepaid expenses                                                                  4,162                                 3,663   
Income taxes receivable                                                           2,430                                   307   
Deferred income taxes                                                             2,592                                 2,603   
Goodwill and other intangibles -- net                                            85,360                                83,385   
Other assets                                                                      1,096                                 2,290   
                                                                               --------                              --------
                         Total assets                                          $278,431                              $274,232   
                                                                               ========                              ========   
 
 
                Liabilities and Stockholders' Equity
 
Notes payable                                                                  $104,488                              $116,960
Accounts payable                                                                 39,045                                46,042
Accrued expenses                                                                 12,841                                 9,948
Accrued rent                                                                      5,073                                 7,564
Accrued compensation                                                              7,685                                 7,655
 
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 -- 29,278,457                                     293                                   293
      at April 30,1998 and at January 31, 1999
    Additional paid-in capital                                                  117,641                               116,645
    Retained deficit                                                             (7,674)                              (28,904)
    Foreign currency translation                                                   (961)                               (1,971)
                                                                               --------                              --------
 
                         Total stockholders' equity                             109,299                                86,063
                                                                               --------                              --------
                         Total liabilities and stockholders' equity            $278,431                              $274,232
                                                                               ========                              ========
</TABLE>
                            See accompanying notes.



Note: The balance sheet at April 30, 1998 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
<PAGE>
 
                              Video Update, Inc.
                     Consolidated Statements of Operations
                                  (Unaudited)
                   (In thousands, except per share amounts)


<TABLE>
<CAPTION>
                                                Three Months Ended January 31,            Nine Months Ended January 31,
                                                    1998             1999                     1998            1999
                                                 -----------      ----------               ----------       ----------
<S>                                              <C>              <C>                      <C>               <C>       
Revenues:                                                                                                
    Rental revenue                                  $ 36,530        $ 60,161                  $ 93,494        $168,816
    Product sales                                      5,073          10,281                    11,703          24,962
    Service fees                                         179             250                       522             791
                                                    --------        --------                  --------        --------
                                                      41,782          70,692                   105,719         194,569
                                                                                                         
Costs and expenses:                                                                                      
    Store operating expenses                          31,205          56,549                    84,821         169,614
    Selling, general and                               3,326           5,483                     8,948          16,590
     administrative                                                                                      
    Cost of product sales                              3,095           6,241                     6,946          16,340
    Amortization of intangibles                          626           1,621                     1,867           4,528
                                                    --------        --------                  --------        --------
                                                      38,252          69,894                   102,582         207,072
                                                    --------        --------                  --------        --------
Operating income (loss)                                3,530             798                     3,137         (12,503)
                                                                                                         
Interest expense                                        (747)         (2,967)                   (1,923)         (8,954)
Other income                                             403              46                       827             227
                                                    --------        --------                  --------        --------
                                                        (344)         (2,921)                   (1,096)         (8,727)
                                                    --------        --------                  --------        --------
                                                                                                         
Income (loss) before income taxes                      3,186          (2,123)                    2,041         (21,230)
Income tax expense                                     1,378               -                     1,128               -
                                                    --------        --------                  --------        --------
Net income (loss)                                   $  1,808        $ (2,123)                 $    913        $(21,230)
                                                    ========        ========                  ========        ========           
                                                                                                         
Net income (loss) per share-basic                                                                        
   and diluted                                      $   0.10        $  (0.07)                 $   0.05        $  (0.73)
                                                    ========        ========                  ========        ========           
</TABLE>
                                                                                


                            See accompanying notes.

                                    4 of 16
<PAGE>
 
                              Video Update, Inc.
                     Consolidated Statements of Cash Flows
                                  (Unaudited)
                                (In thousands)

<TABLE>
<CAPTION>
                                                                                      Nine Months Ended January 31,
                                                                                      1998                   1999          
                                                                                    ---------              ---------      
Operating activities                                                                                                      
<S>                                                                                 <C>                     <C>           
    Net income (loss)                                                                $    913               $(21,230)     
    Adjustments to reconcile net income (loss) to net                                                                     
      cash provided by operating activities:                                                                              
        Depreciation and amortization                                                  31,505                 65,767      
        Deferred income taxes                                                           1,086                    (11)     
        Changes in operating assets and liabilities, net                                                                  
          of acquisitions of businesses:                                                                                  
            Accounts receivable                                                            10                    639      
            Inventory                                                                    (663)                (4,876)     
            Income taxes                                                               (1,627)                 2,123      
            Other assets                                                               (2,230)                  (916)     
            Accounts payable                                                           13,016                  6,352      
            Accrued liabilities                                                         2,764                 (1,210)     
         Other operating activities                                                         -                     24      
                                                                                      -------               --------      
Net cash provided by operating activities                                              44,774                 46,662      
                                                                                                                          
Investing activities                                                                                                      
    Purchase of video and game rental inventory                                       (42,638)               (50,964)     
    Purchase of property and equipment                                                (14,312)               (11,578)     
    Investment in businesses, net of cash                                                (610)                  (525)     
     acquired                                                                                                             
    Payment of deficiency on stock guarantee                                           (1,327)                     -      
    Other investing activities                                                           (177)                     -      
                                                                                      -------               --------      
Net cash used in investing activities                                                 (59,064)               (63,067)     
                                                                                                                          
Financing activities                                                                                                      
    Proceeds from notes payable                                                        15,204                 27,300      
    Payments on notes payable                                                          (1,914)               (16,032)     
    Proceeds from sale lease-back                                                           -                  5,000      
    Other financing activities                                                              -                   (600)     
                                                                                      -------               --------      
Net cash provided by financing activities                                              13,290                 15,668      
                                                                                      -------               --------      
Decrease in cash and cash equivalents                                                  (1,000)                  (737)     
Cash and cash equivalents at beginning of the period                                    2,424                  1,433      
                                                                                      -------               --------      
Cash and cash equivalents at end of the period                                        $ 1,424               $    696      
                                                                                      =======               ========      
</TABLE>
                                                                                



                                        
                            See accompanying notes.

                                    5 of 16
<PAGE>
 
                              VIDEO UPDATE, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                               JANUARY 31, 1999
                                  (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 nine months ended January 31, 1999 are
not necessarily indicative of the results that may be expected for the fiscal
year ending April 30, 1999.  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, 1998.

     Reclassification
     Certain prior year items have been reclassified to conform with the fiscal
1999 presentation.

2.   Earnings Per Share

     In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings per Share.  Statement 128
replaced the previously reported primary and fully diluted earnings per share
with basic and diluted earnings per share.  Unlike primary earnings per share,
basic earnings per share excludes any dilutive effect of options, warrants and
convertible securities.  Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share.  All earnings per share
amounts for all periods have been presented, and when necessary, restated to
conform to the Statement 128 requirements.

     The following table is a reconciliation of the basic and diluted earnings
per share computation:

<TABLE>
<CAPTION>
                                                                            Three Months                       Nine Months 
                                                                          Ended January 31,                  Ended January 31,
                                                                      --------------------------        --------------------------
                                                                         1998           1999               1998           1999
                                                                      ------------    ----------        -----------    -----------
                                                                                (In thousands, except per share amounts)
Numerator:
---------
<S>                                                                   <C>             <C>               <C>            <C>          

Numerator for basic and diluted earnings per share--
    net income (loss) available to common stockholders                   $ 1,808        $(2,123)         $   913         $(21,230)
                                                                         =======        =======          =======         ========
Denominator:                                                                        
-----------                                                                         
Denominator for basic earnings per share--weighted-average shares                   
    Class A common shares                                                 18,105         29,278           18,105           29,278
    Class B common shares                                                    700              -              700                -
                                                                         -------        -------          -------         --------
Denominator for basic earnings per share                                  18,805         29,278           18,805           29,278
Effect of dilutive securities:                                                      
     Contingent stock acquisition                                            177              -              177                -
                                                                         -------        -------          -------         --------
Dilutive potential common shares                                             177              -              177                -
                                                                         -------        -------          -------         --------
Denominator for diluted earnings per share--                                        
     adjusted weighted-average shares and assumed conversions             18,982         29,278           18,982           29,278
                                                                         -------        -------          -------         --------
Basic net earnings (loss) per share                                      $  0.10        $ (0.07)         $  0.05         $  (0.73)
                                                                         =======        =======          =======         ========
Diluted net earnings (loss) per share                                    $  0.10        $ (0.07)         $  0.05         $  (0.73)
                                                                         =======        =======          =======         ========
</TABLE>


                                    6 of 16
<PAGE>
 
3.   Comprehensive Income

     As of May 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, Reporting Comprehensive Income (Statement 130).  Statement
130 establishes new rules for the reporting and display of comprehensive income
and its components; however, the adoption of the Statement had no impact on the
Company's net loss or stockholders' equity.  Statement 130 requires unrealized
gains or losses on the Company's foreign currency translation adjustments, which
prior to adoption were reported separately in stockholders' equity to be
included in other comprehensive income.  Prior years' financial statements have
been reclassified to conform to the requirements of Statement 130.  During the
three months ended January  31, 1998 and 1999, total comprehensive income (loss)
amounted to $1,136,000 and $(1,700,000), respectively; and during the nine
months ended January 31, 1998 and 1999, total comprehensive income (loss)
amounted to $52,000 and $ (22,240,000), respectively.

4.   Income Tax Expense

     The Company has estimated that its effective tax rate for fiscal year 1999
will be 0%.  The Company has therefore used this rate in providing for income
taxes in the current quarter and nine months ended January 31, 1999.  The
Company will continue to evaluate and estimate its effective tax rate at the end
of each interim period during fiscal 1999.

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 January 31, 1999 operated 661 Company-owned stores in 32
states and five provinces in Canada, and had 66 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.

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

<TABLE>
<CAPTION>
                            Three Months Ended                   Nine Months Ended
                                January 31,                          January 31,
                      --------------------------------    -----------------------------------
                           1998              1999              1998                1999
                      -------------      -------------    --------------       --------------
                               (In thousands)                        (In thousands)
<S>                   <C>                <C>               <C>                  <C>      
Rental revenue            $ 36,530          $ 60,161          $ 93,494            $168,816
Product sales                5,073            10,281            11,703              24,962
Service fees                   179               250               522                 791
                          --------          --------          --------            --------
    Total Revenues        $ 41,782          $ 70,692          $105,719            $194,569
                          ========          ========          ========            ========
</TABLE>



     Overall revenues, including same store sales, did not meet management
expectations for the first nine months of fiscal 1999, due in significant part
to certain factors, including: (i) a significant number of Moovies locations not
yet performing to management's expectations for the period; and, (ii) the timing
advantage afforded by direct studio revenue sharing arrangements obtained by
some of the Company's largest competitors, including the Blockbuster
Entertainment division of Viacom, Inc. and Hollywood Entertainment Corporation.



                                    7 of 16
<PAGE>
 
     Management is continuing several actions intended to enhance prospects for
profitable revenue growth for fiscal 1999.  The Company successfully converted
all Moovies stores by November 30, 1998.  During the first nine months of fiscal
1999, the Company opened 13 new stores, closed 32 under-performing stores, and
performed significant conversions on seven other stores.  The Company is now
obtaining inventory under five direct revenue sharing arrangements with major
motion picture studios and is pursuing additional direct revenue sharing
arrangements with other studios.

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.

<TABLE>
<CAPTION>
                                                      Three Months Ended January 31,         Nine Months Ended January 31,
                                                    ---------------------------------      ---------------------------------
                                                          1998           1999                     1998           1999
                                                    ---------------   ---------------      ----------------   --------------  
Revenues:
<S>                                                  <C>               <C>                  <C>                <C>
    Rental revenue                                        87.4 %         85.1 %                   88.4 %         86.8 %
    Product sales                                         12.2           14.5                     11.1           12.8
    Service fees                                           0.4            0.4                      0.5            0.4
                                                         -----          -----                    -----          -----
Total revenues                                           100.0          100.0                    100.0          100.0
 
Costs and expenses:
    Store operating expenses                              74.7           80.0                     80.2           87.2
    Selling, general and administrative                    8.0            7.8                      8.5            8.5
    Cost of product sales                                  7.4            8.8                      6.6            8.4
    Amortization of intangibles                            1.5            2.3                      1.7            2.3
                                                         -----          -----                    -----          -----
Total cost and expenses                                   91.6           98.9                     97.0          106.4
                                                         -----          -----                    -----          -----
Operating income (loss)                                    8.4            1.1                      3.0           (6.4)
 
Other income (expense):
    Interest expense                                      (1.8)          (4.2)                    (1.8)          (4.6)
    Other income                                           1.0            0.1                      0.8            0.1
                                                         -----          -----                    -----          -----
Total other income (expense)                              (0.8)          (4.1)                    (1.0)          (4.5)
                                                         -----          -----                    -----          -----
Income (loss) before income taxes                          7.6           (3.0)                     2.0          (10.9)
Income tax expense                                         3.3              -                      1.1              -
                                                         -----          -----                    -----          -----
Net income (loss)                                          4.3 %         (3.0) %                   0.9 %        (10.9) %
                                                        ======          =====                    =====          =====
</TABLE>

Nine Months Ended January 31, 1998 Compared to Nine Months Ended January 31,
1999


     Rental revenue.  Rental revenue was approximately $93,494,000 and
     --------------                                                   
$168,816,000, or 88.4% and 86.8% of total revenues for the nine months ended
January 31, 1998 and 1999, respectively. The increase in rental revenue of
$75,322,000 was derived primarily from the 266 video stores acquired from
Moovies in March 1998 and from a 2% increase in same store revenues.  Rental
revenues did not meet management's expectations for the nine months, primarily
due to the conversion of the Moovies locations in several significant markets,
which was completed during the third quarter, as well as the simultaneous impact
during the period of revenue sharing arrangements and copy title depth obtained
by competitors in markets where the Company's stores are located.  Management
expects that future results will be positively impacted by the operation of all
of the now fully converted Moovies locations.  In addition, the Company is now
obtaining additional videocassette product under five direct revenue sharing
arrangements with 



                                    8 of 16
<PAGE>
 
motion picture studios, allowing it to better compete with larger competitors at
a time when all of its Company-owned locations are now operating under the Video
Update name and operating system.

     Product sales.  Product sales were approximately $11,703,000 and
     -------------                                                   
$24,962,000, or 11.1% and 12.8% of total revenues for the nine months ended
January 31, 1998 and 1999, respectively. The increase in product sales of
$13,259,000 was primarily a result of product sales by the Moovies video stores
acquired in March 1998 and from the sale of videocassettes of the movie
"Titanic".  The increase as a percentage of total revenues was primarily due to
a difference in product mix and high Titanic video sales.

     Service fees.  Service fees were approximately $522,000 and $791,000, or
     ------------                                                             
0.5% and 0.4% of total revenues for the nine months ended January 31, 1998 and
1999, respectively.

     Store operating expenses. Store operating expenses were approximately
     ------------------------                                             
$84,821,000 and $169,614,000, or 80.2% and 87.2% of total revenues for the nine
months ended January 31, 1998 and 1999, respectively. The increase in store
operating expenses of $84,793,000 was primarily the result of the Moovies video
stores acquired in March 1998.  The increase in store operating expenses as a
percentage of total revenues was primarily due to: (i) the timing advantage
resulting from revenue sharing arrangements and copy title depth obtained by
competitors in the markets where the Company's stores were located; (ii)
revenues of a significant number of acquired Moovies locations not yet
performing to management's expectations; and, (iii) corresponding higher costs
of new video stores prior to revenue reaching maturity during the first two
years of operations.  Store operating expenses consist of the following (in
000's):

<TABLE>
<CAPTION>
                                                         Nine Months Ended January 31,        Percent of Revenue
                                                            1998             1999            1998            1999
                                                        -------------     ------------   ------------     -----------
<S>                                                     <C>                <C>            <C>              <C>          
Cost of rental revenue                                     $ 25,218         $ 52,909         23.9%           27.2%
Occupancy expenses                                           27,226           53,657         25.7%           27.6%
Compensation and related benefits                            23,529           45,803         22.3%           23.5%
Furniture, fixtures, and equipment expenses                   4,784            9,518          4.5%            4.9%
Other store operating expenses                                4,064            7,727          3.8%            4.0%
                                                           --------         --------         ----            ----
    Total Store Operating Expenses                         $ 84,821         $169,614         80.2%           87.2%
                                                           ========         ========         ====            ====
</TABLE>

     Cost of rental revenue was approximately $25,218,000 and $52,909,000, or
23.9% and 27.2% of total revenues for the nine months ended January 31, 1998 and
1999, respectively. Cost of rental revenue reflects the amortization of
videocassettes and video games, revenue sharing expenses, and fees paid to
videocassette and video game suppliers.  The increase of $27,691,000 was
primarily attributable to the addition of new release videocassette inventory
for new, existing, and the acquired Moovies locations. Cost of rental revenue 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, revenue sharing arrangements, studio release
schedules and anticipated market demand.

     Occupancy expenses were approximately $27,226,000 and $53,657,000, or 25.7%
and 27.6% of total revenues for the nine months ended January 31, 1998 and 1999,
respectively. The increase of approximately $26,431,000 was primarily due to the
Moovies locations acquired in March 1998.

     Compensation and related benefits were approximately $23,529,000 and
$45,803,000, or 22.3% and 23.5% of total revenues for the nine months ended
January 31, 1998 and 1999, respectively. The increase of approximately
$22,274,000 was primarily due to the Moovies locations acquired in March 1998.

     Selling, general and administrative.  Selling, general and administrative
     -----------------------------------                                      
expenses were approximately  $8,948,000 and $16,590,000, or 8.5% and 8.5% of
total revenues for the nine months ended January 31, 1998 and 1999,
respectively.  The increase of approximately $7,642,000 was primarily due to (i)
additional personnel and related expenses to support the Company's growth; (ii)
outside legal and accounting fees; (iii) upgraded computer and phone systems;
and, (iv) bank service fees related to additional locations.   The Company
anticipates that the 


                                    9 of 16
<PAGE>
 
expense as a percentage of revenues will decline in the next year with the
Moovies locations now integrated into its operations.

     Cost of product sales.  Cost of product sales was approximately $6,946,000
     ---------------------                                                     
and $16,340,000, or 6.6% and 8.4% of total revenues for the nine months ended
January 31, 1998 and 1999. The cost of product sales as a percentage of total
product sales revenue was approximately 59.4% and 65.5% for fiscal 1998 and
1999, respectively.  The increase in the cost of product sales as a percentage
of  product sales was primarily due to the sale of the Titanic video which was
sold at a low margin due to industry competition.

     Amortization of intangibles.  Amortization of intangibles was approximately
     ---------------------------                                                
$1,867,000 and $4,528,000 for the nine months ended January 31, 1998 and 1999,
respectively. The increase was primarily attributable to the acquisition of
Moovies in March 1998.

     Interest expense.  Interest expense was approximately $1,923,000 and
     ----------------                                                    
$8,954,000, or 1.8% and 4.6% of total revenues for the nine months ended January
31, 1998 and 1999, respectively. The increase of $7,031,000 was primarily
attributable to interest on increased borrowings under the Company's Senior
Facility (as defined below).

     Other income.  Other income was approximately $827,000 and $227,000 for the
     ------------                                                               
nine months ended January 31, 1998 and 1999, respectively.

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 and the
purchase of video and game rental inventory, each of which varies based on
market conditions, expansion plans and conversion of the acquired Moovies
stores.

     At January 31, 1999, the Company had cash and cash equivalents of
approximately $696,000.  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 video and game 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 video and game 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 videos and games.

     For the nine months ended January 31, 1999 net cash provided by operating
activities was approximately $46,662,000.  Net cash used in investment
activities was approximately $63,067,000 consisting primarily of approximately
$50,964,000 for the purchase of video and game rental inventory for existing and
new stores and approximately $11,578,000 for new and remodeled stores, and
conversion costs associated with acquired stores.  Net cash generated from
financing activities was approximately $15,668,000 resulting primarily from
proceeds under the Company's Senior Facility (as defined below) and a
sale/leaseback arrangement.

  In March 1998 the Company completed the acquisition of Moovies, Inc. The
Company issued approximately 9.3 million shares of Class A Common Stock in
exchange for Moovies common stock. The transaction was treated as a tax-free
exchange for federal income tax purposes and recorded under the purchase method
of accounting.

  Simultaneous with the closing of the Moovies transaction, the Company
announced that a syndicate led by Banque Paribas (the "Senior Facility Lenders")
had extended it a $120 million credit/term loan facility (the "Senior
Facility") which was subsequently amended during the second and third quarters
of fiscal 1999.  This Senior Facility replaced the Company's previous line of
credit. The Senior Facility, as amended in the second quarter, consists of the
following: (i) two term loans totaling $95.0 million; (ii) a $15.0 million
capital expenditure line; and, (iii) a $5.0 million revolving line, reduced from
$10.0 million.  The Company borrowed the $95.0 million of the two term loans in
conjunction with the closing of the Moovies merger and the proceeds were used
to: (i) refinance approximately $35,000,000 of outstanding indebtedness
including accrued interest under the Company's previous line of credit; (ii)
refinance approximately $50,000,000 of indebtedness of Moovies under Moovies'
previous credit agreement; and, 

                                   10 of 16
<PAGE>
 
(iii) pay transaction fees and expenses relating to the Moovies merger of
approximately $10,000,000, (including legal fees, accounting fees, and
registration fees). The capital expenditure line is available to fund the
conversion of the acquired Moovies stores and integration costs, the opening of
new stores, working capital needs, and selected acquisitions. As of January 31,
1999, the Company had $15.0 million outstanding under this facility. The
revolving line is available for normal working capital needs. As of January 31,
1999; the Company had $5.0 million outstanding under this facility.

     Amounts borrowed under the Senior Facility bear interest at variable rates
based on the "base rate" (i.e. the higher of the federal funds rate, plus  1/2
of 1% or the prime commercial lending rate) or the interbank Eurodollar rate
(approximately 7.75% and 4.88% per annum, respectively as of January 29, 1999)
plus an applicable margin rate that could range from 2.75% to 4.5%. Amounts
outstanding at January 31, 1999 had a weighted average rate of 9.35%.

     The Senior Facility includes negative, affirmative and financial covenants
including, but not limited to, minimum pretax earnings, minimum free cash flow,
minimum net worth, maximum indebtedness, maximum leverage, minimum fixed charge
coverage, minimum revenue, a prohibition or restriction on capital expenditures,
debt and guarantees, liens and encumbrances on any property, mergers,
consolidations, investments, advances, divestitures, change of business or
conduct of business, joint ventures, partnerships, the creation of new
subsidiaries, dividends, distributions, repurchases or redemptions of
outstanding stock (including options or warrants), the voluntary prepayment,
repurchase redemption or defeasance of debt, and the acquisition, sale or
transfer, lease or sale-leaseback of assets. The Senior Facility is secured by
substantially all of the Company's assets as well as by pledges of its stock in
its subsidiaries, which subsidiaries also have provided guarantees of the
Company's obligations.

     As a result of its expected results for the first quarter of fiscal 1999,
the Company sought and obtained certain waivers under the Senior Facility for
the quarter ended July 31, 1998. During the second quarter of fiscal 1999, the
Company and the bank syndicate amended the terms of the Senior Facility to,
among other things: (i) reduced the Senior Facility from $120 million to $115
million; (ii) revise certain financial covenants; (iii) modify the terms of the
capital expenditure line to allow usage for working capital needs; (iv) increase
the overall interest rate by 0.5%; and, (v) reprice warrants held by the bank
syndicate to a more current market price. As a result of its operations for the
second quarter of fiscal 1999, the Company was not in compliance with certain
financial covenants under the Senior Facility at the end of the second quarter
but has since received a waiver and is in compliance with the amended covenants
for the quarter ended January 31, 1999. In January and March 1999, the Company
and the Senior Facility Lenders amended the terms of the Senior Facility to,
among other things: (i) revise certain financial covenants; (ii) increase the
overall interest rate by 0.25%; and, (iii) defer the January 31, 1999 principal
payments to April 30, 1999. In connection with the waiver and amendments under
the Senior Facility, the Company has agreed to seek additional junior financing,
including but not limited to a subordinated debt financing, of at least $15
million in gross proceeds on or before May 31, 1999, with the proceeds of such
financing to be used for working capital and possible expansion. The Company is
working towards obtaining a commitment for such financing, the form and
structure of which must be satisfactory to the Senior Facility Lenders, but no
assurances can be given that such a financing can be completed: (i) on terms
that are satisfactory to the Company and the Senior Facility Lenders, or (ii) on
a timely basis, if at all. Failure to obtain the additional junior financing on
a timely basis could cause the Company to incur increased interest rates and
fees and to be in default under the Senior Facility. The Company intends to seek
additional deferrals of principal payments due April 30, 1999 under the Senior
Facility. Moreover, no assurances can be given that future waivers, deferrals,
or amendments will be obtained if the Company is unable to maintain a level of
operations necessary to meet the covenants and requirements of the Senior
Facility. If the Company is unable to maintain such a level of operations, it
will be required to reduce its overall expenditures and expansion plans to
comply with the covenants and requirements of the Senior Facility. Additionally,
any failure by the Company to maintain its level of operations within the
covenants and requirements of the Senior Facility could cause the Company to be
in default thereunder, allowing the lenders to take legal action against the
Company, including but not limited to, the immediate acceleration of payment of
borrowed funds, which could materially and adversely affect the Company's
operations. The immediate acceleration of debt thereunder or the lack of further
borrowing capacity, in whole or in part, would have a material adverse effect on
the Company's operations and financial condition.

  In November 1998, the Company entered into a sale/leaseback arrangement with
respect to certain of its furniture, fixtures, equipment and signage used in
selected retail locations.  Under the arrangement the Company obtained
approximately $5.0 million.


                                   11 of 16
<PAGE>
 
     During the remainder of fiscal 1999, the Company expects to continue its
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 has maintained a longstanding and
satisfactory relationship with its primary product vendors and has negotiated
extended payment terms with several of these vendors. The loss of its primary
product vendors could have a material adverse effect on the Company. In addition
to such traditional product purchase relationships, the Company also recently
entered into five direct revenue sharing arrangements with major motion picture
studios, which agreements allow the Company to obtain videocassette rental
product directly from the studios under arrangements that involve a sharing of
revenues over the first months of the release of a movie title on videocassette.
The Company expects that such arrangements will allow its locations to offer a
greater number of titles and copies of new releases than it would have obtained
under traditional inventory purchasing arrangements, allowing it to lower the
cost of inventory and compete better with larger competitors as well as
independently owned locations. Given that the Company has recently entered into
such revenue sharing arrangements, no assurances can be given as to the impact
on the Company's operations or that such arrangements will allow the Company to
achieve its intended results.

     Assuming the Company is able to maintain a satisfactory relationship with
its selected vendors and its bank lenders, the Company expects that cash from
operations, trade credits, equipment leases, available revenue sharing
arrangements, and available borrowing under the Senior Facility will be
sufficient to fund future inventory purchases and other working capital needs
for the next twelve months, although 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 the Senior Facility as a result of disappointing operating
results, or unanticipated cash needs or opportunities. In fact, in connection
with the waiver and amendments under the Senior Facility, the Company has agreed
to seek additional junior financing, including but not limited to a subordinated
debt financing, of at least $15 million in gross proceeds on or before May 31,
1999, with the proceeds of such financing to be used for working capital and
possible expansion. The Company is working towards obtaining a commitment for
such a financing, the form and structure of which must be satisfactory to the
Senior Facility Lenders, but no assurances can be given that such a financing
can be completed: (i) on terms that are satisfactory to the Company and the
Senior Facility Lenders, or (ii) on a timely basis, if at all. Failure to obtain
the additional junior financing on a timely basis could cause the Company to
incur increased interest rates and fees and to be in default under the Senior
Facility. Moreover, 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.

     Daniel A. Potter, the Company's Chief Executive Officer and John Bedard,
the Company's President, have issued notes to the Company (the "Recourse
Notes") in connection with stock option exercises, for approximately $2,080,147
and $1,155,637, respectively, including accrued interest through April 30, 1998.
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
the 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 evidenced by promissory notes bearing accrued interest at a
rate of 8% per annum (through April 30, 1998) with payment of principal and
interest due on October 4, 1999. 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 connection with restated employment agreements for Mr. Potter and Mr.
Bedard, the Board has approved an accrual of bonuses that will be directed
primarily to satisfying obligations arising from the Recourse Notes. For fiscal
year 1998, bonus payments aggregating $816,580 were awarded as reimbursement of
previous payments of principal and interest on the recourse notes and
accompanying tax liability to the recipients. In addition, the Board has
approved the subsequent payment of additional aggregate bonuses of approximately
$6,345,000 to be used primarily to satisfy the Recourse Notes as well as the
anticipated income tax liabilities to these executives, subject to any required
approval of the Company's bank lenders. If such bonuses are not effected, the
Recourse Notes will remain outstanding.

     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 

                                   12 of 16
<PAGE>
 
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
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. 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, 1998.


Year 2000 Compliance

     The year 2000 issue is the result of computer programs that were written
using two digits rather than four to define the applicable year.  For example,
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000.  To the extent that the
Company's (and its vendors' and suppliers') software applications contain source
code that is unable to interpret appropriately the upcoming calendar year 2000
and beyond, some level of modification or replacement of such applications will
be necessary to avoid system failures and the temporary inability to process
transactions or engage in other normal business activities.

     The Company's information services group has been coordinating the
Company's internal year 2000 compliance efforts and has identified all computer-
based systems and applications (including embedded systems) the Company uses in
its operations that might not be year 2000 compliant.  The Company is
determining what modifications or replacements will be necessary to achieve
compliance; implementing any necessary modifications and replacements;
conducting tests necessary to verify that the modified systems are operational;
and transitioning the compliant systems into the regular operations of the
Company.  The Company estimates that these actions with respect to systems that
it believes would have a material effect on the business are approximately 70%
complete.  The Company estimates that all critical systems and applications will
be year 2000 compliant by June 1999.

     The Company is also examining its relationship with certain key outside
vendors, suppliers, and others with whom the Company has significant business
relationships to determine, to the extent practical, the degree of such outside
parties' year 2000 compliance.  The Company has been contacting such outside
parties and attempting to seek assurances that such parties will be year 2000
compliant.  The Company does not believe that its relationships with any single
third party is material to the Company's operations and, therefore, does not
believe that the failure of any single third party to be year 2000 compliant
would have a material adverse effect on the Company.  The Company believes that
if it, or any third party with whom the Company has a significant business
relationship, has a year 2000 related systems failure, the most significant
impact would likely be the inability, with respect to a store or group of
stores, to conduct operations due to a power failure, to deliver inventory in a
timely fashion, to receive certain products from vendors or to process
electronically customer sales at the store level.  The Company does not
anticipate that any such impact would be material to the Company's liquidity or
results of operations.

     The Company is establishing and implementing a contingency plan to provide
for viable alternatives to ensure that the Company's core business operations
are able to continue in the event of a year 2000 related systems failure.  The
Company expects to have a comprehensive contingency plan established by October
1999.  If the Company's systems are not sufficiently year 2000 compliant by the
end of calendar year 1999 or if the Company does not have an appropriate
contingency plan in place at that time, the Company's business, financial
condition and results of operations may be materially and adversely affected.
Such adverse effects may include, but may not be limited to, the ability to
manage store operations, collect revenues from customers, supply stores with
inventory, make payments to vendors and suppliers, remit wages to employees, and
conduct other essential business-related activities.

     Through January 31, 1999, the Company has expended approximately $371,200
to address year 2000 compliance issues.  The Company estimates that it will
incur an additional $2,323,900 for a total of approximately $2,695,100 to
address year 2000 compliance issues, which includes the estimated costs of all
modifications, testing and consultant fees.


                                   13 of 16
<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 and game 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. The Company initiated an action in
federal district court in Minnesota for a declaratory judgment that the
Videoland Sellers are not entitled to any deficiency payment in light of the
failure by such sellers to comply with the lockup or sale restrictions. In
January, 1998, the court entered a judgment against Video Update in the amount
of $1,220,403 plus interest from October, 1996, and attorney's fees.  The
Company believes it has meritorious grounds for its appeal, which is currently
pending.  The foregoing description is qualified in its entirety by reference to
the full text of the complaint and papers on file in the action (Case No. 3-96-
735).

     In May, 1998, Rousnam Video, Inc., a Michigan corporation and Hani (Al)
Monsour (collectively "Monsour") filed a lawsuit in state court (Macomb County
Michigan) claiming amounts due pursuant to post-closing adjustments contemplated
in connection with an Asset Purchase Agreement among Monsour and Moovies, Inc.
dated as of March 14, 1997, and the alleged default on a Promissory Note among
Monsour and Moovies, Inc. in the amount of $2,000,000 which is currently
reflected in notes payable. The trial court has ruled in favor of the plaintiffs
on a motion for summary judgment, and a judgment for $2,370,195 has been entered
against the Company. The Company believes it has meritorious grounds for its
appeal which is currently pending, although assurances cannot be given as to the
outcome of such action. The foregoing description is qualified in its entirety
by reference to the full text of the complaint and papers on file in the action
(Case No. 98-1998-CK).

     In May, 1998, four stockholders filed suit in the US District Court for the
Central District of California. The Plaintiff stockholders allege that Mr.
Potter and the Company made false and misleading statements or omitted material
information about the Company and the video industry during the period April,
1995 to September, 1996, the date of its subsequent public offering. Plaintiffs
are seeking "at least the sum of $967,967," plus interest, additional damages
and attorneys' fees. The Company and Mr. Potter believe that the claims are
unsubstantiated, without merit and they intend to defend the matter vigorously.
A motion to dismiss the First Amended Complaint was granted, but the court
allowed Plaintiffs to re-file. At present, the Second Amended Complaint has been
filed.  
                                   14 of 16
<PAGE>

     The Company has filed a renewed motion to dismiss.  The foregoing
description is qualified in its entirety by reference to the full text of the
complaint and papers on file in the action (Case No. SACV 98-415 GLT-ANx).
 
     In August, 1998, the Company filed suit in federal court in Oregon against
Rentrak Corporation, an Oregon Corporation.  The Company alleges that Rentrak
has violated the federal antitrust law, given Rentrak's position in the market
and its exercise of monopoly power.  Rentrak's motion for summary judgment on
the Company's antitrust claims was denied last month, with discovery in the
matter now set for at least the next six months.  The federal court also
rejected Rentrak's motion for $4.4 million in fees and interest, which had been
interposed as a counterclaim by Rentrak after the Company initiated its
antitrust claims.  Rentrak has indicated that it intends to renew its motions
following discovery and to pursue its claims against the Company.  The Company
intends to pursue its claims aggressively, although assurances cannot be given
as to the outcome of this matter.  The foregoing description is qualified in its
entirety by reference to the full text of the complaint and papers on file in
the action (Case No. CV 98-1013-HA)
 
     In addition to the above, the Company is involved in various legal
proceedings arising during the normal course of conducting business. Management
believes that the resolution of these proceedings will not have any material
adverse impact on the Company's financial statements.

                                   15 of 16
<PAGE>
 
Item 6.   Exhibits and Reports on Form 8-K

          A.  Exhibits.  The following exhibits are filed herewith:
              ---------                                            

              Exhibit No.    Title
              -----------    -----

                  10.1     Third Amendment to Credit Agreement

                  10.2     Fourth Amendment to Credit Agreement

                  10.3     Fifth Amendment to Credit Agreement

                  27       Financial Data Schedule



          B.  Reports on Form 8-K.
              --------------------

              A report on Form 8-K dated January 25, 1999 was filed by the
              Company on February 3, 1999.




                                  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:  March 17, 1999:          By:  /s/Daniel A. Potter
                                   -----------------------------------------
                                         Daniel A. Potter,
                                         Chief Executive Officer and
                                         Chairman of the Board of Directors


Date:  March 17, 1999:          By:  /s/Dale E. Lauwagie
                                   -----------------------------------------
                                         Dale E. Lauwagie
                                         Chief Financial Officer


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