<PAGE> 1

                                  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 : June 30, 1999

                                       or

             [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                        For the transition period from to


                         Commission File Number: 0-23753


                                   CDnow, Inc.
             (Exact name of registrant as specified in its charter)


             Pennsylvania                                23-2979814
    (State or other jurisdiction of         (I.R.S. Employer Identification No.)
     incorporation of organization)


                 1005 Virginia Drive, Fort Washington, PA 19034
              (Address of principal executive offices and Zip Code)

                                 (215) 619-9900
              (Registrant's telephone number, including area code)

                 (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 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 [ ]

Indicate the number of shares outstanding of each of the registrant's classes of
common stock as of August 9, 1999:  30,266,710  shares of common  stock,  no par
value

<PAGE> 2

                                   CDnow, Inc.

                                      INDEX




Part I -  Financial Information

Item 1.   Financial Statements                                              Page

Unaudited Consolidated Balance Sheets as of June 30, 1999 and
December 31, 1998..............................................................3

Unaudited Consolidated Statements of Operations for the three and six months
ended June 30, 1999 and 1998...................................................4

Unaudited Consolidated Statements of Cash Flows for the six months ended
June 30, 1999 and 1998.........................................................5

Notes to Unaudited Consolidated Financial Statements...........................6


Item 2.   Management's Discussion and Analysis of Financial Condition
          and Results of Operations...........................................10


Item 3.   Quantitative and Qualitative Disclosures About Market Risk..........18

Part II - Other Information

          ITEM 1. Legal Proceedings...........................................19
          ITEM 2. Changes in Securities and Use of Proceeds...................20
          ITEM 3. Defaults Upon Senior Securities.............................20
          ITEM 4. Submission of Matters to a Vote of Security Holders.........20
          ITEM 5. Other Information...........................................20
          ITEM 6. Exhibits and Reports on Form 8-K............................20

Signatures      ..............................................................21


<PAGE> 3

                                     PART I.
                              FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS


                          CDNOW, INC. AND SUBSIDIARIES
                      UNAUDITED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>


                                                                   June 30, 1999      December 31, 1998
                                                                 -----------------    -----------------
                                     ASSETS
                                     ------
<C>                                                              <S>                  <S>
CURRENT ASSETS:
  Cash and cash equivalents                                        $ 41,928,290         $ 49,041,370
  Accounts receivable (net of reserves of $738,807 and $299,991)      4,126,885              839,672
  Prepaid expenses and other                                          9,991,392            8,322,889
                                                                 -----------------    -----------------
    Total current assets                                             56,046,567           58,203,931
                                                                 -----------------    -----------------
  Property and equipment, net                                        16,451,332            6,643,995
  Goodwill and other intangibles, net                                85,897,634              833,735
  Other assets                                                        2,062,782            3,361,982
                                                                 -----------------    -----------------
                                                                   $160,458,315         $ 69,043,643
                                                                 =================    =================


                      LIABILITIES AND STOCKHOLDERS' EQUITY
                      ------------------------------------

CURRENT LIABILITIES:
  Current portion of long term debt                                $  1,316,860         $    822,043
  Accounts payable                                                   19,844,678           10,306,323
  Accrued merger costs                                                4,801,119                   --
  Accrued expenses and other current liabilities                     16,570,593            4,667,395
                                                                 -----------------    -----------------
    Total current liabilities                                        42,533,250           15,795,761
                                                                 -----------------    -----------------

Long term debt                                                        1,992,417            1,750,892
Common stock subject to put rights                                    2,999,995                   --
Deferred rent liabilities                                               873,954              358,053

COMMITMENTS AND CONTINGENCIES (Note 4)
STOCKHOLDERS' EQUITY:
Preferred Stock, no par value, 50,000,000 and 20,000,000
  shares authorized, no shares issued and outstanding
Common stock, no par value, 200,000,000 and 50,000,000
  shares authorized, 30,149,867 and 17,842,975 issued
  and outstanding                                                   204,250,328          102,137,536
Additional paid-in capital                                           13,853,623            4,325,817
Deferred compensation                                                  (110,676)            (216,913)
Accumulated deficit                                                (105,934,576)         (55,107,503)
                                                                 -----------------    -----------------
    Total stockholders' equity                                      112,058,699           51,138,937
                                                                 -----------------    -----------------
                                                                   $160,458,315         $ 69,043,643
                                                                 =================    =================
</TABLE>

        The accompanying notes are an integral part of these statements.

<PAGE> 4


                          CDNOW, INC. AND SUBSIDIARIES
                 UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>

                                                   Three Months Ended June 30,      Six Months Ended June 30,
                                                  -----------------------------   -----------------------------
                                                      1999            1998            1999            1998
                                                  -------------   -------------   -------------   -------------
<S>                                               <C>             <C>             <C>             <C>
Net sales                                         $ 34,616,244    $ 11,610,141    $ 57,459,113    $ 21,624,030
Cost of sales                                       28,000,743       9,290,241      45,984,318      17,568,588
                                                  -------------   -------------   -------------   -------------
    Gross profit                                     6,615,501       2,319,900      11,474,795       4,055,442

Operating expenses:
  Operating and development                          5,827,207       1,684,665       9,553,389       2,765,714
  Sales and marketing                               21,680,005       9,293,703      39,731,187      18,355,629
  General and administrative                         3,362,400         855,074       4,733,756       1,705,359
  Amortization of goodwill and other intangibles     8,144,055          28,800       9,481,681          28,800
                                                  -------------   -------------   -------------   -------------
    Total operating expenses                        39,013,667      11,862,242      63,500,013      22,855,502

  Operating loss                                   (32,398,166)     (9,542,342)    (52,025,218)    (18,800,060)
                                                  -------------   -------------   -------------   -------------
Interest and other income                              766,131         722,012       1,394,253       1,228,051
Interest expense                                       (88,242)        (48,400)       (192,862)       (494,914)
                                                  -------------   -------------   -------------   -------------
Net loss                                           (31,720,277)     (8,868,730)    (50,823,827)    (18,066,923)
                                                  -------------   -------------   -------------   -------------

Accretion of preferred stock to redemption value            --              --              --        (115,542)

Net loss applicable to common shareholders        $(31,720,277)   $ (8,868,730)   $(50,823,827)   $(18,182,465)
                                                  =============   =============   =============   =============

Basic and diluted loss per common share:
  Net loss per common share                       $      (1.06)   $      (0.55)   $      (2.04)   $      (1.29)
                                                  =============   =============   =============   =============
Weighted average number of shares outstanding       30,038,908      16,074,787      24,960,940      14,044,939
                                                  =============   =============   =============   =============
</TABLE>

        The accompanying notes are an integral part of these statements.

<PAGE> 5

                           CDNOW, INC AND SUBSIDIARIES
                 UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>

                                                             Six Months Ended June 30,
                                                          -------------------------------
                                                               1999            1998
                                                          --------------   --------------
<C>                                                       <S>              <S>
Operating Activities:
  Net loss                                                $ (50,823,827)   $ (18,066,923)
  Adjustments to reconcile net loss to
    net cash used in operating activities:
      Depreciation and amortization                          12,124,299          750,610
      Common Stock options issued to non-employees               31,979               --

  Increase in operating assets and liabilities:
      Accounts receivable                                    (1,785,111)           2,661
      Prepaid expenses and other                              5,193,536       (1,597,421)
      Accounts payable                                        4,496,676       (5,549,024)
      Accrued expenses                                         (735,214)         902,594
      Deferred revenue                                          225,385         (105,266)
      Deferred rent liability                                   515,901           89,166
                                                          --------------   --------------
    Net cash used in operating activities                   (30,756,376)     (23,573,603)
                                                          --------------   --------------
Investing Activities:
  Sales and maturities of short-term investments                     --        1,003,045
  Purchases of property and equipment                        (1,633,771)      (1,637,206)
  Net cash acquired in (used in) acquisition                 25,266,787         (423,694)
                                                          --------------   --------------
    Net cash provided by (used in) investing activities      23,633,016       (1,057,855)
                                                          ==============   ==============
Financing Activities:
  Payments on term loans payable                                (29,310)         (25,139)
  Repayment of Series A Notes and warrants                           --       (5,777,500)
  Repayment of advances due to related parties                       --           (3,261)
  Payments on capitalized lease obligations                    (481,712)        (176,476)
  Proceeds from warrants exercised                              102,352           59,890
  Proceeds from options exercised                               418,950           80,706
  Proceeds from issuance of Common stock, net                        --       67,077,862
                                                          --------------   --------------
    Net cash provided by financing activities                    10,280       61,236,082
                                                          --------------   --------------
Increase (decrease) in cash and cash equivalents             (7,113,080)      36,604,624
Cash and cash equivalents, beginning of period               49,041,370       10,686,001
                                                          --------------   --------------
Cash and cash equivalents, end of period                  $  41,928,290    $  47,290,625
                                                          ==============   ==============
</TABLE>

        The accompanying notes are an integral part of these statements.

<PAGE> 6

                          CDNOW, INC AND SUBSIDIARIES.
              NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


NOTE 1 -- BASIS OF PRESENTATION

The accompanying  unaudited  consolidated  financial statements are presented in
accordance  with the  requirements  for Form  10-Q  and do not  include  all the
disclosures  required by generally accepted  accounting  principles for complete
financial  statements.  Reference  should be made to the Form 10-K as of and for
the year ended  December  31, 1998 for CDnow,  Inc.  and its  subsidiaries  (the
"Company")  for  additional  disclosures  including  a summary of the  Company's
accounting policies.

In the opinion of management,  the consolidated financial statements contain all
adjustments,  consisting of normal recurring  adjustments,  necessary to present
fairly the  consolidated  financial  position  of the  Company  for the  periods
presented. The interim operating results of the Company may not be indicative of
operating  results  for the full year or for any  other  interim  period  due to
seasonality and other factors.

NOTE 2 -- THE COMPANY

The Company is one of the leading electronic  commerce retailers of pre-recorded
music,   including  compact  discs  ("CDs"),  and  other   entertainment-related
products.  The Company is also a source of  entertainment-related  content and a
focal point of an Internet  community for the exchange of  entertainment-related
news and  information.  The  Company's  revenues  are  derived  from the sale of
pre-recorded music, other entertainment-related  products and advertising on the
Company's  cdnow.com  site.  The  Company  contracts  with  outside  vendors for
fulfillment services to deliver its products to customers.

Since  inception  (February  12,  1994),  the Company has  incurred  significant
losses,  and as of June 30, 1999 had accumulated  losses of $105.9 million.  For
the six months ended June 30, 1999 and the year ended  December  31,  1998,  the
Company's net losses were $50.8  million and $43.9  million,  respectively.  The
Company  intends to  continue  investing  heavily in  marketing  and  promotion,
Internet site development and technology,  and development of its administrative
organization.  As a result,  the  Company  believes  it will  continue  to incur
substantial operating losses for the foreseeable future. Because the Company has
relatively  low product gross  margins,  achieving  profitability  given planned
spending  levels  depends  upon the  Company's  ability to generate  and sustain
substantially  increased  revenue and gross  margins.  There can be no assurance
that the Company will be able to generate  sufficient  revenues or gross margins
to achieve or sustain profitability in the future.

On October 22, 1998, CDnow and N2K Inc., a Delaware corporation, entered into an
Agreement and Plan of Merger (the "Merger Agreement"). The parties created a new
public  company,  initially  named  CDnow/N2K,  Inc.  ("CDnow/N2K").  The Merger
Agreement provided for the merger (the "Merger") of wholly-owned subsidiaries of
CDnow/N2K  into each of CDnow and N2K.  CDnow and N2K  survived  the  Merger and
became wholly-owned  subsidiaries of CDnow/N2K.  In the Merger, each outstanding
share of common stock of CDnow was  converted  into one share of  CDnow/N2K  and
each  outstanding  share of common stock of N2K was converted into .83 shares of
CDnow/N2K. As a result, the shareholders of CDnow owned approximately 60% of the
combined  company and the  stockholders  of N2K owned  approximately  40% of the
combined company as of the date the Merger was completed on March 17, 1999. Also
on the Merger completion date, CDnow/N2K was renamed CDnow, Inc.

On July 13, 1999, the Company announced the execution of a definitive  agreement
with Sony  Corporation  of America and Time  Warner Inc. to merge with  Columbia
House,  the leading  club-based  direct  marketer of music and videos,  which is
owned equally by Sony  Corporation  and Time Warner Inc. The agreement  provides

<PAGE> 7

for the  formation  of a new public  company to be owned 37 percent each by Sony
and  Time  Warner.  CDnow's  existing  stockholders  will own the  remaining  26
percent. Consummation of the merger is subject to various conditions, including,
but not limited to,  approval by the  shareholders  of the Company.  The Company
expects the merger to be completed during the fourth quarter of 1999.

NOTE 3 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation.  The consolidated  financial statements include the
accounts of the Company and its wholly  owned  subsidiaries.  All  inter-company
balances and transactions have been eliminated in consolidation.

Reclassifications.  The consolidated financial statements for prior periods have
been reclassified to conform with the current period's presentation.

Management's  Use of  Estimates.  The  preparation  of financial  statements  in
conformity with generally accepted accounting  principles requires management to
make estimates and  assumptions  that affect the reported  amounts of assets and
liabilities,  disclosure of contingent assets and liabilities at the date of the
financial  statements and the reported  amounts of revenues and expenses  during
the reporting period. Actual results could differ from those estimates.

Net Loss Per Common Share.  The Company has presented net loss per share amounts
for the three and six month  periods  ended June 30,  1999 and 1998  pursuant to
Statement of Financial  Accounting  Standards  ("SFAS")  No. 128  "Earnings  per
Share" and the Securities and Exchange  Commission Staff Accounting Bulletin No.
98.

Basic and diluted loss per share was computed by dividing net loss applicable to
common  shareholders  by the weighted  average  number of shares of Common stock
outstanding  during  the  three and six  months  ended  June 30,  1999 and 1998.
Diluted loss per share is the same amount as basic  earnings  per share  because
the impact on loss per share using the treasury  stock  method is  anti-dilutive
due to the Company's losses.

Cash and Cash  Equivalents.  For the purposes of the consolidated  balance sheet
and statement of cash flows, the Company considers  investment  instruments with
an  original  maturity  of three  months  or less to be cash  equivalents.  Cash
equivalents  are  comprised of  investments  in money market  funds,  government
mortgage backed bonds and highly rated corporate securities.

Common Stock Subject to Put Rights.  America Online,  Inc.  ("AOL") and N2K Inc.
("N2K"),  a  predecessor-in-interest  to and, as of the merger of CDnow and N2K,
which  occurred on March 17, 1999, a wholly-owned  subsidiary of CDnow,  entered
into an  agreement,  pursuant  to which AOL agreed to  purchase  from N2K at its
initial public offering price per share of $19.00 (less  underwriting  discounts
and commissions) an aggregate  amount of  approximately  $3.0 million or 169,779
shares of N2K's Common stock (the "AOL Purchase"). Subsequent to the Merger, the
price per  share  converted  to $22.89  and the  number of shares  converted  to
140,916  shares of CDnow common  stock.  N2K granted AOL certain shelf and other
registration  rights  with  respect  to the shares  purchased  by AOL in the AOL
Purchase, including the right to require N2K to register such shares for resale,
to have such registration  statement  declared  effective on or before April 16,
1998 and to maintain the  effectiveness  of such  registration  statement  for a
period of two years from the  consummation  of the AOL Purchase.  As N2K had not
caused such registration  statement to be declared  effective by April 16, 1998,
AOL has the right to require the Company, as a successor-in-interest  to N2K, to
repurchase  such shares for cash at a price equal to the greater of the original
purchase price or the then-current fair market value. Accordingly,  the value of
these shares is not included in Stockholders'  equity.  The fair market value of
the Company's  common stock as of August 4, 1999 was $16.25 per common share. As
of  August  4,  1999,  these  shares  had not  been  registered  and AOL had not
exercised its put right. The Common stock subject to put rights on the Company's
consolidated balance sheets will be accreted to its fair market value based upon
the price of the Company's  stock at each reporting  date. The fair market value
will be  recorded as a charge to retained  earnings at each  reporting  date and
will reduce  earnings  available to Common  shareholders.  As of August 4, 1999,
there was no charge as the market value of the  Company's  common stock is below
$22.89 per Common share.

<PAGE> 8

Revenue  Recognition.  Net sales,  which consist primarily of pre-recorded music
sold via the Internet,  include  shipping and handling  charged to customers and
are recognized when the products are shipped.  The Company records a reserve for
estimated returns, which is based on historical return rates. Revenues for sales
of advertising on the Company's  cdnow.com site are recognized as advertising is
run.

Operating and Development  Expense.  Operating and development  expense consists
primarily  of  payroll  and  related  expenses  for  store  management,  design,
development and network  operations  personnel,  systems and  telecommunications
infrastructure  and royalties paid by the Company on product sales in return for
licensing of ratings, reviews, sound samples and other information.

Sales and Marketing  Expense.  Sales and marketing expense consists primarily of
expenses related to advertising,  promotion and marketing  agreements as well as
payroll and related  expenses for personnel  engaged in  marketing,  selling and
customer service  activities and credit card processing fees.  Advertising costs
are  included  in sales and  marketing  expenses  and are  charged to expense as
incurred.  Advertising costs were approximately  $14.6 million and $28.0 million
for the three and six months ended June 30, 1999 compared to approximately  $6.7
million  and $14.0  million  for the three and six months  ended June 30,  1998,
respectively.

NOTE 4 -- COMMITMENTS AND CONTINGENCIES

Payments  Under  Marketing  Agreements.  Under the Company's  current  marketing
agreements, the Company is required to pay aggregate minimum fixed fees of $20.1
million, $18.9 million, and $7.4 million during the remaining six months of 1999
and the years ending December 31, 2000 and 2001, respectively.

The  Company  expects  to  amortize  the  costs  associated  with its  marketing
agreements over the contract terms, with the amortization method primarily based
on the rate of delivery of certain  guarantees  (impressions,  click-throughs or
customers) to be received during the contract term.

General. Many of the Company's marketing agreements,  including, but not limited
to, the AOL,  Yahoo!,  Excite,  Netscape,  MTV/VH1  and  Rolling  Stone  Network
agreements,  contain provisions which may require additional payments to be made
by the  Company  based  on  factors  such as  click-throughs  and new  customers
generated.  To date,  the amount of such  payments has not been  material.  Such
payments  are expensed as  incurred.  The Company will  continue to evaluate the
realizability  of assets  recorded,  and if necessary,  write down the assets to
their net realizable value.

NOTE 5 -- ACQUISITION

On March 17, 1999,  the Company  completed its merger with N2K by acquiring 100%
of N2K's  capital  stock for  12,159,249  shares of the  Company's  common stock
valued at  approximately  $101,834,000  and  warrants  and  options to  purchase
1,713,644   shares  of  the  Company's  common  stock  valued  at  approximately
$9,281,000.  CDnow  was  the  acquiring  entity  for  accounting  purposes.  The
acquisition  has been  accounted  for under the purchase  method of  accounting,
whereby the purchase  price has been  allocated to the assets  purchased and the
liabilities   assumed  based  on  their  fair  market  values  at  the  date  of
acquisition.  The excess of the purchase price over the net assets  acquired was
recorded as goodwill and other  intangibles.  The following  table indicates the
preliminary  allocation  of  excess  purchase  price and  expected  amortization
periods:

<TABLE>
<CAPTION>

        Intangible Assets:             Assigned Value    Amortization Period
------------------------------------   --------------    -------------------
<S>                                    <C>                    <C>
Web site technology                    $   4,000,000          2 years
Strategic alliances/customers             19,000,000          3 years
Assembled workforce                        2,200,000          3 years
Goodwill                                  69,345,579          3 years
                                       --------------
Total goodwill and other intangibles   $  94,545,579
</TABLE>

<PAGE> 9

Amortization of goodwill and other intangibles related to the acquisition of N2K
and superSonic Boom,  Inc.,  which was acquired in May 1998, were  approximately
$8.1  million and $9.5 million for the three and six months ended June 30, 1999,
respectively. Amortization of goodwill and other intangibles was $28,800 for the
three and six months ended June 30, 1998 and only related to the  acquisition of
superSonic Boom, Inc. Accumulated  amortization as of June 30, 1999 and December
31, 1998 was approximately $9.7 million and $203,000, respectively. In addition,
the  balance of accrued  merger  costs  relating to the  acquisition  of N2K was
approximately  $4.8 million as of June 30, 1999 and include  investment  banking
fees and severance-related costs.

If the N2K acquisition  had occurred on January 1, 1998, pro forma revenue,  net
loss and loss per common  share  would  have been as set forth in the  following
table for the three and six months ended June 30, 1999 and 1998, respectively:

<TABLE>
<CAPTION>

                          Three Months Ended June 30,        Six Months Ended June 30,
                                  (Pro forma)                       (Pro forma)
                        -------------------------------   -------------------------------
                             1999             1998             1999             1998
                        --------------   --------------   --------------   --------------
<S>                     <C>              <C>              <C>              <C>
Revenue                 $  34,616,244    $  20,675,018    $  70,943,492    $  37,016,870
Net loss                $ (31,720,277)   $ (33,356,952)   $ (69,961,539)   $ (64,414,693)
Loss per common share   $       (1.06)   $       (1.18)   $       (2.33)   $       (2.46)
</TABLE>

<PAGE> 10

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

This Management's  Discussion and Analysis of Financial Condition and Results of
Operations and other sections of this Quarterly  Report contain  forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995.  These  forward-looking  statements  are  subject  to  certain  risks  and
uncertainties  that  could  cause  actual  results  to  differ  materially  from
historical  and  anticipated  results  or other  expectations  expressed  in the
Company's  forward-looking  statements.  Such forward-looking  statements may be
identified  by the use of certain  forward-looking  terminology,  such as "may,"
will,"  "expect,"  "anticipate",  "intend,"  "estimate,"  "believe,"  "goal," or
"continue"  or comparable  terminology  that  involves  risks or  uncertainties.
Actual  future  results and trends may differ  materially  from  historical  and
anticipated  results,  which  may  occur as a result  of a  variety  of  factors
including,  but not  limited  to,  those set  forth  under  the  "Overview"  and
"Liquidity  and Capital  Resources"  sub-sections  included in the  Management's
Discussion and Analysis of Financial Condition and Results of Operations section
of this document and in the "Risk Factors"  section of the Company's  Definitive
Proxy  Statement  on Form 14A (File  No.  000-23753),  which was filed  with the
Securities  and Exchange  Commission  ("SEC") on February  17, 1999.  Particular
attention  should be paid to the cautionary  statements  involving the Company's
limited operating  history,  the  unpredictability  of its future revenues,  the
unpredictable and evolving nature of its key markets, the intensely  competitive
online commerce and entertainment environments,  the Company's dependence on its
marketing  agreements  and  key  suppliers  and  distributors,   and  the  risks
associated with capacity  constraints,  systems development,  relationships with
artists and the  management  of growth.  Except as required by law,  the Company
undertakes no obligation to update any forward-looking  statement,  whether as a
result of new information,  future events or otherwise. Readers should carefully
review the  factors  set forth in other  reports or  documents  that the Company
files from  time-to-time  with the SEC and matters  generally  affecting  online
commerce and online sale of entertainment-related  products,  including, but not
limited to, music retailing.

RECENT DEVELOPMENTS

Acquisition  of N2K Inc. On October  22,  1998,  CDnow and N2K Inc.,  a Delaware
corporation,  entered  into  an  Agreement  and  Plan  of  Merger  (the  "Merger
Agreement"). The parties created a new public company, initially named CDnow/N2K
Inc. ("CDnow/N2K").  The Merger Agreement provided for the merger (the "Merger")
of wholly-owned  subsidiaries of CDnow/N2K into each of CDnow and N2K. CDnow and
N2K survived the Merger and became  wholly-owned  subsidiaries of CDnow/N2K.  In
the Merger,  each outstanding  share of common stock of CDnow was converted into
one share of  CDnow/N2K  and each  outstanding  share of common stock of N2K was
converted into .83 shares of CDnow/N2K.  As a result,  the shareholders of CDnow
owned  approximately  60% of the combined  company and the  stockholders  of N2K
owned  approximately  40% of the combined  company as of the date the Merger was
completed on March 17, 1999. Also on the Merger  completion date,  CDnow/N2K was
renamed CDnow, Inc.

Columbia House Merger.  On July 13, 1999, the Company announced the execution of
a definitive  agreement with Sony Corporation of America and Time Warner Inc. to
combine the businesses of the Company and Columbia House, the leading club-based
direct marketer of music and videos,  which is owned equally by Sony Corporation
and Time Warner Inc. The  agreement  provides for the  formation of a new public
company to be owned 37 percent  each by Sony and Time Warner.  CDnow's  existing
stockholders  will own the remaining 26 percent.  Consummation  of the merger is
subject to various  conditions,  including,  but not limited to, approval by the
shareholders  of the  Company.  The Company  expects the merger to be  completed
during the fourth quarter of 1999.

OVERVIEW

The Company is one of the leading electronic  commerce retailers of pre-recorded
music, including CDs, and other  entertainment-related  products. The Company is
also a source of entertainment-related  content and a focal point of an Internet
community for the exchange of  entertainment-related  news and information.  Its
early entry into the online music retailing industry has helped the Company gain
a  well-recognized  brand and a large  customer  base.  The  Company  strives to
combine the advantages of online commerce with superior  customer focus in order
to be the  authoritative  source for the  online  purchase  of music  including,

<PAGE> 11

without limitation, CDs, and other entertainment-related products. The Company's
online  store,   cdnow.com,   offers  broad  selection,   informative   content,
easy-to-use  navigation  and  search  capabilities,  a high  level  of  customer
service, competitive pricing and personalized merchandising and recommendations.
Due to the Company's retail focus,  revenues are primarily derived from the sale
of  pre-recorded  music and related  products,  drawing  from its  comprehensive
selection of  approximately  500,000 items.  The Company also sells  advertising
space and  sponsorships  on its site to companies  interested in promoting their
own goods and services to the  Company's  customer  base and the large number of
visitors to the Company's web site.

The Company has grown  rapidly since its  inception in 1994.  Approximately  2.4
million customers have made purchases from either CDnow or from Music Boulevard,
the Internet music retail store operated previously by N2K (which, as of May 17,
1999 was consolidated  into the cdnow.com  online store),  since their inception
through June 30, 1999, of whom approximately 755,000 made their initial purchase
during the six months ended June 30, 1999. The Company's net sales grew to $34.6
million  during the three months ended June 30, 1999,  compared to $11.6 million
during the three months ended June 30, 1998.  The Company's net sales  increased
to $57.5  million  during the six months ended June 30, 1999,  compared to $21.6
million  during the six months  ended June 30,  1998.  In  addition to the sales
generated  from the  traffic  of Music  Boulevard  customers  as a result of the
acquisition of N2K, and the rapid acquisition of new customers,  the Company has
also generated  significant  customer  loyalty.  Repeat customers  accounted for
approximately  63% of net sales during the six months  ended June 30,  1999,  up
from approximately 54% during the six months ended June 30, 1998.

The Company  believes that the key factors  affecting  its  long-term  financial
success include its ability to obtain new customers at reasonable costs,  retain
customers  and  encourage  repeat  purchases.  The  Company  seeks to expand its
customer base through multiple marketing channels, which include (i) pursuing an
aggressive  marketing  campaign  using a combination  of online and  traditional
marketing,  (ii) establishing  marketing  agreements with major Internet content
and service  providers,  (iii)  entering  into linking  arrangements  with other
Internet  sites as part of its Cosmic Credit and C2 affiliate  website  programs
and (iv) using direct marketing  techniques to target new and existing customers
with personalized communications. The Company periodically enters into marketing
agreements  with various  Internet  portals and online  content  providers.  The
Company  presently has marketing  agreements in place with,  among others,  AOL,
Yahoo!, Excite, MTV/VH1 and Rolling Stone Network.

Since its inception,  the Company has incurred significant net losses and, as of
June 30, 1999, had accumulated  losses of $105.9 million.  As it seeks to expand
aggressively,  the Company believes that its operating expenses will continue at
a high level as a result of the financial commitments related to the development
of marketing  channels,  future  marketing  agreements,  and improvements to its
Internet site and other capital  expenditures.  The Company expects that it will
continue to incur losses and generate negative cash flow from operations for the
foreseeable  future as it continues to develop its  business.  Since the Company
has relatively low product gross margins, the ability of the Company to generate
and enhance profitability depends upon its ability to substantially increase its
net sales. To the extent that significantly  higher net sales do not result from
the  Company's  marketing  efforts,  the Company  will be  materially  adversely
affected.  There can be no  assurance  that the Company will be able to generate
sufficient  revenues from the sale of  pre-recorded  music,  including  CDs, and
other  entertainment-related  products to achieve or maintain profitability on a
quarterly or annual basis.

RESULTS OF OPERATIONS

                Three Months Ended June 30, 1999, Compared to the
                         Three Months Ended June 30,1998
                -------------------------------------------------

Net  Sales.  Net  sales  reflect  the  sale  of  pre-recorded  music  and  other
entertainment-related  products,  net of estimated  returns and include outbound
shipping  and  handling  charges.  The  sale  of  advertising  on the  Company's
cdnow.com  site is also  included in net sales.  For the three months ended June
30, 1999,  net sales were $34.6 million,  representing  an increase of 198% over
the  corresponding  period in 1998.  Net sales for the three month  period ended
June 30, 1999,  include the Company's  sales to Music  Boulevard  customers as a
result of the acquisition of N2K. The increase in sales is also  attributable to
continued  growth of the Company's  customer base,  increased  sales from repeat
customers and increased advertising revenue. International sales represented 20%
of net sales

<PAGE> 12

for the three months ended June 30, 1999,  compared to 22% for the corresponding
period in 1998. The decrease in international sales as a percentage of net sales
is  due to a  proportionally  larger  increase  in  domestic  sales  from  Music
Boulevard customers as a result of the acquisition of N2K.

For the three  months  ended June 30,  1999,  the  Company  added  approximately
332,000 new  customers,  bringing the total  number of  customers  who have made
purchases at either CDnow or Music Boulevard  since  inception to  approximately
2.4  million  as  of  June  30,  1999.  Repeat  customer  purchases  represented
approximately 66% of net sales for the three months ended June 30, 1999 compared
to 57% for the three months ended June 30, 1998.  During the quarter the Company
focused  on  implementing  the  fusion of the CDnow and Music  Boulevard  online
stores into a single  integrated site and on migrating  existing Music Boulevard
customers  to the new CDnow online  store.  As a result,  the Company  primarily
targeted its marketing efforts at existing  customers,  rather than new customer
acquisition. In addition, the Company's second-quarter revenues were affected by
delays in transitioning  certain links from a large marketing partner to the new
CDnow online store and by delays in fulfilling CDnow customer orders as a result
of a warehouse relocation by a major supplier.

Cost of Sales. Cost of sales consists  primarily of the cost of merchandise sold
to customers,  including product  fulfillment and outbound shipping and handling
charges.  Cost of sales was $28.0  million for the three  months  ended June 30,
1999,  compared  to $9.3  million  for the  corresponding  period  in 1998.  The
Company's  gross  margin  decreased to 19.1% for the three months ended June 30,
1999,  compared to 20.0% for the  corresponding  period in 1998. The decrease in
gross margin  percentage  was  primarily  due to the overall  price decline as a
result of the  synchronization of CDnow and N2K's price lists effective April 1,
1999;  and an  extended  storewide  sale  beginning  May 17, 1999 to promote the
re-launch of the Company's website (cdnow.com). This impact was partially offset
by the positive  effect of advertising  revenue,  which has a higher margin than
product sales.

During the quarter ended  September 30, 1998, the Company  determined to include
credit card processing fees ("Credit Card Fees") in sales and marketing expenses
rather than in cost of sales,  as was previously the case.  This change was made
based on management's determination that including Credit Card Fees in sales and
marketing  expense was more  consistent  with the  treatment of such expenses by
retailers generally.  The financial information in this Form 10-Q related to the
Company's  results of operations for the three months ended June 30, 1998,  have
been  restated  to reflect  this  change.  Credit  Card Fees were  approximately
$843,000  and  $310,000  during the three  months  ended June 30, 1999 and 1998,
respectively.  If Credit Card Fees were included in cost of sales,  gross profit
margins would have been 16.7% and 17.3%,  during the three months ended June 30,
1999 and 1998, respectively.

Operating and Development  Expense.  Operating and development  expense consists
primarily  of  payroll  and  related  expenses  for  store  management,  design,
development and network  operations  personnel,  systems and  telecommunications
infrastructure, and royalties paid by the Company on product sales in return for
licensing  of  ratings,  reviews,  sound  samples and other  information.  Store
development costs are charged to expense as incurred.  Operating and development
expense was $5.8 million for the three  months  ended June 30, 1999  compared to
$1.7 million for the corresponding period in 1998. As a percentage of net sales,
operating and development  expense was 16.8% for the three months ended June 30,
1999 compared to 14.5% for the three months ended June 30, 1998. The increase in
both dollars and  percentage  terms is  attributable  to costs  associated  with
supporting increased traffic and sales volume in the CDnow store,  including the
costs  associated  with  operating  two  separate  websites  from March 18, 1999
through May 17, 1999  following  the  acquisition  of N2K.  The increase is also
attributable to increased staffing and associated costs related to enhancing the
features   and    functionality    of   the   Company's    Internet   site   and
transaction-processing  systems,  as  well as  increased  investments  in  store
content, systems and telecommunications  infrastructure to support the increased
transaction volume in the CDnow store.

Sales and Marketing  Expense.  Sales and marketing expense consists primarily of
expenses related to marketing agreements,  advertising and promotion, as well as
payroll and related  expenses for personnel  engaged in  marketing,  selling and
customer service  activities.  Sales and marketing expense was $21.7 million for
the three  months  ended June 30,  1999,  compared to $9.3 million for the three
months  ended June 30,  1998.  The  increase in absolute  dollars was  primarily
attributable  to  increased  costs  associated  with  the  Company's   marketing
agreements,  including marketing  agreements assumed by CDnow as a result of the
acquisition  of N2K and  marketing  agreements  entered into during or after the
second  quarter of 1998. The increase is also due to increased  advertising  and

<PAGE> 13

promotional  expenditures,  increased  staffing and related  costs in connection
with  the   implementation  of  its  marketing  strategy  and  customer  service
activities  necessary to support its  increased  customer  base,  and  increased
credit card processing  fees related to the growth of revenues.  As a percentage
of net  sales,  sales and  marketing  expense  decreased  to 62.6% for the three
months  ended June 30,  1999,  compared to 80.0% for the three months ended June
30, 1998. The decrease as a percentage of sales is primarily attributable to the
increased  percentage of the  Company's  sales from repeat  customer  purchases,
which are relatively less expensive than the cost of acquiring new customers.

The Company expects the dollar amount of sales and marketing expense to continue
to increase in future  periods.  The Company is hopeful  that its net sales will
increase  in  future  periods  and that its  sales and  marketing  expense  will
represent a decreasing  percentage  of net sales.  However,  no assurance can be
given  that the  Company  will  achieve  increased  net sales or that  sales and
marketing expense will decrease as a percentage of net sales.

General and Administrative Expense.  General and administrative expense consists
of payroll and related  expenses for executive,  accounting  and  administrative
personnel,  insurance,   professional  fees  and  other  general  and  corporate
expenses.  General and  administrative  expense  was $3.4  million for the three
months  ended June 30, 1999  compared to $0.9 million for the three months ended
June 30, 1998. As a percentage of net sales, general and administrative  expense
increased  to 9.7% for the three  months  ended June 30,  1999 from 7.4% for the
three  months ended June 30,  1998.  The increase in general and  administrative
expense,  in both dollars and percentage  terms, was primarily due to the hiring
of  additional  personnel  to support the overall  growth of the Company and the
acquisition of N2K. The increase is also attributable to increased  professional
fees and the  inclusion of  merger-related  expenses of  approximately  $720,000
incurred in connection with the Company's July 12, 1999 definitive  agreement to
merge with Columbia House.

Amortization  of Goodwill and Other  Intangibles.  Amortization  of goodwill and
other  intangibles  related to the acquisition of N2K and superSonic  Boom, Inc.
was $8.1 million for the three  months ended June 30, 1999,  compared to $28,800
for the three months ended June 30, 1998.

Net Loss Applicable to Common Shareholders. The Company's net loss applicable to
common  shareholders was $31.7 million for the three months ended June 30, 1999,
compared to $8.9 million for the three months ended June 30, 1998.

                Six Months Ended June 30, 1999, Compared to the
                         Six Months Ended June 30, 1998
                -----------------------------------------------

Net Sales.  Net sales were $57.5 million for the six months ended June 30, 1999,
representing  an increase  of 166% over the  corresponding  period in 1998.  Net
sales for the six month period ended June 30, 1999,  include the Company's sales
to Music  Boulevard  customers as a result of the acquisition of N2K as of March
17, 1999. The increase in sales is also  attributable to continued growth of the
Company's  customer base,  increased  sales from repeat  customers and increased
advertising  revenue.  For the six months ended June 30, 1999, the Company added
approximately 755,000 new customers,  bringing the total number of customers who
have made  purchases  at either  CDnow or Music  Boulevard  since  inception  to
approximately  2.4  million  as of June  30,  1999.  Repeat  customer  purchases
represented  approximately  63% of net sales for the six  months  ended June 30,
1999,  compared  to 54% for the six months  ended June 30,  1998.  International
sales  represented  20% of net  sales for the six  months  ended  June 30,  1999
compared  to  22%  for  the  corresponding  period  in  1998.  The  decrease  in
international  sales as a  percentage  of net  sales is due to a  proportionally
larger increase in domestic sales resulting from the inclusion of sales to Music
Boulevard customers as a result of the acquisition of N2K.

Cost of Sales.  Cost of sales were $46.0  million for the six months  ended June
30, 1999 compared to $17.6  million for the  corresponding  period in 1998.  The
Company's  gross profit margin  increased to 20.0% for the six months ended June
30, 1999,  compared to 18.8% for the corresponding  period in 1998. The increase
in gross margin was primarily  attributable  to an increase in revenues from the
sale of  advertising  on the CDnow site,  which has a higher margin than product
sales.

<PAGE> 14

During the quarter ended  September 30, 1998, the Company  determined to include
credit card processing fees ("Credit Card Fees") in sales and marketing expenses
rather than in cost of sales,  as was previously the case.  This change was made
based on management's determination that including Credit Card Fees in sales and
marketing  expense was more  consistent  with the  treatment of such expenses by
retailers generally.  The financial information in this Form 10-Q related to the
Company's results of operations for the six months ended June 30, 1998, has been
restated to reflect this change. Credit Card Fees were approximately  $1,287,000
and $586,000,  during the six months ended June 30, 1999 and 1998, respectively.
If Credit Card Fees were included in cost of sales,  gross profit  margins would
have been 17.7% and 16.0%,  during the six months  ended June 30, 1999 and 1998,
respectively.

Operating and Development  Expense.  Operating and development  expense was $9.6
million for the six months ended June 30, 1999, compared to $2.8 million for the
corresponding  period in 1998.  As a  percentage  of net  sales,  operating  and
development  expense was 16.6% for the six months ended June 30, 1999,  compared
to 12.8% for the six months  ended June 30,  1998.  The  increase  in dollar and
percentage terms is attributable to costs  associated with supporting  increased
traffic  and  sales  volume  in the  CDnow  online  store,  including  the costs
associated with operating both the CDnow and Music Boulevard websites from March
18, 1999,  following the acquisition of N2K,  through May 17, 1999. The increase
is also due to increased  staffing and associated costs related to enhancing the
features   and    functionality    of   the   Company's    Internet   site   and
transaction-processing  systems,  as  well as  increased  investments  in  store
content, systems and telecommunications  infrastructure to support the increased
transaction volume in the CDnow store.

Sales and Marketing  Expense.  Sales and marketing expense was $39.7 million for
the six months ended June 30, 1999, compared to $18.4 million for the six months
ended June 30, 1998. As a percentage of net sales,  sales and marketing  expense
decreased to 69.1% for the six months ended June 30, 1999  compared to 84.9% for
the six months  ended June 30,  1998.  The  increase  in  absolute  dollars  was
primarily   attributable  to  increased  costs  associated  with  the  Company's
marketing  agreements,  including  those  assumed  by CDnow  as a result  of the
acquisition  of N2K and those entered into during or after the second quarter of
1998.  The  increase  is  also  due to  increased  advertising  and  promotional
expenditures  including costs associated with the 1999 Grammy Awards telecast in
February 1999,  which were higher than the comparable  costs for the 1998 Grammy
Awards  telecast.  In  addition,  the Company  incurred  increased  staffing and
related costs in connection with the  implementation  of its marketing  strategy
and customer  service  activities  necessary to support its  increased  customer
base,  and  increased  credit  card  processing  fees  related  to the growth of
revenues. The decrease as a percentage of sales is primarily attributable to the
increased  percentage of the  Company's  sales from repeat  customer  purchases,
which are relatively less expensive than the cost of acquiring new customers.

The Company expects the dollar amount of sales and marketing expense to continue
to increase in future  periods.  The Company is hopeful  that its net sales will
increase  in  future  periods  and that its  sales and  marketing  expense  will
represent a decreasing  percentage  of net sales.  However,  no assurance can be
given  that the  Company  will  achieve  increased  net sales or that  sales and
marketing expense will decrease as a percentage of net sales.

General and Administrative Expense.  General and administrative expense was $4.7
million for the six months ended June 30, 1999  compared to $1.7 million for the
six months  ended June 30,  1998.  As a  percentage  of net sales,  general  and
administrative  expense increased to 8.2% for the six months ended June 30, 1999
from 7.9% for the six months  ended June 30,  1998.  The increase in general and
administrative  expense, in both dollars and percentage terms, was primarily due
to the hiring of  additional  personnel  to support  the  overall  growth of the
Company,  which was largely due to the  acquisition of N2K. The increase is also
attributable to increased  professional fees and the inclusion of merger-related
expenses of  approximately  $720,000  incurred in connection  with the Company's
July 12, 1999 definitive agreement to merge with Columbia House.

Amortization  of Goodwill and Other  Intangibles.  Amortization  of goodwill and
other  intangibles  related to the acquisition of N2K and superSonic  Boom, Inc.
was $9.5 million for the six months ended June 30, 1999  compared to $28,800 for
the six months ended June 30, 1998.

Net Loss Applicable to Common Shareholders. The Company's net loss applicable to
common shareholders was $50.8 for the six months ended June 30, 1999 compared to
$18.2 million for the six months ended June 30, 1998.

<PAGE> 15

LIQUIDITY AND CAPITAL RESOURCES

At June 30, 1999,  the Company's  cash and cash  equivalents  were $41.9 million
compared to $49.0  million at December 31, 1998. In February  1998,  the Company
consummated  its initial  public  offering by selling an  aggregate of 4,561,250
shares of Common Stock and raising net proceeds of approximately  $67.0 million.
In July 1998,  the Company  consummated a second  public  offering by selling an
aggregate  of  1,250,000  shares of Common  Stock and  raising  net  proceeds of
approximately  $21.5  million.  Prior to February  1998,  the Company  primarily
financed its operations  through private sales of capital stock (which,  through
December 31, 1997, totaled $10.5 million,  including $9.3 million raised in July
and  August of 1997),  the  private  sale of $5.8  million  of Series A Notes in
November 1997,  internally-generated  cash flows,  advances from related parties
and certain other short-term loans.

Net cash used in operating  activities of $30.8 million for the six months ended
June 30, 1999 was primarily  attributable  to a net loss of $50.8 million and an
increase  of $1.8  million  in  accounts  receivable  as a result  of  increased
revenues.  These uses of cash were partially  offset by a $12.1 million non-cash
charge for  depreciation  and  amortization,  a $5.2 million decrease in prepaid
expenses  and other  assets  primarily  due to the expense of prepaid  marketing
agreements,  and a  $3.7  million  increase  in  accounts  payable  and  accrued
expenses,  due to an  increase  in accrued  merchandise  costs.  The  changes in
working capital exclude the impact of the acquisition of the assets acquired and
liabilities  assumed of N2K as of the merger date,  March 17, 1999.  For the six
months ended June 30, 1998,  cash used in operating  activities of $23.6 million
resulted  primarily from a net loss of $18.1 million, a decrease of $4.6 million
in accounts  payable and accrued  expenses,  and an increase of $1.6  million in
prepaid expenses, partially offset by depreciation and amortization of $751,000.

Net cash provided by investing  activities  was $23.6 million for the six months
ended June 30, 1999,  which consisted of $25.3 million in net cash acquired from
the  acquisition  of N2K,  partially  offset by  purchases  of equipment of $1.6
million.  Net cash used for  investing  activities  was $1.1 million for the six
months  ended June 30, 1998 and  consisted  of  purchases  of  equipment of $1.6
million and  $424,000  of cash used in the  purchase  of  superSonicBoom,  Inc.,
partially offset by the sale of short term investments of $1.0 million.

Net cash provided by financing  activities  was $10,000 for the six months ended
June 30, 1999, and consisted of proceeds from warrants and options  exercised of
$520,000,  partially  offset by  payments  on  capital  leases and term loans of
$510,000.  Net cash provided by financing  activities  was $61.2 million for the
six months ended June 30, 1998,  and consisted of net proceeds of  approximately
$67.1 million from the Company's  initial public  offering,  partially offset by
the retirement of $5.8 million of the Company's Series A Notes.

The Company is required to pay aggregate  minimum fixed fees under the Company's
marketing agreements of $20.1 million, $18.9 million and $7.4 million during the
remaining  six months of 1999 and the years  ended  December  31, 2000 and 2001,
respectively.  The Company also has minimum lease  obligations  associated  with
leased office space and capital financing arrangements.

The Company expects to fund its future payment  obligations  under its marketing
agreements  from its cash and cash  equivalents  and from  cash  generated  from
future operations and financing activities. As of June 30, 1999, the Company had
$41.9  million  of cash and cash  equivalents.  As of that date,  the  Company's
principal commitments consisted of obligations under its marketing agreements as
well as obligations outstanding under capital and operating leases. Although the
Company has no material  commitments  for capital  expenditures,  it anticipates
substantial   increases  in  its  capital  expenditures  and  lease  commitments
consistent with anticipated growth in operations, infrastructure and personnel.

In conjunction with the Company's  execution of a definitive  agreement on April
12,  1999 with Sony  Corporation  of America and Time Warner Inc. to combine the
businesses of the Company and Columbia House,  the Company received a commitment
from Sony Music  Entertainment  Inc. and Time Warner Inc. to provide the Company
with up to $30 million in working capital financing,  if needed based on certain

<PAGE> 16

working capital  minimums,  drawable on or after December 15, 1999 to assist the
Company in meeting its  working  capital  requirements  until the closing of the
merger,  which is expected to be  completed in the fourth  quarter of 1999.  The
Company  believes that its current cash and cash  equivalents  are sufficient to
meet payment obligations until December 15, 1999.

FACTORS AFFECTING THE COMPANY'S BUSINESS AND PROSPECTS

The  Company  expects  to  experience  significant  fluctuations  in its  future
quarterly  operating  results  due to a variety  of  factors,  many of which are
outside the Company's control.  Factors that may affect the Company's  quarterly
operating results include (i) its ability to retain existing customers,  attract
new customers and maintain customer  satisfaction,  (ii) the introduction of new
or enhanced  Web pages,  services,  products  and  marketing  agreements  by the
Company and its competitors, (iii) price competition or higher wholesale prices,
(iv) the level of use of the Internet and  consumer  acceptance  of the Internet
for the purchase of the Company's products,  (v) seasonal  fluctuations in sales
of the Company's  products,  (vi) its ability to upgrade and develop its systems
and   infrastructure   and  attract   qualified   personnel,   (vii)   technical
difficulties,  system  downtime  or  Internet  brownouts,  (viii) the amount and
timing of operating costs and capital expenditures  relating to expansion of the
Company's business,  operations and  infrastructure,  (ix) the timing of Company
promotions and sales programs,  (x) the level of merchandise returns experienced
by the Company, (xi) government regulation and (xii) general economic conditions
and economic  conditions  specific to the Internet,  the online sale of products
and the  entertainment  industry.  These and other  factors are  included in the
"Risk Factors"  section of the Company's  Definitive Proxy Statement on Form 14A
(File No. 000-23753), which was filed with the SEC on February 17, 1999.

The  Company  expects  that  it will  experience  seasonality  in its  business,
reflecting  a  combination  of  seasonal  fluctuations  in  Internet  usage  and
traditional  retail  seasonality  patterns affecting sales of recorded music and
other  entertainment-related  products.  Sales in the  traditional  retail music
industry are  significantly  higher in the fourth calendar  quarter of each year
than in the preceding  three-quarters.  However,  to date, the Company's limited
operating history and rapid growth make it difficult to ascertain the effects of
seasonality on its business,  especially  with regard to products other than the
sale of music CDs. The Company believes that period-to-period comparisons of the
Company's  historical  results are not necessarily  meaningful and should not be
relied upon as an indication of future results.

Risks  Associated  with the Year  2000.  The Year  2000  issue is the  result of
computer  programs being written using two digits rather than four to define the
applicable  year. In other words,  date-sensitive  software may recognize a date
using  "00" as the year 1900  rather  than the year 2000.  This could  result in
system failures or miscalculations causing disruptions of operations, including,
among others, a temporary inability to process  transactions,  send invoices, or
engage in similar normal business activities.

The Company  does not  believe  that it has  material  exposure to the Year 2000
issue with respect to its own information  technology since its existing systems
correctly  define  the  year  2000.  The  Company's  non-information  technology
systems,  which  include,  but are not limited  to,  systems  such as  security,
heating, ventilating and air conditioning systems and facsimile machines are not
considered by the Company to be date sensitive to the Year 2000 and,  therefore,
do not raise Year 2000 issues.

The Company is currently conducting an analysis to determine the extent to which
its major suppliers' systems (insofar as they relate to the Company's business),
including,   but  not  limited  to,  the  systems  of  credit  card  processors,
telecommunications  providers,  product distributors and companies with whom the
Company has strategic alliances, are subject to the Year 2000 issue. The Company
is  currently  unable to  predict  the  extent to which the Year 2000 issue will
affect  its  suppliers,  or the  extent to which it would be  vulnerable  to the
suppliers'  failure to  remediate  any Year 2000 issues on a timely  basis.  The
failure of a major supplier subject to the Year 2000 to convert its systems on a
timely basis or a conversion  that is  incompatible  with the Company's  systems
could have a material  adverse effect on the Company.  In addition,  most of the
purchases  from the Company's  store are made with credit cards via the Internet

<PAGE> 17

and the Company's  operations may be materially adversely affected to the extent
its customers are unable to use their credit cards or access the Internet due to
the Year 2000 issues that are not  rectified  by their credit card vendors or by
those  organizations  responsible for  maintaining  and providing  access to the
Internet.

The Company  estimates  that, as of June 30, 1999, the cost of  remediating  its
internal systems has been approximately  $100,000, and it estimates that it will
spend an  additional  $150,000  during the  remainder  of 1999.  The  Company is
funding this effort through normal working capital.

The  Company  intends to  actively  work with and  encourage  its  suppliers  to
minimize the risks of business  disruptions  resulting from Year 2000 issues and
develop contingency plans where necessary.  Such plans may include,  but are not
limited to, using  alternative  suppliers  and  establishing  contingent  supply
arrangements.  The Company expects to have such plans in place during the fourth
quarter of 1999.

<PAGE> 18

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

FOREIGN CURRENCY RISK

Currently,  all of the Company's revenues and expenses are denominated in United
States dollars.  Therefore,  the only current  exposure to foreign currency risk
relates to  international  sales.  For the three months ended June 30, 1999, and
the  year  ended   December  31,  1998,   international   sales   accounted  for
approximately  20% and 21% of net sales,  respectively.  To the extent  that the
value of the United States dollar increases relative to foreign  currencies,  it
may be more costly for  international  customers to make  purchases.  Therefore,
changes in exchange  rates may impact the amount of the Company's  international
sales.

INTEREST RATE RISK

The Company's  exposure to market risk as a result of changes in interest  rates
relates  primarily  to  its  investment   portfolio.   The  Company  invests  in
instruments  that  meet high  credit  quality  standards,  as  specified  in its
investment policy.  This policy also limits the amount of credit exposure to any
one issue, issuer and type of investment.

As of June 30, 1999, all of the Company's  funds were cash  equivalents.  Due to
the average  maturity and  conservative  nature of its investment  portfolio,  a
sudden change in interest rates would not have a material effect on the value of
the portfolio.  Management estimates that had the average yield of the Company's
investments decreased by 100 basis points, the Company's interest income for the
six months ended June 30, 1999 would have decreased by  approximately  $300,000.
This  estimate  assumes that the decrease  occurred on the first day of 1999 and
reduced the yield of each investment  instrument by 100 basis points. The impact
on the Company's future interest income from future changes in investment yields
will depend  largely on the gross amount of the Company's  investments,  see the
"Liquidity and Capital Resources" section of this report.

<PAGE> 19

PART II
                                OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

N2K (a wholly-owned  subsidiary of the Company) and its directors are defendants
in a  consolidated  purported  class action in the U.S.  District  Court for the
Southern  District  of New York  entitled In re N2K Inc.  Securities  Litigation
(Docket  No. 98 CIV 3304 (HB)) (the  "Consolidated  Action").  The  Consolidated
Action  consolidates  two purported class actions,  entitled Kuhn v. N2K Inc. et
al.  (Docket No. 98 CIV 4360 (HB)) and Bender v. Rosen et al. (Docket No. 98 CIV
3304 (HB)) that were  previously  discussed in N2K's  Quarterly  Reports on Form
10-Q for the quarterly periods ended September 30, 1998, June 30, 1998 and March
31, 1998,  respectively.  The Consolidated Action is a purported class action on
behalf of Common stockholders and seeks to recover unspecified damages and other
relief,  as well as  recovery  of costs  and  expenses,  stemming  from  alleged
violations of the  Securities  Act of 1933, as amended,  in connection  with the
public  offering  of the  shares  of  N2K's  Common  stock in  April  1998.  The
Consolidated  Action alleges that, among other things,  the defendants failed to
disclose N2K's first quarter financial results in the registration statement for
the April 1998 public offering. The Company, as a successor-in-interest  to N2K,
believes  that the claims in the  Consolidated  Action are without  merit and is
vigorously  defending the action.  The defendants moved to dismiss the complaint
on August  31,  1998 for  failure to state a claim  and/or for  failure to plead
fraud with the requisite  particularity.  On May 21, 1999,  Judge Baer dismissed
the plaintiff's  complaint with prejudice.  On June 22, 1999 plaintiffs  filed a
Notice of Appeal in the U.S. Court of Appeals for the Second Circuit.

On or about November 4, 1998, an action entitled  Ticketmaster  Ticketing Co. v.
N2K Inc.  (Docket No.  BC200194) was filed  against N2K in  California  Superior
Court for the County of Los Angeles.  The  Ticketmaster  action alleges that N2K
breached a marketing  and  advertising  contract  dated  April 23, 1998  between
Ticketmaster and N2K, which N2K terminated  effective October 31, 1998, based on
alleged  breaches of the  agreement by  Ticketmaster  as well as other  tortious
conduct.  Ticketmaster seeks damages in an amount not less than $8,000,000, plus
pre- and post-judgment  interest,  as well as fees and costs. The Company,  as a
successor-in-interest  to N2K, believes that it has substantial  defenses to the
claim  asserted,  intends  to  defend  the  action  vigorously  and has  filed a
cross-compliant for affirmative relief.

On or about November 12, 1998, an action  entitled  Metallica v. N2K Inc. et al.
(Docket No. 98-9122 GHK (ANx)) was filed in the United States District Court for
the Central  District of  California  against N2K,  Metro  Independent  Records,
Richard Driscoll, Dutch East India Trading, and ten unnamed persons or entities.
The Metallica  action alleges that N2K and the other  defendants  have infringed
copyrights and trademarks owned by Metallica and the other  plaintiff,  Creeping
Death  Music,  and  have  violated   California  state  law  by   manufacturing,
distributing,  advertising and selling a compact disc entitled  "Metallica,  Bay
Area Thrashers, The Early Years." Plaintiffs seek, inter alia, injunctive relief
including,  but not limited  to, an order  requiring  defendants  to cease their
alleged  copyright  and  trademark  infringements,  damages,  including  but not
limited to treble plaintiffs'  damages and defendants'  profits  attributable to
the alleged infringements,  other damages and injunctive relief, as well as fees
and  costs.  On  June  8,  1999  the  Company  and  plaintiffs  entered  into  a
confidential  Settlement Agreement and Mutual Release for an undisclosed amount,
which amount is not material to the Company.

N2K and seventeen other entities have been named as defendants in a civil action
entitled Interactive Gift Express v. Compuserve, Inc., et al. (Docket 95 CV 6871
(BSJ)), which is pending in the U.S. District Court for the Southern District of
New York. N2K has also been named as defendant in a civil action entitled Parsec
Sight/Sound,  Inc. v. N2K Inc. (Docket 98 CV 0118), which is pending in the U.S.
District Court for the Western District of Pennsylvania.  The plaintiffs in each
of these actions allege  infringement of certain  intellectual  property rights,
and each seeks treble  damages and costs in an  unspecified  amount,  as well as
other  declaratory and injunctive  relief.  In the Interactive Gift action,  the
court has issued a preliminary  ruling favorable to defendants.  Plaintiffs have
stated  that they will  consent to entry of  judgment  against  them in order to

<PAGE> 20

speed their appeal of the court's ruling. In the Parsec action,  the Company has
answered  the   complaint  and   discovery  is  ongoing.   The  Company,   as  a
successor-in-interest to N2K, believes that the claims against it in each action
are  without  merit and  intends  to  vigorously  defend  against  each of them.
Moreover,   the  Company  believes  that  these  lawsuits,   even  if  adversely
determined,  will not have a material adverse effect on the Company's  business,
financial condition or results of operations.

From time to time,  the  Company is  involved in  litigation  incidental  to its
business.  In the opinion of  management,  no litigation to which the Company is
currently a party is likely to have a material  adverse  effect on the Company's
results of operations, financial condition or liquidity, if decided adversely to
the Company.

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

None

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5.  OTHER INFORMATION

None

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

A.  EXHIBITS

    27.1  Financial Data Schedule.

B.  Reports on Form 8-K

      Form    Item #            Description                   Filing Date
    --------  ------  ------------------------------------   -------------
    Form 8-K   5,7    Report of the execution of an          July 12, 1999
                      Agreement of Merger and
                      Contribution by and among CDnow,
                      Inc., Time Warner Inc. and Sony
                      Corporation of America to combine
                      the businesses of CDnow and Columbia
                      House

<PAGE> 21

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.



                                   CDnow, Inc.



Date:  August 27, 1999                       /s/ Jason Olim
                                             -----------------------------------
                                                                      Jason Olim
                                             President & Chief Executive Officer





                                             /s/ Joel Sussman
                                             -----------------------------------
                                                                    Joel Sussman
                                                   Vice President, Treasurer and
                                                     Chief Financial Officer