<PAGE>


                   U. S. SECURITIES AND EXCHANGE COMMISSION
                           WASHINGTON, D.C. 20549

                               FORM 10-KSB/A

(Mark One)
[X]                ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934


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

   For the transition period from _____________to________________.


FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996  COMMISSION FILE NUMBER 000-21887

                         CD WAREHOUSE, INC.
                         ------------------
    (Exact name of registrant as specified in its charter)

     DELAWARE                                 73-1504999
     --------                                 ----------
(State or other jurisdiction of   (I.R.S. Employer Identification No.)
incorporation or organization)

722 NORTH BROADWAY, OKLAHOMA CITY, OKLAHOMA                     73102
-------------------------------------------                   ----------
(Address of principal executive offices)                      (Zip Code)

    Registrant's telephone number, including area code:  (405) 232-2797

Securities registered pursuant to Section 12(b) of the Act:  NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:  COMMON STOCK, $.01
PAR VALUE PER SHARE (TITLE OF CLASS)

CHECK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED 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    No  X    (not subject to filing requirements for the past 90 days)
       ---    ---

Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B
is not contained in this form, and will not be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB.    X
                    ---
Registrant's revenues for its most recent fiscal year were None.
                                                           ----
As of March 26, 1997, the aggregate market value of the voting stock held by
non-affiliates computed by reference to the price at which the stock was sold,
or the average bid and asked prices of such stock, was $4,734,506.

As of March 26, 1997, there were 1,820,000 shares of Common Stock outstanding.

Transitional Small Business Disclosure Format (check one):   YES     NO  X
                                                                 ---    ---
DOCUMENTS INCORPORATED BY REFERENCE: None

<PAGE>

                                FORM 10-KSB/A

                              TABLE OF CONTENTS


  ITEM                          PART I                              PAGE
-------  -----------------------------------------------------      ----
  1.     Description of Business                                      1
  2.     Description of Property                                     10
  3.     Legal Proceedings                                           10
  4.     Submission of Matters to a Vote of Security Holders         10

                               PART II
         -----------------------------------------------------
  5.     Market for Common Equity and Related
         Stockholder Matters                                         11
  6.     Management's Discussion and Analysis or Plan of
         Operation                                                   11
  7.     Financial Statements                                        15
  8.     Changes In and Disagreements With Accountants on
         Accounting and Financial Disclosure                         16

                              PART III
         -----------------------------------------------------
  9.     Directors, Executive Officers, Promoters and Control
         Persons; Compliance With Section 16(a) of the Exchange
         Act                                                         16
  10.    Executive Compensation                                      17
  11.    Security Ownership of Certain Beneficial Owners and
         Management                                                  19
  12.    Certain Relationships and Related Transactions              20
  13.    Exhibits and Reports on Form 8-K                            21

  Signatures                                                         24

  Financial Information                                           Appendix A

                                  i
<PAGE>

                                 PART I

ITEM 1.   DESCRIPTION OF BUSINESS.

GENERAL

    CD Warehouse, Inc. (the "Company") was formed in September 1996 to acquire
the assets of Compact Discs International, Ltd. ("CDIL"), a Texas limited
partnership which franchises stores throughout the United States and England
under the name "CD Warehouse."  CD Warehouse stores sell, trade and buy new
and preowned compact dics ("CD's") and related products.  According to the
January 1996 issue of ENTREPRENEUR MAGAZINE, CDIL was ranked among the top 30
new franchises in the United States.  At December 31, 1996, there were 113
franchised CD Warehouse stores in 26 states and England.

    The CD is a digital storage medium developed by Phillips Electronics of the
Netherlands and Sony Corporation of Japan and introduced commercially in the
U.S. in 1983.  The pronounced freedom from surface noise, the absence of tape
hiss, and the large dynamic range of the CD (i.e., the ability to play very
quiet and very loud passages without excessive distortion) have made the
digitally-recorded CD a success in the music industry.  Moreover, improved
mechanical isolation of CD players, information buffering and rapid random
access have made CD playing acceptable for automobile as well as home use.

    According to the Recording Industry Association of America (the "RIAA"), CD
sales in the United States were over 700 million units in 1995, generating
annual sales exceeding $9 billion.  The lack of any audible difference between
new and preowned CD's, durability of the medium, cost savings and the
accumulating stock of available CDs for resale, suggest the possibility for
rapid market growth in the preowned CD market.

    The CD Warehouse concept capitalizes on the emergence of CD's as the
prevailing form of prerecorded music.  Because the CD is encased in plastic
and read by a laser, the playing of CD's, and even the occasional careless
handling of CDs, rarely cause damage that will impair performance or result
in any degradation of sound quality.  In the absence of pronounced abuse,
CD's may reasonably be expected to last for decades; premium (gold-plated)
CD's may last for centuries.  Such extraordinary durability, coupled with the
standard error-correction circuitry in CD players, means that preowned CDs
are essentially indistinguishable from new CDs in terms of audible
performance.  By offering quality preowned CD's at substantial savings and
responding to consumers' desire to recycle merchandise they no longer want or
use but which has intrinsic value, the CD Warehouse remarketing concept
emphasizes consumer value.  The CD Warehouse marketing slogan, "selling
compact discs at compact prices," embodies this concept.

    CD Warehouse stores sell their products to the general public in the
market area where the respective store is located.  A typical CD Warehouse
store, located in a high traffic strip shopping center, will occupy between
1,000 and 2,000 square feet and offer between 8,000 and 12,000 selections,
with approximately 80% of the dollar sales volume being preowned selections
and the balance being new releases from the major music categories.  At each
CD Warehouse store, a customer selects from a number of new and preowned CD's
and may listen to preowned CD's before purchase.  CD Warehouse sells CD's,
takes customers' CD's in trade or buys customers' CD's for cash.  Typically,
each CD Warehouse store carries the majority of the Billboard Top 100
selections as "new" inventory, filling out its inventory selection with
preowned CD's which are purchased for $1 to $4 and remarketed for $6 to $9.


    The Company's expansion strategy for 1997 is to open 9 to 12 Company-owned
stores and 18 to 24 franchised stores.  Simultaneously with the closing of the
Company's initial public offering (the "Offering"), which was consummated on
January 27, 1997, the Company  acquired the assets of CDIL (the "CDIL
Acquisition") for a purchase price of $3.2 million.  See Item 12 - Certain
Relationships and Related Transactions.  In a related transaction (the
"MacDonald Acquisition"), which also occurred simultaneously with the closing
of the Offering, the Company's wholly owned subsidiary, Compact Discs
Management, Inc. ("CD Management") acquired the equity interests of Bruce D.
MacDonald (together with his affiliates, "MacDonald") with respect to 36
franchised CD Warehouse stores.  Pursuant to the MacDonald Acquisition, the
Company acquired 100% ownership of an existing store in Dallas, Texas (the
"Montfort Street Store") and minority equity interests (including MacDonald's
interest as a managing general partner or limited liability company manager)
in 35 other existing stores (the "MacDonald Equity Interests").  The Company
formed CD Management to act as the successor general partner or manager of,
respectively, 15 partnerships and two limited liability companies originally
organized by MacDonald to fund, own and operate the 35 franchised stores in
which MacDonald holds a minority equity interest.  Pursuant to the MacDonald
Acquisition, the Company issued to MacDonald 80,000 shares of the Company's

                                       1
<PAGE>

Common Stock.  See Item 12 - Certain Relationships and Related Transactions.
Upon consummation of the CDIL Acquisition and the MacDonald Acquisition, the
Company acquired the rights to the CD Warehouse name, assumed CDIL's role as
franchisor under the franchise agreements to which CDIL was a party and
acquired interests in the CD Warehouse Stores in which MacDonald had an
interest.

    During the year ended December 31, 1996, on a pro forma basis taking into
account the CDIL Acquisition and the MacDonald Acquisition, the Company had pro
forma total revenues of approximately $5,006,000, and pro forma net income, as
adjusted, of approximately $176,000.  There can be no assurance that the
historical level of the Company's revenues and net income will continue to be
achieved in the future.

    Certain statements contained herein relating to the Company's proposed
business strategy and expansion plans are not based on historical facts, but
are forward-looking statements that are based upon numerous assumptions about
future conditions which may ultimately prove to be inaccurate and actual
events and results may materially differ from anticipated results described
in such statements.  The Company's ability to achieve such results is subject
to certain risks and uncertainties, such as those inherent generally in the
retail and franchising industries, the impact of competition and pricing,
changing market conditions, the risks detailed in Item 3 - Legal Proceedings
and other risks detailed throughout this Annual Report (the "Report").  These
forward-looking statements represent the Company's judgment as of the filing
date of  this Report.  The Company disclaims, however, any intent or
obligation to update these forward-looking statements.  As a result, the
reader is cautioned not to place reliance on these forward-looking statements.

BUSINESS STRATEGY

    The Company believes that there is a growing consumer willingness to
purchase preowned CD's, which  is providing an expanding market niche in the
retail music industry for CD resellers.  The Company's business strategy is
to establish itself as the recognized industry leader in the domestic
buy-sell-trade retail CD marketplace by pursuing a three-fold approach: (1)
offering quality, preowned CD's at exceptional value; (2) selling new
releases at competitive prices; and (3) offering to accept as a trade, or buy
for cash, selected CD's from customers.

    The Company's expansion strategy for 1997 is to open 9 to 12
Company-owned stores and 18 to 24 franchised stores.  Management believes
that, in addition to the Company, Disc Go Round and The Wherehouse are the
only national chains engaged in the sale of preowned CD's.  Based on publicly
available information regarding such companies, the Company believes that CD
Warehouse stores currently account for approximately 23% of the estimated 480
chain-based CD reseller stores that operate throughout the United States.
Management believes that the market for CD remarketers is fragmented and
underserved, and that the Company can increase its market share by expanding
the CD Warehouse concept in targeted markets.  To accomplish this objective,
the Company intends to employ a business strategy that includes the following
elements:

      INVENTORY MANAGEMENT SYSTEM.  The Company considers its inventory
management system, which is a proprietary software program, to be essential
to the success of its business strategy and the CD Warehouse concept.  The
program, which has a database in excess of 60,000 titles and includes
catalogs from all the major record labels, assists each store in selectively
procuring preowned CD's by supplying buying directions for every CD offered.
The ability to access this data instantly gives store operators the
capability to make an informed decision on every CD presented by a customer
for purchase or trade, by reviewing the title's historic sales data, as well
as the recommended purchase price that the CD has been assigned by the
Company.  By scanning each CD (utilizing bar coding capability), the program
also includes point-of-sale recording of all transactions, including customer
profiles with which mailing lists may be created.  Additionally, as each
transaction is entered, the program provides for the printing of customer
receipts which concurrently compiles inventory by title, including respective
costs, selling price and gross profit results. Accordingly, the program can
generate reports of comprehensive data for any selected period or any facet
of store operations, including sales by title, sales by dollar volume,
inventory by title, individual transaction summaries, acquisitions for any
period, system adjustments, cash register reconciliation and virtually any
other pertinent financial information.

    The Company believes that its inventory management system contributes to
more efficient system-wide management of inventory by reducing the need to
purchase new titles from music distributors for new store inventories and
affording existing stores the opportunity to sell excess inventory.  As new
stores are developed, opening packages

                                       2
<PAGE>

of inventory are assembled by the Company and sold to the franchisees.  The
demand for inventory by new stores allows existing stores to sell excess
inventory.  The Company has a policy of buying available inventory directly
from the retail locations and, with modem and Internet capability, the
Company compiles real-time inventory information.  If, for example, it is
determined that a store may be overstocked on a particular selection, the
Company may purchase the selection and resell it to another unit or as part
of the opening inventory of a new store.  The Company believes that this is a
significant advantage in comparison to its competitors since the Company can
review all titles available and source its own system for inventory.
Management anticipates, based on CDIL's operational history, that as much as
75% of the opening inventory for a new store can be purchased from the
current system of CD Warehouse stores.  This constant inventory turnover
allows existing stores to make a reasonable profit and provide a source of
capital while providing an opportunity for the Company to acquire quality
inventory to open new stores or update an existing location's inventory.

    CUSTOMER SERVICE.   The Company emphasizes excellent customer service and
seeks to employ, and to sell franchises to, motivated and energetic people.
Management believes in employing an owner/operator principal in which the store
manager has a vested interest in increasing sales and profitability.  It is
management's intent to encourage this same philosophy to its multi-unit
franchises.  The Company also intends to foster enthusiasm for its customer
service philosophy and the CD Warehouse concept through annual franchise
conventions, regional meetings and other frequent contacts with its franchisees
and store managers.

    TARGETED EXPANSION.   The Company believes that its existing core and
developing markets offer significant growth opportunity for both Company-owned
and franchised store development.  During 1997, the Company intends to
concentrate its expansion of Company-owned stores in markets where it can
cluster stores, thereby expanding consumer awareness and creating significant
operating, distribution and advertising efficiencies.  To increase its
penetration of core markets, the Company intends to co-develop markets with
franchisees, divide markets among franchisees or divide markets among the
Company and franchisees.  The Company also intends to cluster its Company-owned
stores and franchised stores through the use of area development agreements and
its site selection approval process.  The Company believes that this approach
will result in increased average store sales.

STORE LOCATIONS

    The table below illustrates the location by state of all CD Warehouse
retail stores in the United States and England as of December 31, 1996:

DOMESTIC
--------
ALABAMA                        IDAHO             MARYLAND
Decatur                        Idaho Falls       Laurel
Huntsville
                               ILLINOIS          MISSOURI
ARKANSAS                       Carol Stream      Ballwin
Little Rock*                   Lombard           Branson*
                               Streamwood        Cape Girardeau
COLORADO                       Wheaton           Gladstone*
Colorado Springs                                 Springfield*
Denver*                        IOWA              St. Louis
Ft. Collins*                   Des Moines
                               Davenport         MONTANA
FLORIDA                                          Bozeman
Ft. Myers                      KANSAS
Jacksonville*                  Overland Park*    NEBRASKA
Lake Park                      Shawnee*          Omaha*
Naples                         Wichita*
Neptune Beach*                                   NEW YORK
Orange Park*                   LOUISIANA         New York
Tallahassee                    Baton Rouge*
Tampa*                         Baton Rouge*      OHIO
Venice                         Bossier City      Columbus
                               Kenner*           Columbus
GEORGIA                        Lafayette*        Mayfield Heights
Atlanta                        Metarie*          Miamisburg
Martinez                       Shreveport        Parma Heights
                               Slidell           Toledo

                                       3
<PAGE>

OKLAHOMA                       Beaumont*                Temple
Edmond*                        Carrollton               Waco*
Oklahoma City - N              College Station*         Webster
May*                           Dallas - Montfort**      Wichita Falls
Oklahoma City-NW               Dallas- Oak Lawn         Midland
Expressway*                    Dallas- Preston          N. Richland Hills
Tulsa - S Sheridan*            Dallas- Skillman         Plano
Tulsa - S Peoria               Dallas - Walnut Hill
                               Denton *                 UTAH
OREGON                         El Paso                  Provo
Portland - SW                  Ft. Worth - Berry        St. George
Washington St.                 Street                   Taylorsville*
Portland - NE                  Ft. Worth - S. Hulen
Broadway                       Garland                  VIRGINIA
                               Houston - FM 1960 W      Alexandria*
SOUTH CAROLINA                 Houston - D.S.
Greenville                     Shepherd*                WASHINGTON
                               Houston -                Seattle
SOUTH DAKOTA                   Copperfield
Rapid City                     Irving*                  WISCONSIN
                               Lewisville*              Appleton
                               Lubbock                  Brookfield
TENNESSEE                      Mesquite*                Kenosha
Jackson                        San Angelo               Milwaukee
Memphis*                       San Antonio - NW
                               Military                 INTERNATIONAL / UK
TEXAS                          San Antonio -
Abilene                        Thousand Oaks            Ealing
Arlington  - Cooper            San Antonio - Evers      Leeds
Street*                        San Antonio -            London
Arlington - N                  Broadway
Collins                        San Antonio - San
Austin - Research Blvd         Pedro
Austin - Guadalupe             Sherman

____________________

*   Franchise store operations managed by CD Management, a wholly-owned
    subsidiary of the Company, which also owns a minority equity interest in
    the indicated store.

**  Pursuant to the MacDonald Acquisition, which was consummated on January
    27, 1997, the Company acquired 100% ownership.

EXPANSION STRATEGY

    The first CD Warehouse store opened in Dallas, Texas in August 1992 and, as
of December 31, 1996, there were a total of 113 CD Warehouse stores in 26 states
and England, all but one of which were franchised.  In 1997, the Company expects
to open between 18 and 24 new franchised stores and 9 to 12 new Company-owned
stores.  Key elements of the Company's expansion strategy include:

    AGGRESSIVE, BALANCED GROWTH.  The Company's expansion strategy is to
balance the growth of its Company-owned and franchised stores by increasing its
emphasis on Company-owned store expansion.  A Company-owned store provides a
greater potential economic return to the Company than does a franchised store.
The Company believes that, in many cases, the Company will be able to take
advantage of a promising new location by establishing a Company-owned store when
a delay in finding a qualified franchisee might jeopardize the Company's ability
to secure the site.  Company-owned stores also provide a training ground for
Company-owned store and district managers and a controllable testing ground for
new products and promotions, operating and training methods and merchandising
techniques.  The Company also plans to open additional franchised stores, which
enable the Company to expand its system more quickly with no capital investment.

    NAME RECOGNITION AND NEW MARKET PENETRATION.  The Company believes the
visibility of its stores at high traffic strip shopping centers has generated
good name recognition in the areas in which stores currently are located.  CD
Warehouse stores historically have been concentrated in the Southwest United
States, but recent growth has generated a gradual shift outward into adjoining
states and scattered parts of the Midwestern and Southeastern United States.
The Company's expansion strategy involves initially the building-out of these
existing markets and subsequently the further penetration of developing markets
through the clustering of both Company-owned and franchised stores.  This
expansion strategy is designed to take advantage of operational and advertising
efficiencies through store clustering within television and other advertising
markets, thereby increasing market penetration and consumer awareness.  To
accelerate penetration of larger markets, the Company intends to co-develop
markets with franchisees or divide markets among franchisees, and intends to
utilize market co-development where appropriate.  In determining which new
markets to

                                       4
<PAGE>

develop, the Company considers many factors, including the size of the
market, demographics and population trends, competition and real estate
availability and pricing.

    INTERNATIONAL FRANCHISE EXPANSION.  There are three franchised stores
currently operating in England.  In connection with the CDIL Acquisition, the
Company has entered into a master franchise agreement (the "Worldwide Area
Development Agreement") with the founder of CDIL, Mark E. Kane.  The Worldwide
Area Development Agreement provides for a period of ten years for development of
franchise operations worldwide, excluding the United States, Canada and Mexico,
and includes a provision which allows the Company, at its option, to purchase
Mr. Kane's interest in any franchised operations developed pursuant to the
Worldwide Area Development Agreement.  The development schedule under the
agreement requires that Mr. Kane open 100 stores over the ten year period.  The
agreement provides that Mr. Kane will pay the Company an amount to be jointly
determined between the Company and Mr. Kane on a country-by-country basis,
provided that the Company will receive a franchise fee of not less than $3,000
per store, a minimum royalty of  1% of gross sales based on individual store
sales volume and 20% of the total fee received from each subfranchisee by Mr.
Kane.  The Company's intent is to focus its own efforts on developing the CD
Warehouse franchise system domestically, and it considers the Worldwide Area
Development Agreement an attractive vehicle to utilize the expertise of Mr. Kane
to develop the international franchise system.  See Item 12 - Certain
Relationships and Related Transactions.

    CONSIDERATION OF ACQUISITIONS.  Concurrently with the Offering, the
Company acquired the interests of MacDonald, the largest CD Warehouse
franchisee.  The Company intends to pursue the acquisition of other local and
regional preowned music retailers to implement its strategy of building out
current markets and establishing itself in new target markets that may be
concurrently developed by the Company as well as franchised stores.

    NEW STORE CONCEPT.  The Company is investigating the need for a new,
consistent appearance, both externally and internally, for all units.  A
prototype unit opened in August 1996, in Plano Texas.  This particular store
carries slightly more inventory (16,000 titles) and utilizes updated decor and
lighting schemes.  The Company believes that by offering a larger variety in
both new and preowned titles, it will derive greater profits.  Once a
determination is made, a uniform, low cost remodel plan will be devised for the
system as a whole.

OPERATIONS

    ACQUISITION OF PREOWNED CD'S.  A key component of the CD Warehouse concept
is to accept as a trade or buy for cash selected CD's from customers;
accordingly, the Company anticipates that it will obtain its preowned CD
inventory primarily from within the system itself.  Additionally, utilizing its
inventory management system, which is a proprietary program, the Company affords
existing stores the opportunity to sell excess inventory.  As new stores are
developed, opening packages of inventory are assembled by the Company and sold
to the franchisees.  The demand for inventory by new stores allows existing
stores to sell excess inventory.  The Company has a policy of buying available
inventory directly from the retail locations and, with modem and Internet
capability, the Company compiles real-time inventory information.  If, for
example, it is determined that a store may be overstocked on a particular
selection, the Company may purchase the selection and resell it to another unit
or as part of the opening inventory of a new store.  The Company believes that
this is a significant advantage in comparison to its competitors since the
Company can review all titles available and source its own system for inventory.
Management anticipates, based on CDIL's operational history, that as much as 75%
of the opening inventory for a new store can be purchased from the current
system of CD Warehouse stores.  This constant inventory turnover allows existing
stores to make a reasonable profit and provide a source of capital while
providing an opportunity for the Company to acquire quality inventory to open
new stores or update an existing location's inventory.

    PURCHASING OF NEW CD'S, OTHER POINT-OF-SALE ITEMS AND STORE FIXTURES.
For new music releases, the Company contracts with six major industry CD
suppliers (Sony Music; Warner/Elektra/Atlantic Corp. (subsidiary of Time
Warner); BMG Music (subsidiary of Bertelsman); MCA, Inc. (subsidiary of
Matsushita); PolyGram (subsidiary of Philips); and CEMA (subsidiary of
Thorn-EMI) to provide the necessary access to new titles.  As these new
releases become available, the Company reviews all titles and determines what
specific releases will be acquired for sale to the system.  The Company then
provides a weekly sales program to franchisees and Company-owned stores
consisting of available inventory.  This program includes new releases,
catalog titles (i.e. Elvis Presley, Pink Floyd, movie soundtracks, etc.),
preowned titles and various point of sale and merchandising items.  The
Company negotiates on behalf

                                       5
<PAGE>

of the system for inventory display racks, lighting and related products
which are then shipped directly from the manufacturers to the individual
stores.

    As the system grows, the Company believes that additional quantity
discounts can be negotiated with the respective equipment and product suppliers.
The Company maintains its own distribution facility to provide its franchise and
Company-owned stores with available new and preowned CD's.  Additionally, the
Company is researching the possibility of forward warehousing inventory in
specific regions to reduce the shipping time and related shipping costs.

MARKETING AND ADVERTISING

    Historically, CDIL has had only a limited involvement in direct retail
operations.  Although the Company  provides new stores with certain pre-opening
items and point-of-sale materials, and additional point-of-sales materials are
available to all stores at no cost from the record companies, CD Warehouse
franchisees currently conduct marketing and advertising activities independently
through newspapers and radio, the funds for which are reserved pursuant to the
franchise agreement, which provides for each store to reserve 2.5% of sales to
spend specifically on advertising.  It is the Company's intent, as markets reach
relative points of saturation, to develop an advertising cooperative that the
Company will manage to support enhanced advertising (i.e., television, direct
mail, etc.).  Additionally, the Company is considering making preowned CD's
available for sale through Internet access.

FRANCHISING PROGRAM

    GENERAL.  As of December 31, 1996, there were a total of 113 CD Warehouse
stores in 26 states and England.  The Company expects that 18 to 24 new
franchised stores will open by the end of 1997.  However, there can be no
assurance that all of these stores will be opened or that the development
schedule set forth in each area development agreement will be achieved.

    The Company's franchise agreement provides the franchisee the right to use
the Company's trade names, service marks and trademark; design plans, color
schemes, signs and fixtures for store premises; buying and selling guidelines;
computerized inventory management system; initial inventory, operations and
financial control guidelines; initial management training; and advertising
assistance.

    The following table sets forth the number of CD Warehouse stores opened and
closed since the inception of the CD Warehouse franchise system:

                  1992      1993      1994      1995      1996      TOTAL
                  ----      ----      ----      ----      ----      -----
    Opened         2         17        51        36        24        130
    Closed         0         0          3         7         7         17
                                                                     ---
                                                                     113

    FRANCHISE SOURCING AND SELECTION.  The majority of new franchises are
awarded to persons referred by existing franchisees, to interested consumers
who have visited CD Warehouse stores and to existing franchisees.  Franchisees
are approved by the Company on the basis of the applicant's net worth and
liquidity, together with an assessment of work ethic and personality
compatibility with the Company's operating philosophy.

    FRANCHISE MARKETING PROGRAM.  The Company's franchise marketing program
seeks to attract prospective franchisees with management experience, a minimum
level of net worth and strong interest in the retail music business.  The
Company markets its franchise opportunities by advertising in selected business
magazines and franchise-oriented publications.  Each inquiry is responded to and
an initial determination is made as to the prospect's qualifications to

                                       6
<PAGE>

become a CD Warehouse franchisee.  Once initially qualified, the prospect is
mailed the Company's brochure and marketing materials.  The inquiry is then
followed up on within a period of two weeks.  In June 1996, CDIL implemented
an enhanced advertising strategy utilizing Entrepreneur Magazine.  The
Company believes that the new marketing program has resulted in heightened
awareness of CD Warehouse as a franchise opportunity.

    The Company also intends to establish a home page via the Internet (World
Wide Web) that will provide detail on the franchise opportunities presented by
operating a CD Warehouse store.

    TRAINING AND SUPPORT.  The Company's philosophy is one of service and
commitment to its franchise system and it intends to implement a plan to
improve its franchise support services. Each franchise owner/operator and each
franchised store manager is required to complete a comprehensive training
program in store operation and management. Topics covered in the training
course include the Company's philosophy of store operation and management,
customer service, merchandising, marketing, pricing, inventory and cost
control, record keeping, labor scheduling and personnel management.  Training
is based on standard operating policies and procedures contained in an
operations manual provided to all franchisees, which the franchisee is
required to follow by terms of the franchise agreement. Additionally, trainees
are provided with a complete orientation to Company operations by meeting with
members of the senior management of the Company. Training continues through
the opening of the store, where Company field personnel assist and guide the
franchisee in all areas of operation.

    THE FRANCHISE AGREEMENT; TERMS AND CONDITIONS.  The domestic offer and sale
of CD Warehouse franchises is made by its Uniform Franchise Offering Circular
prepared in accordance with federal and state laws and regulations.  States that
regulate the sale and operation of franchises require a franchisor to register
or file certain notices with the state authorities prior to offering and selling
franchises in those states.

    Under the current form of domestic franchise agreement in effect at March
26, 1997, franchisees pay the Company (i) an initial franchise fee of $15,000,
(ii) royalties equal to 5% of monthly gross sales and (iii) a marketing fee
equal to 2.5% of monthly gross sales.  CD Warehouse franchisees existing prior
to January 27, 1997, who enter into a Franchise Agreement for a new location
on or prior to December 31, 1998, will pay the Company (i) an initial
franchise fee of $6,000;  (ii) royalties equal to 5% of monthly gross sales
and (iii) a marketing fee equal to 2.5% of monthly gross sales. Franchisees
are generally granted exclusive territory with respect to the operation of CD
Warehouse stores only in the immediate vicinity of their stores.

    The franchise agreement requires franchisees to purchase from the Company
certain proprietary software and the store's initial inventory, and to comply
with the Company's procedures of operation, to permit inspections and audits by
the Company and to remodel stores to conform with standards in effect from time
to time for the CD Warehouse system.  The Company may terminate the franchise
agreement upon the failure of the franchisee to comply with the conditions of
the agreement and upon the occurrence of certain events, such as insolvency or
bankruptcy of the franchisee or the commission by the franchisee of any unlawful
or deceptive practice, which in the judgment of the Company is likely to
adversely affect the CD Warehouse system.  The Company's ability to terminate
franchise agreements pursuant to such provisions is subject to applicable
bankruptcy and state laws and regulations.

    The agreement prohibits the transfer or assignment of any interest in a
franchise without the prior written consent of the Company.  The agreement also
gives the Company a right of first refusal to purchase any interest in a
franchise if a proposed transfer would result in a change of control of that
franchise.  The refusal right, if exercised, would allow the Company to purchase
the interest proposed to be transferred under the same terms and conditions and
for the same price as offered by the proposed transferee.

    The term of each franchise agreement is ten years, and franchisees
generally have the right to renew for an additional ten-year term.  All of the
franchise agreements assigned to the Company in connection with the CDIL
Acquisition will expire between 2002 and 2006.

                                       7
<PAGE>

    UNIT ECONOMICS.  The Company believes that future CD Warehouse stores can
be opened for an  initial investment range of  $88,000 to $113,000.  The
estimated initial investment is comprised of the following:

                                       MINIMUM   MAXIMUM
                                       --------  ---------
    Franchise Fee..................... $  6,000  $  15,000
    Inventory.........................   45,000     55,000
    Leasehold Improvements............    9,500     11,500
    Proprietary Software..............    1,500      1,500
    Signage (exterior and interior)...    5,500      7,000
    Fixtures and equipment............    9,000     10,000
    Lease and utility deposits........    1,500      3,000
    Initial working capital...........   10,000     10,000
                                       --------   --------
           Total......................  $88,000   $113,000
                                       --------   --------
                                       --------   --------

    Management believes that a key indicator of the success of a franchise
location is the sales to capitalization ratio.  That ratio is defined as the
annual sales revenue generated by the business divided by the capitalization
costs to open the business.  For the year ended December 31, 1996, average unit
sales on a comparable basis were $276,000.  Based on an average initial
estimated capitalization of $100,000, the sales to capitalization ratio to open
a new CD Warehouse store is 2.76 to 1.

    FRANCHISE FINANCING.  The Company's predecessor did not provide prospective
franchisees with financing for its stores.  Typically, franchisees have obtained
their own sources of such financing and have not required the Company's
assistance.  On March 3, 1997, the Company executed an agreement with Berthel
Fisher Leasing Company, Inc. ("Berthel Fisher"), pursuant to which Berthel
Fisher has agreed to provide up to an aggregate $1 million of equipment,
furniture and fixtures financing to new franchisees.

COMPANY STORE PROGRAM

    As a result of the MacDonald Acquisition, the Company acquired interests in
36 CD Warehouse stores, and intends to open 9 to 12 Company-owned stores in
1997.  Although Company-owned stores require an initial capital outlay by the
Company, they also provide a greater potential economic return to the Company
than franchised stores.  The Company estimates that the cost of opening a new
Company-owned store is approximately $90,000, excluding pre-opening costs but
including initial inventories.

    Company-owned stores also permit market penetration, or seeding, in the
absence of an immediately-viable multi-location franchise operator.  Company
stores provide an opportunity to continually refine the Company's standard store
model in order to respond to market dynamics.  Variations in inventory mix,
ancillary product offerings, and marketing and sales techniques can be tested
and refined before implementation throughout the system.

    The Company believes in the owner-operator concept.  It is the intent
that each Company-owned store will be operated by an owner-manager.  The
Company believes that this relationship provides operators with an incentive
to perform with a higher degree of commitment to the store's business.  As a
market is developed, manager-owners will be given opportunities to progress
into multi-unit management.  A typical multi-unit supervisor will own up to
20% of each unit under his supervision.

    Managers of Company-owned stores are required to comply with all Company
operating standards and undergo training and receive support from the Company
similar to the training and support provided to franchisees.  See Item I --
Description of Business.  The Company's Vice President-Company Store
Operations and his staff regularly visit Company-owned stores to ensure
compliance with Company standards and procedures and to provide advice and
support.

                                       8
<PAGE>

GOVERNMENTAL REGULATION

    The Company is subject to various federal, state and local laws affecting
its business.  Each of the Company's stores is subject to licensing and
regulation by a number of governmental authorities, which include taxing, zoning
and building agencies in the state or municipality in which the store is
located.  Difficulties in obtaining or failures to obtain required licenses or
approvals could delay or prevent the opening a new store in a particular area.

    The Company is subject to Federal Trade Commission ("FTC") regulation and
various state laws which regulate the offer and sale of franchises.  The FTC has
adopted a rule that requires franchisors to make certain disclosures to
prospective franchise owners prior to the offer or sale of franchises.  This
rule requires the disclosure of information necessary for a franchise owner to
make an informed decision as to whether to enter into a franchise relationship
and delineates the circumstances in which franchisors may make predictions on
future sales, income and profits.  Failure to comply with this rule constitutes
an unfair or deceptive act or practice under the Federal Trade Commission Act.
Additionally, numerous states have in recent years adopted laws regulating
franchise operations and the franchisor-franchisee relationship, and similar
legislation is pending in Congress and several other states.  Existing laws and
pending proposals vary from filing and disclosure requirements in the offer and
sale of franchises to the application of statutory standards regulating the
establishment and termination of franchise relationships.  These laws generally
apply to both area and individual franchises.  Although the foregoing matters
may result in some modification in the Company's franchising activities and some
delays or failures in enforcing certain of its rights and remedies under certain
area or individual franchise agreements, such modifications, delays or failures
have not had a material adverse effect on the Company's operations or business.
However, the law applicable to franchise operations and relationships is still
developing, and the Company is unable to predict the effect, if any, on its
operations of additional requirements or restrictions that may be enacted or
promulgated or of court decisions that may be adverse to the franchise industry.
While it is difficult to assess potential effects of federal and state
legislation in the U.S. or new international laws that may impact the industry,
the Company does not anticipate any material adverse effects from such
legislation or laws at this time.

    The Company's operations are also subject to federal and state laws
governing such matters as wages, working conditions and overtime.

COMPETITION

    The Company competes in the retail music industry, which is highly
competitive in price, selection, service and location and is often affected by
changes in consumer trends, economic conditions, demographics, traffic patterns
and technological innovations.  The following profile provides an overview and
comparison of how the retail "new release" CD industry and the emerging retail
"remarketing" or "buy-sell-trade" CD industry are currently structured and
segmented.

    According to the RIAA, CD sales in the United States were over 700 million
units in 1995, generating annual sales exceeding $9 billion.  The Company has
various competitors in the industry who sell new recordings and music related
merchandise.  These companies vary from those who are specialty music stores in
malls (such as Musicland, Camelot) and those who utilize free-standing buildings
(such as Blockbuster Music, Wherehouse Records).  Empirical studies conducted by
the Company indicate that companies in mall locations typically charge $15.99 to
$17.99 for their front-line CD products.  Those in free-standing buildings
generally have much larger facilities (between 12,000 to 20,000 square feet).
Their selling price for front-line items range between $13.99 and $15.99, with
the latest top 20 releases on sale for $11.99 to $13.99 per CD.  None of these
"superstores" sell preowned music except for Wherehouse Records, which has
generally offered an inventory of preowned CDs in less than 500 square feet of
space with limited selections.

    Other retailers offering music include major national discount stores,
including Wal-Mart, K-Mart and Target stores.  These national discounters
maintain a very small number of new music titles while offering no preowned
music.  Their pricing will typically vary from $11.99 to $13.99 per item in
approximately 1,000 square feet of space.  In another category are the
multi-media electronic stores (such as Best Buy, Circuit City), which have
generally utilized approximately 1,000 square feet of space and discount
their new releases from $9.99 to $12.99 per item.

                                       9
<PAGE>

    The CD Warehouse system competes currently with one other national
company specializing in the sale of preowned CD's.  Disc-Go-Round-R- is
a Minneapolis-based company owned by Grow Biz International, Inc., a
franchisor of several other concepts including Play It Again Sports.
Disc-Go-Round-R-maintains smaller quantities of preowned inventory than does
CD Warehouse. Both CD Warehouse and Disc-Go-Round-R- sell preowned CD's at
$6.00 to $9.00 and new releases at $10.99 to $12.99 as compared to Best Buy
and Circuit City prices of new CD's which range generally from $9.99 to
$12.99 per selection.  Grow Biz International, Inc.'s Form 10-Q for the
quarter ended June 29, 1996 indicates that, at such date, there were 107
units in the Disc-Go-Round-R- system, as compared to 113 units in the CD
Warehouse system.

     The Company believes that CD Warehouse stores compete favorably with its
competition in the preowned CD market in terms of price, selection, service
and location.

     The Company also competes in the franchise industry for prospective
franchisees.  With respect to the only franchisor known to the Company to
engage in a business similar to that of the Company, the Company believes that
it competes favorably.

TRADEMARKS AND SERVICE MARKS

    The Company has registered the name "CD Warehouse" with the United States
Patent and Trademark Office.  The Company believes that its trademark has
significant value and is important to its marketing efforts.

EMPLOYEES

    The Company as of March 26, 1997 employs 23 full-time employees.  None of
the Company's employees are represented by a labor union and the Company
believes that its relations with its employees are good.

ITEM 2.  DESCRIPTION OF PROPERTY.

    The Company's principal executive offices are located at 722 N. Broadway,
Oklahoma City, Oklahoma 73012, where it leases from a director of the Company
approximately 800 square feet under a month-to-month lease with a monthly
lease payment of $600.  See Item 12 - Certain Relationships and Related
Transactions. The Company anticipates that during 1997 it will relocate its
principal offices to a larger facility in Oklahoma City.

    Since the completion of the CDIL Acquisition  in January 1997, and for a
transition period anticipated to last through approximately May 1997, the
Company is also leasing CDIL's offices and warehouse operations located at 1710
Firman, Suite 300, Richardson, Texas 75081.  The total facility is approximately
4,500 square feet and is held under a month-to-month lease with a monthly lease
payment of $2,087.  Approximately 2,500 square feet is used for administrative
purposes and the balance of the space is utilized as a warehouse.

ITEM 3.  LEGAL PROCEEDINGS.

    From time to time, the Company may be involved in litigation relating to
claims arising out of its normal business operation.  The Company is not
currently engaged in any legal proceedings.

    The Company's predecessor, CDIL, was subject to a currently effective order
from the state of South Dakota, issued by the South Dakota Division of
Securities, to cease and desist and refrain from offering or selling franchises
in the State of South Dakota until CDIL had complied with the South Dakota
franchise registration laws.  This cease and desist order was issued because
CDIL sold a franchise to two South Dakota residents and had not registered the
franchise in South Dakota.  The franchise was subsequently terminated, and the
Company has no current plans to offer franchises in South Dakota.

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

    Matters submitted to a vote of security holders during the fourth quarter
of the year ended December 31, 1996 included (1) approval of the Company's
Amended and Restated Certificate of Incorporation, Amended and Restated Bylaws
and the 1996 Stock Option Plan by unanimous written consent dated December 6,
1996; and (2) the election of Jerry W. Grizzle, Gary D. Johnson, Christopher M.
Salyer, and Ronald V. Perry as Directors of the Company by unanimous written
consent dated October 29, 1996.

                                       10
<PAGE>

                                     PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

    As of December 31, 1996, there was no public trading market.  On January
22, 1997, the Company's Common Stock began trading on the Nasdaq SmallCap Market
System under the symbol "CDWI."

    As of March 26, 1997, there were approximately 34 registered holders of
record of the Common Stock.

RECENT SALES OF UNREGISTERED SECURITIES

    The following sets forth certain information regarding sales of securities
of the Company issued within the past three years which were not registered
pursuant to the Securities Act of 1933, as amended (the "Securities Act").

    The Company was organized as a Delaware corporation in September 1996.  The
initial subscribing stockholders, who each subscribed on September 5, 1996, were
Jerry W. Grizzle for 230,000 shares of Common Stock, Matthew Grizzle (Mr.
Grizzle's son) under the Uniform Transfers to Minors Act ("UTMA") for 10,000
shares of Common Stock, Brittany Grizzle (Mr. Grizzle's daughter) under the UTMA
for 10,000 shares of Common Stock, Gary D. Johnson for 75,000 shares of Common
Stock and Doyle E. Motley for 25,000 shares of Common Stock.  Each of such
stockholders paid a purchase price of $1.00 per share for the Common Stock thus
purchased.  No sales commissions were paid in connection with such issuance.
The securities were issued in reliance on the exemption from registration
provided by Section 4(2) of the Securities Act.

    The Company entered into a subscription agreement on October 1, 1996 with
Mark E. Kane for the sale to him of 350,000 shares of Common Stock, at a
purchase price of $1.00 per share.  Because payment of the subscription price
was conditioned upon the successful completion of the Offering, the 350,000
shares of Common Stock were issued, and the subscription price was paid, on
January 27, 1997.  Additionally, in connection with the closing of the MacDonald
Acquisition, on January 27, 1997, Bruce D. MacDonald was issued an aggregate of
80,000 shares of Common Stock.  No sales commissions were paid in connection
with the subscription agreements.  The securities were issued in reliance on the
exemption from registration provided by Section 4(2) of the Securities Act.

ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.

COMBINED STATEMENTS OF OPERATIONS

    The following table (unaudited) sets forth the combined historical results
of operations of CDIL, CD Acquisitions and the MacDonald Assets acquired by the
Company on January  27, 1997.  The historical information has been adjusted to
eliminate operations retained by CDIL and to provide charges for executive
compensation and income taxes as explained below.  The information should be
read in conjunction with the historical Financial Statements and the Pro Forma
Combined Condensed Financial Statements included elsewhere in this Report.


                                                     YEARS ENDED DECEMBER 31,
                                                     ------------------------
                                                         1995         1996
                                                         ----         ----
                                                           (IN THOUSANDS)
       Revenues:
         Retail store sales...........................  $   281       $   241
         Wholesale merchandise sales..................    2,717         3,469
         Software income, net.........................       24             7
         Royalty income...............................      947         1,201
         Franchise and development fees...............      184            88
                                                         ------        ------
            Total revenues............................    4,153         5,006

                                       11
<PAGE>

                                                     YEARS ENDED DECEMBER 31,
                                                     ------------------------
                                                         1995         1996
                                                         ----         ----
                                                          (IN THOUSANDS)
       Costs and expenses:
         Cost of sales - retail store sales...........      180           150
         Cost of sales - wholesale merchandise sales..    2,511         3,277
         Retail store operating expenses..............       68            69
         General and administrative (2)...............    1,015         1,323
         Depreciation and amortization................        9            13
                                                         ------        ------
              Total costs and expenses................    3,783         4,832
                                                         ------        ------
       Operating income...............................      370           174
       Other income...................................       49            48
                                                         ------        ------
       Income before pro forma provision for income
        taxes.........................................      419           222
       Pro forma provision for income taxes(2)........      142            78
                                                         ------        ------
       Pro forma net income(2)........................     $277          $144
                                                         ------        ------
                                                         ------        ------
_______________________

(1) Operations retained by CDIL have been eliminated from the combined
    information presented above.

(2) The operations acquired were organized as partnerships and did not
    historically include charges for executive compensation or income taxes.
    The information presented above includes charges for executive compensation
    based on the cash distribution to partners in each of the periods
    presented.  These amounts which are included in general and administrative
    expenses above, are $296,000 and $509,000 for 1995 and 1996 respectively:

    The pro forma provisions for income taxes are based on a rate of 34%
    applied to pro forma income before income tax in each of the periods
    presented.

OVERVIEW

    The Company was formed in September 1996 to acquire the assets of CDIL, a
Texas limited partnership which franchises and operates stores throughout the
United States and England under the name "CD Warehouse." The first CD Warehouse
store was opened in 1992.  Under the CD Warehouse name, as of December 31, 1996,
there are 110 domestic units operating in 26 states and 3 international units
operating in England.

    Simultaneously with the closing of the Offering, the Company acquired the
CDIL Assets for a purchase price of $3.2 million.  See Item 12 -- Certain
Relationships and Related Transactions.  In a related transaction, which
occurred simultaneously with the closing of the Offering, the Company acquired
the equity interests of MacDonald in 36 franchised CD Warehouse stores.
Pursuant to the MacDonald Acquisition, the Company acquired 100% ownership of
MacDonald's Montfort Street Store and minority equity interests (including
MacDonald's interest as a managing general partner or limited liability
company manager) in the other 35 franchised stores in which MacDonald had an
interest.

    The following discussion and analysis reviews the operations acquired by
the Company in connection with the CDIL Acquisition and the MacDonald
Acquisition for the years ended December 31, 1995 and 1996.  All of such
periods reflect the historical operations of CDIL and financial information
attributable to the MacDonald Assets.  The following discussion and analysis
should be read in conjunction with the discussion about risk factors and the
financial statements of the Company, CDIL and CD Acquisitions and notes
related thereto and "Combined Statements of Operations" included elsewhere in
this document.

                                       12
<PAGE>

    CDIL previously conducted its business through two separate entities, CDIL
and CD Acquisitions.  CD Acquisitions was formed to support the inventory needs
of the CD Warehouse franchise system and engaged in the wholesale supply of new
and preowned CD's to the franchise system, as well as sales of computer hardware
and proprietary software to franchisees.  CDIL and CD Acquisitions were merged
effective January 1, 1996 as a Texas limited partnership.

    Historically, CDIL has had only a limited involvement in direct retail
operations.  The assets acquired from CDIL include minority interests in three
partnerships which operate stores in Memphis, Tennessee, Edmond, Oklahoma and
Tulsa, Oklahoma.  The earnings from such partnerships are reflected as other
income and the investment in those partnerships is reflected as an asset on
CDIL's balance sheet.  The retail store sales relate to the earnings
attributable to the Montfort Street Store acquired from MacDonald.

    On a pro forma basis, the Company's revenues are derived from three
principal sources: (1) franchise fees and royalties from franchised stores; (2)
sales of CD's and proprietary software to stores in the franchise system; and
(3) revenues attributable to the Montfort Street Store.  Franchise and
development fees are initially recorded as deferred revenue until each
franchised store opens, at which time such fees are recorded as revenue.

    Cost of sales include the cost for CD's sold at retail and those sold at
wholesale to franchised stores.  Operating expenses consist primarily of labor
costs, rent and advertising.  General and administrative expenses include
corporate and administrative salaries, accounting, legal and direct costs
associated with franchise operations.


RESULTS OF OPERATIONS

    The following table sets forth the percentage relationship of certain
operating statement data to total revenues, except as otherwise indicated:

                                                   YEARS ENDED DECEMBER 31,
                                                   ------------------------
                                                      1995          1996
                                                      ----          ----
    REVENUES:
      Retail store sales.............................  6.8%         4.8%
      Wholesale merchandise sales.................... 65.4%        69.3%
      Software income, net...........................   .6%          .2%
      Royalty income................................. 22.8%        24.0%
      Franchise and development fees.................  4.4%         1.7%
                                                     ------       ------
        Total revenues...............................100.0%       100.0%

    COST AND EXPENSES:
      Cost of sales - retail store sales (1)......... 64.1%        62.2%
      Cost of sales - wholesale merchandise sales(2). 92.4%        94.5%
      Retail store operating expenses (1)............ 24.2%        28.6%
      General and administrative..................... 24.4%        26.4%
      Depreciation and amortization..................   .2%          .3%

    OPERATING INCOME.................................  8.9%         3.5%
    PRO FORMA NET INCOME.............................  6.7%         2.9%
_______________________

(1) As a percentage of sales from the majority owned retail store.
(2) As a percentage of wholesale merchandise sales.

                                       13
<PAGE>

YEAR ENDED DECEMBER 31, 1995 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1996

    REVENUES

    Total revenues increased by $853,000, or 21%, to $5,006,000 for the year
ended December 31, 1996 compared to $4,153,000 for the year ended December 31,
1995.  This increase resulted primarily from the 24 franchised stores opened
during the year ended December 31, 1996, as well as from the 36 stores opened
periodically throughout 1995 (which contributed revenues for the entire period
in 1996), and the resulting increases in royalties and  merchandise sales to
more stores.

    Wholesale sales to franchised stores increased $752,000, or 28%, to
$3,469,000 for the year ended December 31, 1996 compared to $2,717,000 for the
year ended December 31, 1995.  This increase resulted primarily from the opening
inventory packages purchased by the 24 new franchised stores opened during the
year ended December 31, 1996.

    Royalties from franchised stores increased $254,000, or 27%, to $1,201,000
for the year ended December 31, 1996 compared to $947,000 for the year ended
December 31, 1995.  This increase resulted primarily from the 24 new franchised
stores opened during the year ended December 31, 1996, as well as from the 36
stores opened periodically throughout 1995 (which contributed revenues for the
entire period in 1996).

    COSTS AND EXPENSES

    Cost of sales for wholesale sales to franchised stores increased $766,000,
or 31%, to $3,277,000 for the year ended December 31, 1996 compared to
$2,511,000 for the year ended December 31, 1995.  This increase is primarily the
result of greater volume due to the increased number of stores opened during the
period, as well as higher product cost from suppliers.

    General and administrative expenses increased by $308,000, or 30%, to
$1,323,000 for the year ended December 31, 1996 compared to $1,015,000 for the
year ended December 31, 1995.  This increase resulted from the 24 new franchised
stores opened during the year ended December 31, 1996 and the increase of
executive salaries taken by the previous owners of $509,000 for the year ended
December 31, 1996 compared to $296,000 for the same period of 1995.

    NET INCOME

    Net income decreased $133,000, or 48%, to $144,000 for the year ended
December 31, 1996 compared to $277,000 for the same period ended December 31,
1995.  This decrease was primarily due to the additional $213,000 in salary
taken by CDIL's owners compared to the prior period.

LIQUIDITY AND CAPITAL RESOURCES

    Historically, CDIL has required capital primarily for the development of
the franchise system and to fund inventory purchases for CD Acquisitions.  CDIL
has historically funded such expenditures with cash provided by operations.  Net
cash provided by operating activities of CDIL was $316,000 and $765,000 for the
years ended December 31, 1995 and December 31, 1996, respectively.

    The Company has available approximately $1,500,000 in working capital from
the proceeds of the Offering and the stock subscription of Mark E. Kane in
connection with the CDIL Acquisition.  This available capital will be used to
support an aggressive Company store development program.  In addition, the
Company will be developing a standard decor package to establish the identity of
the system through its appearance.  Once the decor package is developed, the
Company will evaluate the need to remodel the 36 stores in which the Company has
an equity interest as a result of the MacDonald Acquisition.

    The Company will also use its capital resources to take advantage of any
suitable acquisition opportunities.  The preowned CD market consists of numerous
single store operators that the Company believes may be candidates for
acquisition and conversion to the CD Warehouse concept.

                                       14
<PAGE>

    The Company and Mr. Grizzle were parties to a Finders and Release Agreement
(the "Finders' Agreement"), pursuant to which the Company has paid certain
unaffiliated parties a finder's fee of $100,000 for their assistance in
identifying CDIL for acquisition.   As of December 31, 1996 the Company had made
a nonrefundable payment of $40,000 in partial satisfaction of this obligation
and subsequently paid the balance of $60,000 at the closing of the CDIL
Acquisition.  None of the proceeds of the Offering was used to pay the
remaining obligation under the Finders' Agreement.

    In addition to the working capital expected to be available from the
proceeds of the Offering, Bank One, Oklahoma City, Oklahoma has agreed to
provide the Company a $2,000,000 credit facility (the "Credit Facility").
Although a definitive agreement respecting the Credit Facility had not yet been
executed as of the date of this Report, amounts borrowed under the Credit
Facility are expected to bear an interest rate equal to .75% over Bank One's
base rate, adjusted automatically  based upon current prime rate.  As of the
date of this Report, no funds had been borrowed under this Credit Facility.
It is the Company's opinion that the excess proceeds generated from the
Offering, combined with the Credit Facility, will be sufficient to support the
ongoing activities of the business for the foreseeable future.

ITEM 7.  FINANCIAL STATEMENTS.

    The consolidated financial statements of the Company and its predecessor,
CDIL, are incorporated by reference from pages F-1 through F-50 of the attached
Appendix, and include the following:

1.  Pro Forma Combined Condensed Financial Statements:
    (a)  Pro Forma Combined Condensed Balance Sheet at December 31, 1996
    (b)  Pro Forma Combined Condensed Statement of Operations for the year
         ended December 31, 1996

2.  Historical Financial Statements:

    (a)  Financial Statements of C D Warehouse, Inc.

    (1)  Report of Independent Auditors
    (2)  Consolidated Balance Sheet at December 31, 1996
    (3)  Consolidated Statement of Operations for the period from September 5,
         1996 (inception) to December 31, 1996
    (4)  Consolidated Statement of Stockholders' Equity for the period from
         September 5, 1996 (inception) to December 31, 1996
    (5)  Consolidated Statement of Cash Flows for the period from September 5,
         1996 (inception) to December 31, 1996
    (6)  Notes to Consolidated Financial Statements

    (b)  Financial Statements of Compact Discs International, Ltd.

    (1)  Independent Auditors' Report
    (2)  Balance Sheet at December 31, 1996
    (3)  Statement of Income for the year ended December 31, 1996
    (4)  Statement of Partners' Capital for the year ended December 31, 1996
    (5)  Statement of Cash Flows for the year ended December 31, 1996
    (6)  Notes to Financial Statements

    (c)  Financial Statements of Compact Discs International, Ltd. and
         Subsidiary

         (1)  Independent Auditors' Report
         (2)  Consolidated Balance Sheet at December 31, 1995
         (3)  Consolidated Statement of Income for the year ended December 31,
              1995
         (4)  Consolidated Statement of Partners' Capital for the year ended
              December 31, 1995
         (5)  Consolidated Statement of Cash Flows for the year ended December
              31, 1995
         (6)  Notes to Consolidated Financial Statements

                                       15
<PAGE>

    (d)  Financial Statements of C D Acquisitions

         (1)  Independent Auditors' Report
         (2)  Balance Sheet at December 31, 1995
         (3)  Statement of Income and Venturers' Capital for the year ended
              December 31, 1995
         (4)  Statement of Cash Flows for the year ended December 31, 1995
         (5)  Notes to Financial Statements


ITEM 8.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE

    There have been no material disagreements between the Company and its
independent accountants on accounting and financial disclosure matters which are
required to be reported under this Item for the period for which this report is
filed.

    PART III

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
         COMPLIANCE WITH 16(A) OF THE EXCHANGE ACT.

DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES

    The following table sets forth certain information regarding the directors,
executive officers and key employees of the Company.

      NAME                 AGE               POSITION
      ----                 ---               --------
Jerry W. Grizzle..........  44    Chairman of the Board of Directors, President
                                  and Chief Executive Officer
Gary D. Johnson...........  37    Chief Operating Officer, Executive Vice
                                  President and Director
Bruce D. MacDonald........  41    Vice President-Company Store Operations
Doyle E. Motley...........  42    Senior Vice President and Chief Financial
                                  Officer
Christopher M. Salyer.....  44    Director
Ronald V. Perry...........  47    Director


    JERRY W. GRIZZLE founded the Company in September 1996 and has served as
Chairman of the Board of Directors, President and Chief Executive Officer of the
Company since that time.  From 1984 to 1991, Mr. Grizzle was Vice President and
Treasurer of Sonic Corporation, a publicly held fast food franchisor with over
1,500 units operating in 26 states, and from 1991 to 1994, he owned and operated
Orbit Finer Foods, a privately owned Mexican food product manufacturer.  For a
four-month period in 1994, Mr. Grizzle served as President of Skolniks, Inc., a
publicly held bagel manufacturer ("Skolniks").  Mr. Grizzle resigned from
Skolniks in October 1994 as a result of significant disagreements with the Board
of Directors over Skolniks' corporate practices; subsequent to Mr. Grizzle's
resignation, Skolniks was the subject of an involuntary Chapter 11 proceeding.
Mr. Grizzle received his B.S. degree in Accounting from Southwestern Oklahoma
State University in 1976 and received an M.B.A. in 1983 from the University of
Central Oklahoma.  He is currently completing his Ph.D. in Marketing at Oklahoma
State University, and holds the rank of Colonel in the Oklahoma Army National
Guard.

    GARY D. JOHNSON has been Executive Vice President, Chief Operating Officer
of the Company and a director of the Company since the Company's inception in
September 1996.  For the past nine years, from 1987 to 1996, Mr. Johnson served
as Vice President of Purchasing and Distribution for Sonic Corp.  In such
capacity, Mr. Johnson was

                                       16
<PAGE>

responsible for cooperative purchasing and management of all procurement
functions and distribution for the Sonic system.  Mr. Johnson received his
B.S. degree in Business Management from Southwestern Oklahoma State
University in 1981.

    BRUCE D. MACDONALD was appointed Vice President-Company Store Operations
upon completion of the Offering.  Prior to the Company's acquisition of CDIL,
Mr. MacDonald owned an interest in and managed 36 CD Warehouse retail stores.
Mr. MacDonald is a certified public accountant and began his career at Arthur
Andersen in 1977, after graduating with a B.B.A. degree from Southern Methodist
University in 1977. For at least the last five years, Mr. MacDonald has been
self-employed as a certified public accountant, in addition to his activities as
a CD Warehouse franchisee.

    DOYLE E. MOTLEY was appointed Senior Vice President and Chief Financial
Officer of the Company upon completion of the Offering.  For the past two years,
Mr. Motley has served as an internal auditor for Bob Moore Financial Group, a
multi-state auto dealership.  Prior to that, from 1991 to 1994, Mr. Motley
served as Chief Financial Officer of Orbit Finer Foods.  For a four-month period
in 1994, Mr. Motley served as Chief Financial Officer of Skolniks.  Mr. Motley
resigned from Skolniks in October 1994 as a result of significant disagreements
with the Board of Directors over Skolniks' corporate practices; subsequent to
Mr. Motley's resignation, Skolniks was the subject of an involuntary Chapter 11
proceeding.

    CHRISTOPHER M. SALYER has been a member of the Board of Directors since
October 1996. Mr. Salyer is currently serving as the Chairman and Chief
Executive Officer of Accounting Principals, Inc., a company specializing in the
placement of accounting personnel.  From February 1984 through December 1994,
Mr. Salyer served as the Chairman and Chief Executive Officer of National Check
Cashers Corporation, a retail financial services company.  He received his
B.B.A. degree from Southern Methodist University in 1973 and received an M.B.A.
in 1974 from Babson College in Boston, Massachusetts. Mr. Salyer is a certified
public accountant.

    RONALD V. PERRY has been a member of the Board of Directors since October
1996.  Mr. Perry has served as the President and Chief Operating Officer of
Prime Time Travel, Inc., a travel agency specializing in providing services to a
corporate client base since August 1986.  During this same period of time Mr.
Perry has also served as the President and Chief Operating Officer of Prime Cut
Restaurants, Inc. which owns and operates four restaurants.  Mr. Perry received
his B.B.A. degree from Oklahoma State University in 1971.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

    Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires officers, directors and beneficial owners of more
the 10% of any class of equity securities ("10% Beneficial Owners") of an
issuer registered pursuant to Section 12 of the Exchange Act to file, within
certain prescribed time periods, beneficial ownership reports.  Prior to
January 22, 1997, the Company's common stock was not registered pursuant to
Section 12 of the Exchange Act and, consequently, the Company's Officers,
Directors, and 10% Beneficial Owners were not required, for the period for
which this Report is filed, to file the beneficial ownership reports required
by Section 16(a) of the Exchange Act.

ITEM 10.   EXECUTIVE COMPENSATION.

EXECUTIVE COMPENSATION

    The Company was formed in September 1996 and had not paid any executive
compensation as of December 31, 1996.  In connection with the commencement of
operations by the Company immediately subsequent to the closing of the
Offering, the Company entered into employment agreements with each of the
executive officers of the Company, the terms of which are set forth under
"--Employment Agreements."

DIRECTOR'S COMPENSATION

    Directors who are not officers of the Company are to be paid $1,000 for
each Board of Director's meeting attended.  As of December 31, 1996, Directors
Fees had not been paid to any Director.

                                       17
<PAGE>

1996 STOCK OPTION PLAN

    The Company's Board of Directors and stockholders approved the
implementation of the 1996 Stock Option Plan ("1996 Option Plan").  The
description in this Report of the principal terms of the 1996 Option Plan is a
summary, does not purport to be complete, and is qualified in its entirety by
the full text of the 1996 Option Plan, a copy of which has been filed as an
exhibit to this Report.

    Pursuant to the 1996 Option Plan, employees, officers, directors,
consultants and advisers of the Company are eligible to receive awards of stock
options. The 1996 Stock Option Plan provides for grants of "incentive stock
options" ("ISO's") meeting the requirements of Section 422 of the Internal
Revenue Code of 1986, as amended (the "Code"), and "non-qualified stock options"
("NQSO's").

    Under the 1996 Option Plan, the Company reserved 400,000 shares of Common
Stock for issuance of awards under the 1996 Option Plan (subject to antidilution
and similar adjustments).

    The 1996 Option Plan is administered by a Compensation Committee (the
"Committee") composed of two or more directors of the Company who are
"Non-Employee Directors" as such term is used in Rule 16b-3 promulgated under
the Exchange Act. Subject to the provisions of the 1996 Option Plan, the
Committee will determine the type of award, when and to whom awards will be
granted, the number of shares covered by each award and the terms, provisions
and kind of consideration payable with respect to awards.  The Committee may
interpret the 1996 Option Plan and may at any time adopt such rules and
regulations for the 1996 Option Plan as it deems advisable.  The Committee may,
additionally, cancel or amend awards.

    In determining the persons to whom awards shall be granted and the number
of shares covered by each award the Committee shall take into account the duties
of the respective persons, their present and potential contribution to the
success of the Company and such other factors as the Committee shall deem
relevant in connection with accomplishing the purposes of the 1996 Option Plan.

    An option may be granted on such terms and conditions as the Committee may
approve, and generally may be exercised for a period of up to 10 years from the
date of grant. Generally, both NQSO's and ISO's will be granted with an exercise
price equal to the "Fair Market Value" (as defined in the 1996 Option Plan) on
the date of grant.  In the case of ISO's, certain limitations will apply with
respect to the aggregate value of option shares which can become exercisable for
the first time during any one calendar year, and certain additional limitations
will apply to ISO's granted to an employee who possesses more than 10% of the
total combined voting power of all classes of stock of the Company.  The
Committee may provide for the payment of the option price in cash, by delivery
of other Common Stock having a Fair Market Value equal to such option price, by
a combination thereof or by such other manner as the Committee shall determine.
Options granted under the 1996 Option Plan will become exercisable at such times
and under such conditions as the Committee shall determine.  Other than in the
case of death, options generally may not be exercised more than three months
after an employee terminates employment with the Company for any reason other
than termination for cause or voluntary termination without the consent of the
Company (in which event options shall terminate immediately, unless the
Committee shall otherwise determine).  Each year that a director is elected or
reelected to his position at the Company, an option to purchase 6,000 shares of
Common Stock will be granted with an exercise price equal to the Fair Market
Value on the date of grant.  No options had been granted as of December 31,
1996.  Pursuant to the terms of the 1996 Option Plan, directors elected prior to
the closing of the Offering were granted 6,000 shares of Common Stock on January
27, 1997, with an exercise price equal to the Offering price per share on the
effective date of the Offering, subject to pro-rata vesting over a three-year
period.  Directors included in this grant by the Company of shares of Common
Stock pursuant to the 1996 Option Plan included Jerry W. Grizzle, Gary D.
Johnson, Christopher M. Salyer and Ronald V. Perry.

    The Board may at any time and from time to time suspend, amend, modify or
terminate the 1996 Option Plan; provided, however, that, to the extent required
by Rule 16b-3 promulgated under the Exchange Act or any other law, regulation or
stock exchange rule, no such change shall be effective without the requisite
approval of the Company's stockholders.  In addition, no such change may
adversely affect any award previously granted, except with the written consent
of the grantee.

    No awards may be granted under the 1996 Option Plan after the tenth
anniversary of the approval of the 1996 Option Plan.

                                       18
<PAGE>

EMPLOYMENT AGREEMENTS

    The Company has employment agreements with Jerry W. Grizzle, Gary D.
Johnson, Bruce D. MacDonald and Doyle E. Motley (each an "Employee" and
collectively, the "Employees").  Each of these agreements, other than that of
Mr. Grizzle, runs for a term of one year and automatically renews for additional
one-year terms unless terminated by either the Company or Employee.  Mr.
Grizzle's agreement runs for a term of five years and automatically renews for
additional five-year terms unless terminated by either the Company or Mr.
Grizzle.  Under the respective agreements and subsequent to the Offering, Mr.
Grizzle receives an annual salary of $100,000, Mr. Johnson receives an annual
salary of $90,000, Mr. MacDonald receives an annual salary of $100,000, and Mr.
Motley receives an annual salary of $65,000.  In addition, each Employee may be
entitled to receive incentive compensation.  Such incentive compensation
consists of an annual bonus if certain individual and Company objectives are
achieved. "Cause" for termination of an Employee includes: the conviction of a
felony; the perpetration of a fraud, or misappropriation or embezzlement of
property of the Company; willful misconduct with respect to the duties or
obligations of the Employee under his employment agreement; or intentional or
continual neglect of duties.  For two years following the termination of an
Employee, the Employee is prohibited from engaging in or assisting in any
business which is identical, competitive with, or comparable to, the Company's
business within any area in which Employee rendered services to the Company.
Each agreement contains a provision prohibiting the Employees subsequent to
termination of employment from disclosing to third parties proprietary
information relating to the Company.

ITEM 11.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

    The following table sets forth information as of December 31, 1996, and as
adjusted to reflect the sale of the 1,040,000 shares of Common Stock as a result
of the Offering (including the exercise of the underwriters' over-allotment
option) on January 22, 1997, concerning the beneficial ownership of Common
Stock by each of the Company's directors, each executive officer and all
directors and executive officers of the Company as a group, and by each person
who is known by the Company to own more than 5% of the outstanding shares of
Common Stock.  Unless otherwise indicated, the beneficial owner has sole
voting and investment power with respect to such stock.

<TABLE>
<CAPTION>

NAME AND ADDRESS          NUMBER OF SHARES    PERCENT OF CLASS  NUMBER OF SHARES  PERCENT OF CLASS
OF BENEFICIAL HOLDER(1)   BEFORE OFFERING     BEFORE OFFERING    AFTER OFFERING    AFTER OFFERING
-----------------------   -----------------   ----------------  ----------------   ---------------
<S>                       <C>                 <C>               <C>                <C>
Jerry W. Grizzle* (2)(3)       250,000             71.43%             250,000             13.74%
Gary D. Johnson* (2)            75,000             21.43%              75,000              4.12%
Bruce D. MacDonald (4)           (5)                   0%              80,000(5)           4.40%
Doyle E. Motley (2)             25,000              7.14%              25,500(7)           1.40%
Mark E. Kane (4)                 (6)                   0%             350,000(6)          19.23%
All executive officers
 and directors as a
 group (7 persons)             350,000            100.00%             430,500             23.65%
</TABLE>
__________________________
*   Director
(1) Unless otherwise noted, the Company believes that each person named in the
    table has sole voting and investment power  with respect to all shares
    beneficially owned by such person.
(2) Address is c/o CD Warehouse, Inc., 722 N. Broadway, Oklahoma City, Oklahoma
    73102.
(3) 30,000 shares are held in the name of the Jerry W. Grizzle and Shawn L.
    Grizzle Revocable Living Trust, dtd. 1/6/94, and 10,000 shares each are
    held in the names of Mr. and Mrs. Grizzle's children, Brittany and Matthew.
(4) Address is c/o CDIL, 1710 Firman Drive, Suite 300, Richardson, Texas
    75081.
(5) The shares shown as owned by Mr. MacDonald after the Offering were issued
    in connection with the MacDonald Acquisition.  See Item 12 - Certain
    Relationships and Related Transactions.
(6) Mr. Kane subscribed for 350,000 shares of Common Stock, the payment of
    which was made at the successful consummation of the Offering.
(7) 250 shares each are held in the names of Mr. Motley's children, Laura and
    Dylan.

                                       19
<PAGE>

ITEM 12.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

CDIL ACQUISITION

    At the closing of the Offering, the Company acquired for a purchase price
of $3,200,000 (of which $100,000 had previously been paid in the form of an
earnest money deposit) substantially all of the assets of CDIL pursuant to the
CDIL Acquisition.  The assets acquired consisted of all of CDIL's: (a) rights as
the franchisor under existing franchise agreements and existing area development
agreements; (b) inventory of new and used CD's; (c) accounts, notes and warranty
receivables; (d) trademarks and other intellectual property rights; (e) business
records, including but not limited to CDIL's customer lists, vendor lists,
prospective franchisee lists, franchise files, accounting and tax records
concerning the same, sales literature and promotional materials; (f) software
programs; (g) furniture, equipment, files and other assets located at CDIL's
corporate offices; and (h) the equity interests of CDIL in CD Warehouse stores
in Tulsa, Oklahoma, Edmond, Oklahoma and Memphis, Tennessee.  The Company became
entitled to all franchise fees and royalties accruing to  CDIL after the closing
date of the CDIL Acquisition.  As part of the CDIL Acquisition, the Company
assumed CDIL's accounts payable for the inventory being acquired as of the
closing date, as well as CDIL's obligations under the franchise agreements and
franchise and area development agreements.

    Pursuant to the CDIL Acquisition, Mark E. Kane, the founder and manager
of CDIL, was granted a World Wide Area Development Agreement at the closing
of that transaction.  Under the terms of the Worldwide Area Development
Agreement, Kane has been granted the right to develop, as a franchisee of the
Company, on a worldwide basis (excluding the United States, Mexico and
Canada) CD Warehouse franchise operations for a ten year period.  The
development schedule requires that Mr. Kane open 100 stores during the term
of the Worldwide Area Development Agreement, in accordance with an agreed
schedule.  Failure to open the requisite number of stores pursuant to the
schedule could result in termination of the World Wide Area Development
Agreement, although such termination would not affect any rights of Mr. Kane
to operate CD Warehouse stores already opened and operating under an existing
franchise agreement.  The Worldwide Area Development Agreement provides that
the Company may, at its option for a period of seven years beginning three
years from the date of the grant thereof, purchase Mr. Kane's interest in any
franchised operations developed pursuant to the agreement.  The Worldwide
Area Development Agreement provides that Mr. Kane will pay the Company an
amount to be jointly determined by the Company and Mr. Kane on a
country-by-country basis, provided that the Company will receive a franchise
fee of not less than $3,000 per store, a minimum royalty of 1% of gross sales
based on individual store sales volume and 20% of the total fee received by
Mr. Kane from each subfranchisee.  Additionally, at the closing of the CDIL
Acquisition, the Company granted Mr. Kane, pursuant to a Domestic Area
Development Agreement, the exclusive right to develop ten domestic CD
Warehouse stores, subject to the Company's approval as to the location of
such stores. Pursuant to the Domestic Area Development Agreement, no initial
franchise fee will be payable by Mr. Kane with respect to the ten franchise
stores, although Mr. Kane will pay a royalty of 2% of net sales for any CD
Warehouse store opened by him pursuant to these franchise agreements.  In
connection with the CDIL Acquisition, Mr. Kane was also granted two franchise
agreements by the Company for CD Warehouse Stores in Ft. Worth, Texas and
Plano, Texas pursuant to which Mr. Kane was not required to pay to the
Company any royalties or franchise fee.

    In connection with the CDIL Acquisition, Mr. Kane subscribed for 350,000
shares of Common Stock, at a subscription price of $1.00 per share.  Payment of
the subscription was made upon the successful completion of the Offering and the
CDIL Acquisition.

MACDONALD ACQUISITION

    Simultaneously with the closing of the Offering, the Company acquired the
CD Warehouse franchise interests of Bruce D. MacDonald, Vice President-Company
Store Operations.  Mr. MacDonald acted as franchisee, either on his own account
or as general partner or manager of entities which themselves acted as
franchisees, of 36 CD Warehouse stores.  Pursuant to the MacDonald Acquisition
the Company acquired 100% ownership of the Montfort Street Store and minority
equity interests (including MacDonald's interest as a managing general partner
or limited liability company manager), in the 35 other franchised stores.  The
Company formed CD Management as a wholly owned subsidiary to act as the
successor general partner or manager of the 15 partnerships and two limited
liability companies originally organized by MacDonald to fund, own and operate
the 35 franchised stores in which MacDonald holds an equity interest.  By virtue
of the acquisition of the Montfort Street Store and the MacDonald Equity
Interests, the Company manages and owns an interest in 36 of the 113 stores in
the CD Warehouse system.  The MacDonald Equity Interests acquired by the

                                       20
<PAGE>

Company range from 1% to 50%, although certain percentages of ownership are
earned only after partnership payout, as defined in the respective
partnership agreement. Pursuant to the MacDonald Acquisition, the Company
issued to MacDonald 80,000 shares of the Company's Common Stock.

ACCOUNTING SERVICES

    Bruce D. MacDonald has ownership in an accounting firm with which the
Company has contracted to provide services for the Company's stores.  This
agreement provides that each store will be charged $150 per store, per month for
certain accounting and bookkeeping services rendered.

OFFICE LEASE

    The Company has entered into a lease agreement with an affiliate of
Christopher M. Salyer, a director of the Company, for its executive offices at
722 North Broadway, Oklahoma City, Oklahoma 73102.  The total office space is
approximately 800 square feet and is held under the lease on a month to month
basis with monthly lease payment of $600.  Additionally, the Company shares
operational facilities with CDIL  during a transitional period anticipated to
last approximately four months.  CDIL is owned or controlled by Mark E. Kane,
who became a principal stockholder of the Company upon completion of the
Offering.  The Company intends to consolidate its executive and operational
offices into a larger facility in Oklahoma City, Oklahoma following the
transition period.

FUTURE TRANSACTIONS

    All future and ongoing transactions between the Company and its directors,
officers, principal stockholders or affiliates will be on terms no less
favorable to the Company than may be obtained from unaffiliated third parties,
and any such transactions will be approved by a majority of disinterested and
independent directors of the Company.


ITEM 13.   EXHIBITS AND REPORTS ON FORM 8-K.

(a) The following documents are filed as part of this report:

    (1)  Financial Statements are attached hereto as Appendix A and included
         herein on pages F-1 through F-50.

    (2)  All other schedules are omitted because they are not applicable or the
         required information is shown in the financial statements or notes
         thereto.

    (3)  The following Exhibits are filed with this Report or are incorporated
         by reference as set forth below:

 EXHIBIT
  NUMBER                         NAME OF EXHIBIT
 --------                        ---------------

 2.1     Asset Purchase Agreement, dated as of October 1, 1996, by and among
         Compact Discs International, Ltd., Mark E. Kane ("Kane") and the
         Company  (filed as Exhibit 2.1 to the Company's Registration Statement
         on Form SB-2, file number 333-15139 and incorporated herein by
         reference)

 2.2     Asset Purchase Agreement, dated as of October 10, 1996, by and between
         Bruce D. MacDonald ("MacDonald") and the Company (filed as Exhibit 2.2
         to the Company's Registration Statement on Form SB-2, file number
         333-15139 and incorporated herein by reference)

 2.3     Assignment and Assumption Agreement, dated as of October 10, 1996, by
         and between MacDonald and the Company  (filed as Exhibit 2.3 to the
         Company's Registration Statement on Form SB-2, file number 333-15139
         and incorporated herein by reference)

 3.1     Amended and Restated Certificate of Incorporation  (filed as Exhibit
         3.1 to the Company's Registration Statement on Form SB-2, file number
         333-15139 and incorporated herein by reference)

                                       21
<PAGE>

 EXHIBIT
  NUMBER                         NAME OF EXHIBIT
 --------                        ---------------

 3.2     Amended and Restated Bylaws  (filed as Exhibit 3.2 to the Company's
         Registration Statement on Form SB-2, file number 333-15139 and
         incorporated herein by reference)

 4.1     Specimen Certificate of the Common Stock (filed as Exhibit 4.1 to the
         Company's Registration Statement on Form SB-2, file number 333-15139
         and incorporated herein by reference)

 4.2     See Articles IV and VIII of the Company's Certificate of Incorporation
         and Article II of the Company's Bylaws (filed as Exhibit 4.2 to the
         Company's Registration Statement on Form SB-2, file number 333-15139
         and incorporated herein by reference)

 4.3     Form of Warrant Agreement between the Company and the Underwriters
         (filed as Exhibit 4.3 to the Company's Registration Statement on Form
         SB-2, file number 333-15139 and incorporated herein by reference)

 4.4*    Bank One Credit Facility Commitment Letter dated as of February 19,
         1997

 4.5     1996 Stock Option Plan (filed as Exhibit 4.5 to the Company's
         Registration Statement on Form SB-2, file number 333-15139 and
         incorporated herein by reference)

 10.1    Employment Agreement by and between the Company and Grizzle (filed as
         Exhibit 10.1 to the Company's Registration Statement on Form SB-2,
         file number 333-15139 and incorporated herein by reference)

 10.2    Employment Agreement by and between the Company and Johnson (filed as
         Exhibit 10.2 to the Company's Registration Statement on Form SB-2,
         file number 333-15139 and incorporated herein by reference)

 10.3    Employment Agreement by and between the Company and MacDonald  (filed
         as Exhibit 10.3 to the Company's Registration Statement on Form SB-2,
         file number 333-15139 and incorporated herein by reference)

 10.4    Employment Agreement by and between the Company and Motley (filed as
         Exhibit 10.4 to the Company's Registration Statement on Form SB-2,
         file number 333-15139 and incorporated herein by reference)

 10.5    Finders and Release Agreement, dated as of September 3, 1996, by and
         among the Company; Grizzle; CDI Acquisition JV, a Texas joint venture;
         and CD Partners JV, a Texas joint venture (filed as Exhibit 10.5 to
         the Company's Registration Statement on Form SB-2, file number
         333-15139 and incorporated herein by reference)

 10.6    Asset Purchase Agreement, dated as of October 1, 1996, by and among
         Compact Discs International, Ltd., Kane and the Company (included
         herein as Exhibit 2.1)

 10.7    Asset Purchase Agreement, dated as of October 10, 1996, by and between
         MacDonald and the Company (included herein as Exhibit 2.2)

 10.8    Assignment and Assumption Agreement, dated as of October 10, 1996, by
         and between MacDonald and the Company (included herein as Exhibit 2.3)

 10.9    Bank One Credit Facility Commitment Letter dated as of February 19,
         1997  (included herein as Exhibit 4.4)

 10.10   Form of Franchise Agreement (filed as Exhibit 10.10 to the Company's
         Registration Statement on Form SB-2, file number 333-15139 and
         incorporated herein by reference)

 10.11   Form of Lockup Agreement (filed as Exhibit 10.11 to the Company's
         Registration Statement on Form SB-2, file number 333-15139 and
         incorporated herein by reference)

                                       22
<PAGE>

 EXHIBIT
  NUMBER                         NAME OF EXHIBIT
 --------                        ---------------

 10.12   Form of Partnership Agreement (filed as Exhibit 10.12 to the Company's
         Registration Statement on Form SB-2, file number 333-15139 and
         incorporated herein by reference)

 10.13   Form of Development Agreement  (filed as Exhibit 10.13 to the
         Company's Registration Statement on Form SB-2, file number 333-15139
         and incorporated herein by reference)

 10.14   Lease Agreement dated October 28, 1996 by and between the Company and
         Magnolia Enterprises (filed as Exhibit 10.14 to the Company's
         Registration Statement on Form SB-2, file number 333-15139 and
         incorporated herein by reference)

 21.1    List of subsidiaries  (filed as Exhibit 21.1 to the Company's
         Registration Statement on Form SB-2, file number 333-15139 and
         incorporated herein by reference)

 24.1    Powers of Attorney  (filed as Exhibit 24.1 to the Company's
         Registration Statement on Form SB-2, file number 333-15139 and
         incorporated herein by reference)

  27*    Financial Data Schedule
------------------
    *   Filed herewith.

(b) No reports on Form 8-K have been filed by the Company during the fourth
    quarter of the year ended December 31, 1996.

                                       23
<PAGE>

    Pursuant to the requirements of Section 13 or 15(d) 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.


March 27, 1997                            CD WAREHOUSE, INC.,
                                          a Delaware corporation



                                          /s/ Jerry W. Grizzle
                                          ------------------------------------
                                          Jerry W. Grizzle
                                          Chairman of the Board of Directors;
                                          President and Chief Executive Officer

    Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.


    NAME AND TITLE                                             DATE
    --------------                                             ----

 /s/ Jerry W. Grizzle
-------------------------------------------                 March 27, 1997
 Jerry W. Grizzle
    Chairman of the Board of Directors;
    President and Chief Executive Officer

 /s/ Gary D. Johnson
-------------------------------------------                 March 27, 1997
Gary D. Johnson
  Executive Vice President; Chief
  Operating Officer; Director

 /s/ Doyle E. Motley
-------------------------------------------                 March 27, 1997
Doyle E. Motley
  Sr. Vice President, Chief Financial Officer,
  Secretary and Treasurer

 /s/ Christopher  M. Salyer
-------------------------------------------                 March 27, 1997
Christopher  M. Salyer
  Director

  /s/ Ronald V. Perry
-------------------------------------------                 March 27, 1997
Ronald V. Perry
  Director


                                       24
<PAGE>
                                  APPENDIX A

                                CD Warehouse


                            INDEX TO FINANCIAL STATEMENTS
                               AND SUPPLEMENTARY DATA
<TABLE>
                                                                             PAGE
                                                                             ----
<S>                                                                          <C>
Pro Forma Combined Condensed Financial Statements:
     Pro Forma Combined Condensed Balance Sheet at December 31, 1996. . . . . F- 3
     Pro Forma Combined Condensed Statement of Operations for the year
       ended December 31, 1996. . . . . . . . . . . . . . . . . . . . . . . . F- 5

Historical Financial Statements:

     Financial Statements of C D Warehouse, Inc.

     Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . F- 8
     Consolidated Balance Sheet at December 31, 1996. . . . . . . . . . . . . F- 9
     Consolidated Statement of Operations for the period from
       September 5, 1996 (inception) to December 31, 1996 . . . . . . . . . . F-10
     Consolidated Statement of Stockholders' Equity for the period from
       September 5, 1996 (inception) to December 31, 1996 . . . . . . . . . . F-11
     Consolidated Statement of Cash Flows for the period from
       September 5, 1996 (inception) to December 31, 1996 . . . . . . . . . . F-12
     Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . F-13

Financial Statements of Compact Discs International, Ltd.

     Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . F-17
     Balance Sheet at December 31, 1996 . . . . . . . . . . . . . . . . . . . F-18
     Statement of Income for the year ended December 31, 1996 . . . . . . . . F-20
     Statement of Partners' Capital for the year ended December 31, 1996. . . F-22
     Statement of Cash Flows for the year ended December 31, 1996 . . . . . . F-23
     Notes to Financial Statements. . . . . . . . . . . . . . . . . . . . . . F-25

Financial Statements of Compact Discs International, Ltd. and Subsidiary

     Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . F-32
     Consolidated Balance Sheet at December 31, 1995. . . . . . . . . . . . . F-33
     Consolidated Statement of Income for the year ended
       December 31, 1995. . . . . . . . . . . . . . . . . . . . . . . . . . . F-35
     Consolidated Statement of Partners' Capital for the year ended
       December 31, 1995. . . . . . . . . . . . . . . . . . . . . . . . . . . F-37
     Consolidated Statement of Cash Flows for the year ended
       December 31, 1995. . . . . . . . . . . . . . . . . . . . . . . . . . . F-38
     Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . F-39

Financial Statements of C D Acquisitions

     Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . F-45
     Balance Sheet at December 31, 1995 . . . . . . . . . . . . . . . . . . . F-46
     Statement of Income and Venturers' Capital for the year ended
       December 31, 1995. . . . . . . . . . . . . . . . . . . . . . . . . . . F-47
     Statement of Cash Flows for the year ended December 31, 1995 . . . . . . F-48
     Notes to Financial Statements. . . . . . . . . . . . . . . . . . . . . . F-49
</TABLE>
                                      F-1
<PAGE>

               PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS


The accompanying Pro Forma Combined Condensed Financial Statements reflect the
historical financial position and results of operations of the Company adjusted
for the business acquisitions in January 1997, using the purchase method of
accounting, and the successful completion of an initial public offering
("Offering") in January 1997.

The Pro Forma Combined Condensed Balance Sheet as of December 31, 1996 assumes
completion of the Offering and resulting acquisition of the CDIL Assets and the
MacDonald Assets by such date. The Pro Forma Combined Condensed Statement of
Operations for the year ended December 31, 1996 has been prepared assuming the
Offering and resulting acquisition of the CDIL Assets and the MacDonald Assets
were completed on January 1, 1996.

The pro forma adjustments are based upon available information and assumptions
that management of the Company believes are reasonable. The Pro Forma Combined
Condensed Financial Statements do not purport to represent the financial
position or results of operations which would have occurred had such
transactions been consummated on the dates indicated or the Company's financial
position or results of operations for any future date or period. These Pro Forma
Combined Condensed Financial Statements and notes thereto should be read in
conjunction with the historical financial statements and notes included
elsewhere herein.



                                      F-2

<PAGE>
                                 CD WAREHOUSE, INC.
                   PRO FORMA COMBINED CONDENSED BALANCE SHEET
                                 December 31, 1996
                                     (unaudited)

                                       ASSETS
<TABLE>
                                           Historical
                              ---------------------------------------
                                             Compact
                                  CD          Discs
                              Warehouse,   International,   MacDonald    Pro Forma
                                 Inc.          Ltd.          Assets     Adjustments     Pro Forma
                              -------------------------------------------------------------------
<S>                           <C>          <C>              <C>        <C>              <C>
Current assets:
  Cash and cash equivalents   $ 15,431     $  525,523       $  4,125   $4,306,995 (1)
                                                                         (323,076)(2)
                                                                       (3,100,000)(2)
                                                                          (80,000)(3)
                                                                          350,000 (5)  $1,698,998
  Accounts receivable, net       -            341,414            -       (237,272)(2)     104,142
  Merchandise inventory          -            326,561         40,737          -           367,298
  Prepaid expenses and other     -            100,215            -        (82,764)(2)      17,451
                              -------------------------------------------------------------------
Total current assets            15,431      1,293,713         44,862      833,883       2,187,889

Furniture, fixtures and
 equipment, net                  -             32,615            507          -            33,122
Investment in partnerships       -             61,992         38,367      (21,886)(2)      78,473
Intangible and other assets,
 net                           444,993          3,358          1,859     (211,995)(1)
                                                                        3,040,271 (2)
                                                                           80,000 (3)
                                                                          317,953 (4)   3,676,439
                              -------------------------------------------------------------------
Total assets                  $460,424     $1,391,678       $ 85,595   $4,038,226      $5,975,923
                              -------------------------------------------------------------------
                              -------------------------------------------------------------------

                           LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable            $ 93,340     $  716,550       $   -      $  (57,099)(2)  $  752,791
  Accrued liabilities           17,382          1,578         3,548        (1,578)(2)      20,930
  Advances and deposits          -            107,500           -        (100,000)(2)       7,500
                              -------------------------------------------------------------------
Total current liabilities      110,722        825,628          3,548     (158,677)        781,221

Stockholders' equity:
  Common stock                   3,500          -               -          10,000 (1)
                                                                              800 (4)
                                                                            3,500 (5)      17,800
  Additional paid-in capital   346,500          -               -       4,085,000 (1)
                                                                          399,200 (4)
                                                                          346,500 (5)   5,177,200
  Accumulated deficit             (298)         -               -             -              (298)
  Partners' capital              -            566,050         82,047     (566,050)(2)
                                                                          (82,047)(4)       -
                              -------------------------------------------------------------------
                               349,702        566,050         82,047    4,196,903       5,194,702
                              -------------------------------------------------------------------
Total liabilities and
 stockholders' equity         $460,424     $1,391,678       $ 85,595   $4,038,226      $5,975,923
                              -------------------------------------------------------------------
                              -------------------------------------------------------------------
</TABLE>
                                          F-3

<PAGE>

                                 CD WAREHOUSE, INC.
                     PRO FORMA COMBINED CONDENSED BALANCE SHEET
                                 December 31, 1996
                                    (unaudited)

 Pro Forma Adjustments:

 (1) To record the issuance of 1,000,000 shares
     of Common Stock of the Company in connection
     with the initial public offering:

     Offering proceeds                           $5,000,000
     Expenses of Offering                           905,000
                                                 -----------
     Net proceeds of Offering                     4,095,000
     Offering expenses previously incurred          211,995
                                                 -----------
     Net cash proceeds                           $4,306,995
                                                 -----------
                                                 -----------

(2)  Acquisition of specified assets of CDIL and
     assumption of specified liabilities:

     Net assets at December 31, 1996             $  566,050
     Less net assets retained by CDIL:
     Ivestment in partnership                       (21,886)
     Cash and accounts receivable, net of
      accounts payable and accrued liabilities     (484,435)
                                                 -----------
     Net assets acquired                             59,729
     Acquisition price                            3,200,000
                                                 -----------
     Excess of purchase price over assets
      acquired                                    3,140,271
     Initial deposit paid to CDIL                  (100,000)
                                                 -----------
                                                 $3,040,271
                                                 -----------
                                                 -----------

(3)  Payment of balance of finder's fee          $   80,000
                                                 -----------
                                                 -----------

(4)  Acquisition of MacDonald Assets for
     80,000 shares of Common Stock:

     Purchase price                              $  400,000
     Less net assets at December 31, 1996            82,047
                                                 -----------
     Excess of purchase price over assets
      acquired                                   $  317,953
                                                 -----------
                                                 -----------

(5)  Payment of Common Stock subscription
      by initial stockholder                     $  350,000
                                                 -----------
                                                 -----------

                                      F-4

<PAGE>

                               CD WAREHOUSE, INC.
             PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
                         Year Ended December 31, 1996
                                  (unaudited)
<TABLE>
                                              Historical
                                 ---------------------------------------
                                                Compact
                                     CD          Discs
                                 Warehouse,   International,   MacDonald    Pro Forma
                                    Inc.          Ltd.          Assets     Adjustments     Pro Forma
                                 -------------------------------------------------------------------
<S>                              <C>          <C>              <C>        <C>              <C>
Revenues:
   Company operations:
   Retail store sales            $   -         $     -         $240,998                   $  240,998
   Wholesale merchandise sales       -          3,468,878          -                       3,468,878
   Software income, net              -              7,030          -                           7,030
   Franchise operations:
   Royalty income                    -          1,200,396          -                       1,200,396
   Franchise and development fees    -             88,321          -                          88,321
                                 -------------------------------------------------------------------
   Total revenues                    -          4,764,625       240,998                    5,005,623

   Operating costs and expenses:
   Cost of sales--retail store
    sales                            -              -           149,775                      149,775
   Cost of sales--wholesale
    merchandise sales                -          3,276,953          -                       3,276,953
   Retail store operating expenses   -              -            69,261                       69,261
   General and administrative      2,335          811,873          -       $  280,500 (2)  1,094,708
   Depreciation and amortization     -             13,238          -          180,000 (3)    193,238
                                 -------------------------------------------------------------------
                                   2,335        4,102,064       219,036       460,500      4,783,935
                                 -------------------------------------------------------------------
   Operating income (loss)        (2,335)         662,561        21,962      (460,500)       221,688

   Other income                    2,037           57,831        27,612       (39,209)(1)     48,271
                                 -------------------------------------------------------------------
   Income (loss) before income
    taxes                           (298)         720,392        49,574      (499,709)       269,959

   Pro forma provision for income
    taxes                            -              -              -           94,000 (4)     94,000
                                 -------------------------------------------------------------------
   Pro forma net income (loss)   $  (298)      $  720,392      $ 49,574     $(593,709)     $ 175,959
                                 -------------------------------------------------------------------
                                 -------------------------------------------------------------------

   Pro forma net income per share                                                               $.10
                                                                                           ---------
                                                                                           ---------

   Shares used in computation                                                              1,780,000
                                                                                           ---------
                                                                                           ---------
</TABLE>
                                      F-5

<PAGE>

                                  CD WAREHOUSE, INC.
                 PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
                           Year Ended December 31, 1996
                                     (unaudited)


                               Pro Forma Adjustments:

(1)  Eliminate partnership interests retained by CDIL          $  39,209
                                                               ---------
                                                               ---------

(2)  Adjust executive compensation as a result of employment
      arrangements with new officers of the Company            $ 280,500
                                                               ---------
                                                               ---------

(3)  Amortization of estimated goodwill on purchase
      transactions over twenty-year period                     $ 180,000
                                                               ---------
                                                               ---------

(4)  Provide for income taxes at statutory rate                $  94,000
                                                               ---------
                                                               ---------


                                         F-6

<PAGE>













                                FINANCIAL STATEMENTS

                                C D WAREHOUSE, INC.

       FOR THE PERIOD FROM SEPTEMBER 5, 1996 (INCEPTION) TO DECEMBER 31, 1996
                        WITH REPORT OF INDEPENDENT AUDITORS















                                        F-7


<PAGE>

                           Report of Independent Auditors


The Stockholders
C D Warehouse, Inc.


We have audited the accompanying consolidated balance sheet of C D Warehouse,
Inc. as of December 31, 1996 and the related consolidated statements of
operations, stockholders' equity and cash flows for the period from September 5,
1996 (inception) to December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit of the financial statements provides a reasonable
basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of C D
Warehouse, Inc. at December 31, 1996 and the consolidated results of its
operations and its cash flows for the period from September 5, 1996 (inception)
to December 31, 1996, in conformity with generally accepted accounting
principles.




                                                   ERNST & YOUNG LLP

Oklahoma City, Oklahoma
February 12, 1997


                                       F-8

<PAGE>

                                 CD Warehouse, Inc.

                             Consolidated Balance Sheet



                                                       DECEMBER 31,
                                                           1996
                                                       ------------
ASSETS
Current assets:
    Cash and cash equivalents                          $ 15,431
Organization costs                                       12,847
Deferred acquisition costs (NOTE 2)                     220,151
Deferred offering costs (NOTE 2)                        211,995
                                                       --------
                                                       $460,424
                                                       --------
                                                       --------

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Accounts payable                                   $ 93,340
    Accrued liabilities                                  17,382
                                                       --------
Total current liabilities                               110,722

Commitments (NOTES 3 AND 4)

Stockholders' equity (NOTES 2 AND 3):
   Preferred stock, $.01 par value; 5,000,000 shares
    authorized, none issued                                 -
   Common stock, $.01 par value; 10,000,000 shares
    authorized, 350,000 shares issued and outstanding      3,500
   Paid-in capital                                       346,500
   Accumulated deficit                                      (298)
                                                        --------
Total stockholders' equity                               349,702
                                                        --------
                                                        $460,424
                                                        --------
                                                        --------


                              SEE ACCOMPANYING NOTES.

                                        F-9

<PAGE>
                                CD Warehouse, Inc.

                       Consolidated Statement of Operations



                                              PERIOD FROM
                                             SEPTEMBER 5,
                                                 1996
                                            (INCEPTION) TO
                                           DECEMBER 31, 1996
                                           -----------------
Interest income                                  $2,037

General and administrative expenses               2,335
                                                 -------
Net loss                                         $ (298)
                                                 -------
                                                 -------


                           SEE ACCOMPANYING NOTES.




                                     F-10

<PAGE>

                             CD Warehouse, Inc.

                Consolidated Statement of Stockholders' Equity


                                    PERIOD FROM SEPTEMBER 5, 1996 (INCEPTION) TO
                                                 DECEMBER 31, 1996
                                    --------------------------------------------
                                        COMMON STOCK
                                    --------------------   PAID-IN   ACCUMULATED
                                      SHARES     AMOUNT    CAPITAL     DEFICIT
                                     -------     ------    --------  -----------

Balance at September 5, 1996             -       $  -      $    -       $  -

Sale of common stock                 350,000      3,500     346,500        -

Net loss                                 -          -           -        (298)
                                     -------     ------    --------     -----
Balance at December 31, 1996         350,000     $3,500    $346,500     $(298)
                                     -------     ------    --------     -----
                                     -------     ------    --------     -----



                              SEE ACCOMPANYING NOTES.











                                      F-11

<PAGE>


                             CD Warehouse, Inc.

                    Consolidated Statement of Cash Flows



                                                                 PERIOD FROM
                                                                 SEPTEMBER 5,
                                                                     1996
                                                                (INCEPTION) TO
                                                                 DECEMBER 31,
                                                                    1996
                                                                --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss--cash used for operating activities                     $    (298)

CASH FLOWS FROM INVESTING ACTIVITIES
Increase in other assets:
  Organizational costs                                             (12,847)
  Deferred acquisition costs                                      (220,151)
                                                                 ---------
Net cash used in investing activities                             (232,998)

CASH FLOWS FROM FINANCING ACTIVITIES
Sale of common stock                                               350,000
Deferred offering costs (exclusive of $110,722 of accounts
 payable and accrued liabilities)
                                                                  (101,273)
                                                                 ---------
Net cash provided by financing activities                          248,727
                                                                 ---------
Net increase in cash                                             $  15,431
                                                                 ---------
                                                                 ---------


                              SEE ACCOMPANYING NOTES.






                                      F-12

<PAGE>


                              CD Warehouse, Inc.

                  Notes to Consolidated Financial Statements

                              December 31, 1996


1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND CONSOLIDATION

The consolidated financial statements include the accounts of C D Warehouse,
Inc. (the "Company") and its wholly-owned subsidiary, Compact Discs Management,
Inc. ("CDM"). The Company was formed in Delaware on September 5, 1996. The
Company has had only limited operations during the period from September 5, 1996
to December 31, 1996.

CASH EQUIVALENTS

Cash equivalents include money-market investments with maturities of three
months or less when purchased.

ORGANIZATION COSTS

Organization costs are amortized on a straight-line basis over five years.

DEFERRED ACQUISITION COSTS

Costs incurred related to a business acquisition completed in January 1997 (NOTE
2) have been deferred and, subsequent to December 31, 1996, have been
capitalized as a component of the total acquisition cost.

DEFERRED OFFERING COSTS

Specific incremental costs directly attributable to the initial public offering
of common stock completed in January 1997 (NOTE 2) have been deferred and,
subsequent to December 31, 1996, have been charged against the gross proceeds of
the offering.

2.  INITIAL PUBLIC OFFERING AND BUSINESS ACQUISITIONS

In January 1997, the Company completed an initial public offering for 1,000,000
shares of its common stock at a price of $5 per share. The proceeds of the
offering, after deducting the underwriting discount and offering expenses were
approximately $4.1 million.


                                      F-13

<PAGE>

                              CD Warehouse, Inc.

             Notes to Consolidated Financial Statements (continued)


2.  INITIAL PUBLIC OFFERING AND BUSINESS ACQUISITIONS (CONTINUED)

Simultaneously with the closing of the Offering, the Company purchased
substantially all of the assets of Compact Discs International, Ltd. ("CDIL")
for $3.2 million. Prior to the acquisition, CDIL was engaged principally in the
business of selling new and preowned audio compact discs to its franchisees.

The acquisition resulted in the Company entering into an area development
agreement (the "ADA") with the principal owner of CDIL. The ADA provides for the
right to develop franchise operations worldwide, except for the United States,
Canada and Mexico. The Company has the right, during a specified period of time,
to cancel the ADA and to acquire any franchise developed under the ADA at a
specified multiple of earnings. In addition, the Company has agreed to grant to
the principal owner of CDIL (1) ten domestic franchises with no initial
franchise fee and royalties of 2% of net sales and (2) two renewal franchises
with no franchise fee or royalty payments. Except as provided for in the above
mentioned franchise agreements, CDIL and the principal owner of CDIL have also
entered into covenants not to compete with the Company for a period of ten
years.

Also in January 1997, the Company and CDM purchased all of the franchise
interests of the largest CDIL franchisee in exchange for 80,000 shares of the
Company's common stock.

The acquisitions were recorded in January 1997 under the purchase method of
accounting and resulted in an excess of purchase price over net assets acquired
of approximately $3.6 million which will be amortized on a straight-line basis
over 20 years.

The following unaudited pro forma combined information presents a summary of the
consolidated results of operations of the Company and the acquired businesses as
if the acquisitions and the initial public offering of the Company had occurred
January 1, 1996.

             Revenues                             $5,005,623

             Net income                           $  175,959

             Net income per share                 $      .10

             Shares used in computation            1,780,000


                                      F-14

<PAGE>

                              CD Warehouse, Inc.

           Notes to Consolidated Financial Statements (continued)


2.  INITIAL PUBLIC OFFERING AND BUSINESS ACQUISITIONS (CONTINUED)


These unaudited pro forma results have been prepared for comparative purposes
only and include certain adjustments, including amortization of goodwill and
provision for executive compensation as a result of the acquisitions. They do
not purport to be indicative of the results of operations which would have
resulted had the acquisitions and initial public offering occurred on January 1,
1996, or of future results of operations of the consolidated entities.


3.  STOCKHOLDERS' EQUITY

Effective September 5, 1996 and October 1, 1996, the Company obtained stock
subscription agreements for the sale of an aggregate of 700,000 shares of common
stock at $1 per share. During October 1996, the Company received $350,000 in
cash in exchange for the issuance of 350,000 shares of common stock. The
subscription agreement for the remaining 350,000 shares provided for payment to
the Company concurrently with the closing of the Company's initial public
offering of common stock (NOTE 2).

On December 10, 1996, the Company adopted the 1996 Stock Option Plan which
provides for grants of up to 400,000 shares of common stock to certain
employees, officers, directors and others. Generally, the purchase price of
stock issuable upon exercise of the options will be at least equal to the fair
market value of the stock on the dates of grant. Generally, options are
exercisable no longer than ten years from the dates of grant. No options were
granted through December 31, 1996. The Company has agreed to grant options to
purchase 6,000 shares annually, subject to pro-rata vesting over a three-year
period, to each director.

4.  COMMITMENTS

Effective in January 1997, after the Company's completion of the initial public
offering, the Company entered into employment agreements with four officers of
the Company. The employment agreements are for terms of one and five years with
renewal options of one and five years and total $355,000 annually for the four
individuals.




                                      F-15


<PAGE>




                      COMPACT DISCS INTERNATIONAL, LTD.

                            FINANCIAL STATEMENTS

                    FOR THE YEAR ENDED DECEMBER 31, 1996

                                    WITH

                        INDEPENDENT AUDITORS' REPORT

















                                    F-16


<PAGE>


                        INDEPENDENT AUDITORS' REPORT


To the General Partner
Compact Discs International, Ltd.

     We have audited the accompanying balance sheet of Compact Discs
International, Ltd. (A Texas Limited Partnership) as of December 31, 1996, and
the related statements of income, partners' capital, and cash flows for the year
then ended.  These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.

     We conducted our audit in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Compact Discs International,
Ltd. as of December 31, 1996 and the results of its operations and its cash
flows for the year then ended in conformity with generally accepted accounting
principles.


                                                        Huselton & Morgan, P.C.

Dallas, TX
February 27, 1997


                                      F-17

<PAGE>

                      COMPACT DISCS INTERNATIONAL, LTD.

                       (A TEXAS LIMITED PARTNERSHIP)

                                BALANCE SHEET

                              DECEMBER 31, 1996


                                    ASSETS


Current assets
  Cash                                                      $  525,523
  Accounts receivable (net of allowance of $132,253)           341,414
  Inventory                                                    326,561
  Prepaid expenses                                              31,090
  Deferred expenses                                             69,125
                                                            ----------
    Total current assets                                     1,293,713
                                                            ----------
Furniture, fixtures and equipment (net of
 accumulated depreciation)                                      32,615
                                                            ----------
Investment in partnerships                                      61,992
Other assets (net of amortization)                               3,358
                                                            ----------
    Total other assets                                          65,350
                                                            ----------
    Total assets                                            $1,391,678
                                                            ----------
                                                            ----------






                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                       OF THESE FINANCIAL STATEMENTS.



                                    F-18

<PAGE>

                      COMPACT DISCS INTERNATIONAL, LTD.

                        (A TEXAS LIMITED PARTNERSHIP)

                                BALANCE SHEET

                              DECEMBER 31, 1996



                      LIABILITIES AND PARTNERS' CAPITAL



Current liabilities
  Accounts payable                                  $  716,550
  Sales tax payable                                      1,450
  Payroll taxes payable                                    128
  Refundable development fees                            7,500
  Deposit on asset sale                                100,000
                                                    ----------
    Total current liabilities                          825,628
                                                    ----------
Partners' capital                                      566,050
                                                    ----------
    Total liabilities and partners' capital         $1,391,678
                                                    ----------
                                                    ----------

Contingent liabilities










                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                        OF THESE FINANCIAL STATEMENTS.


                                   F-19


<PAGE>


                       COMPACT DISCS INTERNATIONAL, LTD.

                         (A TEXAS LIMITED PARTNERSHIP)

                              STATEMENT OF INCOME

                      FOR THE YEAR ENDED DECEMBER 31, 1996


Revenue
  Retail sales                                          $3,468,879
  Royalty income                                         1,200,396
  Franchise fees                                            65,000
  Development fees                                          23,321
  Computer/software income                                   7,029
                                                        ----------
    Total revenue                                        4,764,625
                                                        ----------
Expenses
  Cost of goods sold-retail sales                        3,276,953
  Salaries                                                 299,969
  Bad debts                                                150,030
  Professional fees                                         64,120
  Promotion                                                 40,003
  Taxes                                                     34,028
  Travel                                                    31,949
  Telephone & utilities                                     31,415
  Commissions                                               29,008
  Rent                                                      28,515
  Insurance                                                 20,144
  Office expense                                            18,616
  Printing                                                  16,970
  Depreciation                                              12,782
  Postage                                                    8,907
  Entertainment                                              5,633
  Franchise meeting                                          5,388
  Repairs & maintenance                                      5,041
  Auto expense                                               4,805
  Licenses                                                   4,170


                                 (continued)


                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                      OF THESE FINANCIAL STATEMENTS.


                                    F-20

<PAGE>

                      COMPACT DISCS INTERNATIONAL, LTD.

                       (A TEXAS LIMITED PARTNERSHIP)

                            STATEMENT OF INCOME

                     FOR THE YEAR ENDED DECEMBER 31, 1996

                                 (continued)


Expenses
  Miscellaneous                                             3,571
  Contract labor                                            3,038
  Advertising                                               2,495
  Dues & subscriptions                                      1,407
  Supplies                                                  1,240
  Bank charges                                              1,080
  Amortization                                                456
  Photography                                                 140
  Charitable contributions                                    140
  Interest expense                                             51
                                                       ----------
    Total expenses                                      4,102,064
                                                       ----------
Operating income                                          662,561
Other income
  Gain on sale of assets                                   13,835
  Investment income                                        43,924
  Interest income                                              72
                                                       ----------
    Net income                                         $  720,392
                                                       ----------
                                                       ----------








                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                        OF THESE FINANCIAL STATEMENTS.


                                     F-21


<PAGE>

                      COMPACT DISCS INTERNATIONAL, LTD.

                       (A TEXAS LIMITED PARTNERSHIP)

                       STATEMENT OF PARTNERS' CAPITAL

                             DECEMBER 31, 1996



Beginning balance                                       $ 430,239

Beginning capital - CD Acquisitions                       128,096

Net income                                                720,392

Distributions
  Cash                                                   (508,609)
  Noncash                                                (204,068)
                                                        ---------

Ending balance                                          $ 566,050
                                                        ---------
                                                        ---------











                    THE ACCOMPANYING NOTES ARE AN INTEGRAL
                     PART OF THESE FINANCIAL STATEMENTS.


                                      F-22


<PAGE>


                      COMPACT DISCS INTERNATIONAL, LTD.

                       (A TEXAS LIMITED PARTNERSHIP)

                          STATEMENT OF CASH FLOWS

                             DECEMBER 31, 1996




Cash flows from operating activities:
  Net income                                            $ 720,392

  Noncash items
    Bad debt expense                                      138,629
    Depreciation and amortization                          13,238
    Investment income                                     (43,924)
    Gain on sale of investment                            (13,835)
  Adjustments to reconcile net income to cash
   used by operating activities
    (Increase) in accounts receivable                    (265,127)
    (Increase) in inventory                               (20,804)
    (Increase) in prepaids and deferred expenses          (91,123)
    Increase in accounts payable                          291,983
    Decrease in accrued expenses                          (64,294)
    Increase in deposit on sale                           100,000
                                                         ---------
      Net cash provided by operating activities           765,135

Cash flows from investing activities
  Purchase of fixed assets                                (14,661)
  Proceeds from sale of asset                               4,000
  Contribution to partnership                              (1,600)
  Proceeds from sale of Fort Worth investment              30,925
  Distributions from partnerships                          42,394
                                                        ---------
    Net cash provided by investing activities              61,058


                                 (continued)



                   THE ACCOMPANYING NOTES ARE AN INTEGRAL
                     PART OF THESE FINANCIAL STATEMENTS.


                                      F-23


<PAGE>

                      COMPACT DISCS INTERNATIONAL, LTD.

                       (A TEXAS LIMITED PARTNERSHIP)

                          STATEMENT OF CASH FLOWS

                             DECEMBER 31, 1996

                                 (continued)


Cash flows from financing activities
  Distributions to partners                             (508,609)
                                                       ---------
    Net cash used by financing activities               (508,609)
Net increase in cash                                     317,584
Cash from merger of CDA                                  159,444
Cash at beginning of year                                 48,495
                                                       ---------
Cash at end of year                                    $ 525,523
                                                       ---------

Interest paid                                          $      51
                                                       ---------
                                                       ---------


SUPPLEMENTAL NOTES TO CASH FLOW

     In November, 1996, the Company sold a portion of its interest in the
Fort Worth store to the Company's partners and recorded the sale of $30,636
as a draw to the partners.

     Accounts receivable due from partners of the Company in the amount of
$173,432 were discharged and recognized as a distribution to the partners.

     Accounts receivable in the amount of $35,549 from two franchisees were
exchanged for partnership interests.


                    THE ACCOMPANYING NOTES ARE AN INTEGRAL
                      PART OF THESE FINANCIAL STATEMENTS.


                                      F-24

<PAGE>


                      COMPACT DISCS INTERNATIONAL, LTD.

                       (A TEXAS LIMITED PARTNERSHIP)

                             DECEMBER 31, 1996

                       NOTES TO FINANCIAL STATEMENTS

1.  Organization

     THE COMPANY
     Compact Discs International, Ltd. (the "Company") is a Texas limited
partnership which conducts business under the name "CD Warehouse" and maintains
its principal office in Richardson, Texas.

     In 1995, the Company purchased an 81.25% ownership in CD Warehouse Fort
Worth and consolidated the financial results of this entity with the Company.
This interest was sold during 1996.

     Effective January 1, 1996, CD Acquisitions ("CDA"), a joint venture owned
and operated by the Company's partners, was merged into the Company.

     The Company offers and sells single-unit franchises and development rights
for multi-unit franchises for the operation of retail sales outlets which buy,
sell and trade new and used compact discs and related items.  As of December 31,
1996, the Company has executed 118 franchise agreements for the operation of
stores, of which 113 are operational.  The Company has 3 development agreements
in place as of December 31, 1996.  Effective with the merger of CDA, the Company
began selling new and used compact discs to franchisees.

     CASH AND CASH EQUIVALENTS
     For purposes of the statement of cash flows, the Company considers all
highly liquid debt instruments purchased with a maturity of three months or less
to be cash equivalents.  All cash is held in accounts that are federally
insured.


                                      F-25

<PAGE>

     INVENTORY
     Inventory consists primarily of both new and used compact discs.  All
inventory is valued at the lower of cost or market using the first-in, first-out
(FIFO) method.

     FURNITURE, FIXTURES AND EQUIPMENT
     Furniture, fixtures and equipment are stated at cost.  The provision for
depreciation has been calculated using the straight-line method.  Useful lives
range from 3 to 7 years.

     OTHER ASSETS
     Organization costs and the Company's trademark are being amortized using
the straight-line method over five and fifteen years, respectively.

     INVESTMENT IN PARTNERSHIPS
     The Company records its ownership in four partnerships that own CD
Warehouse stores using the equity method of accounting.

     REVENUE RECOGNITION
     Franchise fees are non-refundable.  Franchise fee income is recognized upon
the opening of the related store.  The Company's commitment and obligations to
franchisees are not significant after the store is opened.  Development right
fees paid are recognized as income on a prorated basis as franchise units within
a development agreement are opened.  Development fees are non-refundable, but
can be applied against future franchise fees and royalty fees due from
development franchisees.  Royalties are recognized when earned.  Specially
designed software and computer equipment are sold to the franchisees, and the
related income is recognized when earned.

     ESTIMATES
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures.  Accordingly,
actual results may differ from those estimates.


                                      F-26

<PAGE>

2.  FURNITURE, FIXTURES AND EQUIPMENT
     Components of furniture, fixtures and equipment at December 31, 1996 are as
follows:

     Equipment                                                      $ 31,607
     Furniture and fixtures                                            9,685
     Automobiles                                                      16,528
     Leasehold improvements                                                0
                                                                    --------
       Total                                                          57,820
     Accumulated depreciation                                        (25,205)
                                                                    --------
       Total                                                        $ 32,615
                                                                    --------
                                                                    --------

3.  OTHER ASSETS

     Components of other assets at December 31, 1996 are as follows:

     Deposits                                                        $ 2,087
     Organization costs                                                2,150
     Trademark                                                           394
                                                                     -------
       Total                                                           4,631
     Accumulated amortization                                         (1,273)
                                                                     -------
          Total                                                      $ 3,358
                                                                     -------
                                                                     -------

4.  INVESTMENTS IN PARTNERSHIPS

     In the latter part of 1995 and in 1996, the Company entered into
partnership agreements to own and operate retail CD outlets in Tulsa, Oklahoma;
Memphis, Tennessee; Orange Park, Florida; and Edmond, Oklahoma.  At December 31,
1996, the Company has the following investments in general partnerships:

                                                                  Percentage
          Partnership                                                Owned
          -----------                                             ----------

     CD Warehouse -Tulsa                                              50

     CD Warehouse -Memphis                                            25

     CD Warehouse -Orange Park                                        50

     CD Warehouse -Edmond                                             50



                                      F-27

<PAGE>

     At December 31, 1996, the Company's investments in partnerships and equity
in the income of these partnerships for the year ended December 31, 1996 consist
of the following:

                                      Investment in        Partnership
                                       Partnership            Income
                                      -------------        -----------
     CD Warehouse - Tulsa              $  25,191            $  10,238
     CD Warehouse - Memphis                  (88)               8,858
     CD Warehouse - Orange Park           21,886               10,886
     CD Warehouse - Edmond                15,003                 (546)
     CD Warehouse - Fort Worth                 0               14,488
                                       ---------            ---------
                                       $  61,992            $  43,924
                                       ---------            ---------
                                       ---------            ---------

     The following summarizes the activity of the CD Warehouse equity
investments of the Company for the year ended December 31, 1996:

                       CD Warehouse   CD Warehouse   CD Warehouse   CD Warehouse
                          Edmond       Orange Park       Tulsa         Memphis
                       ------------   ------------   ------------   ------------
Total assets             $42,505        $ 74,854       $ 64,815       $ 49,728
Total liabilities          3,497           4,080          4,430          4,084
                         -------        --------       --------       --------
  Net assets             $39,008        $ 70,774       $ 60,385       $ 45,644
                         -------        --------       --------       --------
                         -------        --------       --------       --------
Revenues                 $78,670        $260,705       $261,873       $371,627
                         -------        --------       --------       --------
Net income (loss)        $(1,091)       $ 21,772       $ 20,475       $ 35,430
                         -------        --------       --------       --------
                         -------        --------       --------       --------

5.  COMMITMENTS AND CONTINGENCIES

     The Company leases office space under a non-cancelable operating lease
agreement.  The agreement expires in 1997.  Total rent expense for the year
ended December 31, 1996 was $28,515.

     The following is a schedule of future minimum lease payments for the above
lease as of December 31, 1996:

                     1997                            $5,694
                                                     ------


                                      F-28

<PAGE>

     At December 31, 1996, the Company is involved in one situation of pending
litigation. The case involves a wrongful death claim resulting from an accident
at a franchise location. Although the Company does not anticipate a loss in this
case, the extent of possible damages cannot be accurately determined at this
time.

6.  INCOME TAXES

     Taxable income of the Company is includable in the income returns of the
individual partners; therefore, no provision for income taxes has been made in
the accompanying financial statements.

7.  RELATED-PARTY TRANSACTIONS

     The  Company sells new and used merchandise to franchisees.  The
franchisees included the CD Warehouse investments listed in Note 4.  Sales to
these franchisees amounted to $124,796 for the year ending December 31, 1996.

     At December 31, 1996, the accounts receivable balance includes $12,084 of
receivables due from franchisees who are relatives of the partners.

8.  POOLING-OF-INTEREST

     Effective January 1, 1996, CD Acquisitions (A Joint Venture) was merged
into the Company.  As a result of the merger, Compact Discs International, Ltd.
became the successor in interest of all rights, properties, assets, and
liabilities of CDA.

     The 1996 financial statements for the merged entities reflect the merger as
a pooling of interest.  The 1996 statements reflect a full year of operations.

9.  CONCENTRATION OF CREDIT RISK

     The Company maintains its cash balances at various financial institutions
located in the Dallas, Texas area.  Cash and cash equivalents are held in bank
accounts that are insured by the Federal Deposit Insurance Corporation up to
$100,000.  At December 31, 1996, the Company's uninsured


                                      F-29

<PAGE>

balances, before reconciling items, totaled $423,750.

10. FAIR VALUE OF FINANCIAL INSTRUMENTS

     The estimated fair values of the Company's financial instruments, none of
which are held for trading purposes, as of December 31, 1996 are as follows:

                                                Carrying      Fair
                                                 Amount       Value
                                                --------     --------
     Assets:
       Cash and equivalents                     $525,523     $525,523
       Investments in partnerships              $ 61,992     $ 61,992

11. SUBSEQUENT EVENTS

     Effective January 22, 1997, the Company sold a substantial portion of its
assets to an unrelated third party.  The assets sold consist of all of the
Company's (a) rights as the franchisor under existing franchise agreements and
existing area development agreements; (b) inventory of new and used CD's; (c)
accounts, notes and warranty receivables; (d) trademarks and other intellectual
property rights; (e) business records, including but not limited to the
Company's customer lists, vendor lists, prospective franchise lists, franchise
files, accounting and tax records concerning the same, sales literature and
promotional materials; (f) software programs; (g) furniture, equipment, files
and other assets located at the Company's corporate offices; and (h) the equity
interests of the Company in CD Warehouse stores in Tulsa, Oklahoma, (two),
Edmond, Oklahoma and Memphis, Tennessee.  The purchaser will be entitled to all
franchise fees and royalties accruing to the Company after the closing date of
the acquisition.  As part of the acquisition, the purchaser will assume the
Company's accounts payable for the inventory being acquired as of the closing
date, as well as the Company's obligations under the franchise agreements and
franchise and area development agreements.  The Company will continue in
existence; however, the Company's primary business activities remain
undetermined.

     In a separate transaction dated February 1, 1997, the Company sold its
interest in the CD Warehouse - Orange Park investment for $45,000.


                                      F-30


<PAGE>














                      COMPACT DISCS INTERNATIONAL, LTD.

                                AND SUBSIDIARY

                      CONSOLIDATED FINANCIAL STATEMENTS

                    FOR THE YEAR ENDED DECEMBER 31, 1995
                                     WITH
                         INDEPENDENT AUDITORS' REPORT












                                      F-31

<PAGE>


                          INDEPENDENT AUDITORS' REPORT

To the General Partner
Compact Discs International, Ltd. and Subsidiary

     We have audited the accompanying consolidated balance sheet of Compact
Discs International, Ltd. (A Texas Limited Partnership) and Subsidiary as of
December 31, 1995, and the related consolidated statements of income, partners'
capital, and cash flows for the year then ended.  These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.

     We conducted our audit in accordance with generally accepted auditing
standards.  These standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Compact Discs International, Ltd. and Subsidiary as of December 31, 1995, and
the consolidated results of its operations and its cash flows for the year then
ended in conformity with generally accepted accounting principles.


                                                        Huselton & Morgan, P.C.

Dallas, TX
March 6, 1996, except for Note 2,
  as to which the date is October 10, 1996


                                      F-32

<PAGE>

               COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY

                         (A TEXAS LIMITED PARTNERSHIP)

                          CONSOLIDATED BALANCE SHEET

                               DECEMBER 31, 1995


                                     ASSETS


Current assets
  Cash                                                          $ 48,495
  Accounts receivable (net of allowance of $70,171)              228,887
  Due from CD Acquisitions                                       111,316
  Inventory                                                       50,275
  Prepaid expenses                                                 1,179
                                                                --------
    Total current assets                                         440,152
                                                                --------
Furniture, fixtures and equipment (net of
 accumulated depreciation)                                        39,108
                                                                --------
Investment in partnerships                                        25,231
Other assets (net of amortization)                                 5,288
                                                                --------
    Total investment and other assets                             30,519
                                                                --------
      Total assets                                              $509,779
                                                                --------
                                                                --------








                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                       OF THESE FINANCIAL STATEMENTS.



                                    F-33


<PAGE>

               COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY

                         (A TEXAS LIMITED PARTNERSHIP)

                          CONSOLIDATED BALANCE SHEET

                               DECEMBER 31, 1995


                       LIABILITIES AND PARTNERS' CAPITAL



Current liabilities
  Accounts payable                                              $  4,075
  Sales tax payable                                                2,219
  Payroll taxes payable                                              744
  Development fees advanced                                       60,521
                                                                --------

    Total current liabilities                                     67,559
                                                                --------

Minority interest                                                 11,981

Partners' capital                                                430,239
                                                                --------

    Total liabilities and partners' capital                     $509,779
                                                                --------
                                                                --------





                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                        OF THESE FINANCIAL STATEMENTS.


                                    F-34

<PAGE>


               COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY

                        (A TEXAS LIMITED PARTNERSHIP)

                      CONSOLIDATED STATEMENT OF INCOME

                    FOR THE YEAR ENDED DECEMBER 31, 1995


Revenue
  Royalty income                                               $  946,640
  Retail sales                                                    291,948
  Franchise fees                                                  109,750
  Development fees                                                 74,500
  Software income                                                  23,683
                                                               ----------
    Total revenue                                               1,446,521
                                                               ----------
Expenses
  Salaries                                                        332,333
  Cost of goods sold -retail sales                                181,312
  Bad debts                                                       113,539
  Travel                                                           44,029
  Telephone & utilities                                            43,208
  Rent                                                             41,027
  Taxes                                                            29,289
  Professional fees                                                19,006
  Office expense                                                   18,487
  Advertising                                                      14,745
  Depreciation                                                      9,189
  Miscellaneous                                                     8,666
  Printing                                                          7,927
  Insurance                                                         5,768
  Auto expense                                                      5,314
  Entertainment                                                     4,974
  Postage                                                           4,578
  Promotion                                                         4,218
  Licenses                                                          4,136
  Supplies                                                          4,011
  Contract labor                                                    2,542


                                  (Continued)

                   THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                          OF THESE FINANCIAL STATEMENTS.


                                      F-35

<PAGE>

               COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY

                         (A TEXAS LIMITED PARTNERSHIP)

                        CONSOLIDATED STATEMENT OF INCOME

                      FOR THE YEAR ENDED DECEMBER 31, 1995

                                   (Continued)




Expenses
  Repairs & maintenance                                           1,594
  Security                                                        1,355
  Bank charges                                                      820
  Amortization                                                      456
  Dues & subscriptions                                              455
  Photography                                                       356
  Interest expense                                                   46
  Fees                                                               21
                                                               --------
    Total expenses                                              903,401
                                                               --------
Operating income                                                543,120
Other income
  Equity in income of partnerships                                2,898
  Interest income                                                    89
                                                               --------
Net income before minority interest                             546,107
Minority interest                                                (7,293)
                                                               --------
    Net income                                                 $538,814
                                                               --------
                                                               --------










                  THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                         OF THESE FINANCIAL STATEMENTS.


                                      F-36

<PAGE>

               COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY

                        (A TEXAS LIMITED PARTNERSHIP)

                 CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL

                     FOR THE YEAR ENDED DECEMBER 31, 1995



Beginning balance                                                $ 187,702

Net income                                                         538,814

Distributions                                                     (296,277)
                                                                 ---------

Ending balance                                                   $ 430,239
                                                                 ---------















                    THE ACCOMPANYING NOTES ARE AN INTEGRAL
                      PART OF THESE FINANCIAL STATEMENTS.


                                      F-37


<PAGE>

               COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY

                         (A TEXAS LIMITED PARTNERSHIP)

                     CONSOLIDATED STATEMENT OF CASH FLOWS

                     FOR THE YEAR ENDED DECEMBER 31, 1995



Cash flows from operating activities:
    Net income                                                     $ 538,814
  Noncash items
    Bad debt expense                                                  70,171
    Depreciation and amortization                                      9,645
    Minority interest                                                  7,293
    Investment income                                                 (2,898)
  Adjustments to reconcile net income to cash
   used by operating activities
    Increase in accounts receivable                                 (224,071)
    Increase in due from CD Acquisitions                             (69,791)
    Increase in inventory                                            (11,327)
    Increase in prepaid expenses                                      (1,179)
    Increase in development fees advanced                             13,521
    Increase (decrease) in accrued liabilities                       (11,829)
    Increase (decrease) in accounts payable                           (1,997)
                                                                   ---------
      Net cash provided by operating activities                      316,352
Cash flows from investing activities
  Purchase of fixed assets                                           (17,355)
  Distributions from partnership - Memphis store                         167
  Distribution to minority interest owner                             (5,040)
                                                                   ---------
      Net cash used by investing activities                          (22,228)
Cash flows from financing activities
  Distributions to partners                                         (296,277)
  Repayment of loan to Leo Kane                                       (2,842)
                                                                   ---------
      Net cash used by financing activities                         (299,119)
Net decrease in cash                                                  (4,995)
Cash at beginning of year                                             53,490
                                                                   ---------
Cash at end of year                                                $  48,495
                                                                   ---------
                                                                   ---------


Supplemental information:
     1995 -    Trade receivables in the amount of $22,500 are exchanged for a
               minority interest in a general partnership.
          -    Development fees advanced in the amount of $22,500 are used
               to satisfy various trade receivables.

                    THE ACCOMPANYING NOTES ARE AN INTEGRAL
                      PART OF THESE FINANCIAL STATEMENTS.


                                      F-38

<PAGE>


                  COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY

                            (A TEXAS LIMITED PARTNERSHIP)

                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                  DECEMBER 31, 1995

1.  ORGANIZATION

     THE COMPANY

     Compact Discs International, Ltd. (the "Company") is a Texas limited
partnership which conducts business under the name "CD Warehouse" and maintains
its principal office in Richardson, Texas.

     The Company offers and sells single-unit franchises and development rights
for multi-unit franchises for the operation of retail sales outlets which buy,
sell and trade new and used compact discs and related items (Note 8).  As of
December 31, 1995, the Company has executed 112 franchise agreements for the
operation of stores, of which 96 are operational.  The Company has 11
development agreements in place as of December 31, 1995.

     PRINCIPLES OF CONSOLIDATION

     The consolidated financial statements include the accounts of the Company
and CD Warehouse - Fort Worth, an 81.25% owned subsidiary; the remaining 18.75%
is owned by an unrelated third party investor.  All significant intercompany
accounts and transactions have been eliminated in consolidation.  Minority
interest in the consolidated subsidiary represents the minority owner's
proportionate share of the equity of CD Warehouse - Fort Worth.

     CASH AND CASH EQUIVALENTS

     For purposes of the statement of cash flows, the Company considers all
highly liquid debt instruments purchased with a maturity of three months or less
to be cash equivalents.  All cash is held in accounts that are federally
insured.


                                      F-39

<PAGE>

     INVENTORY

     Inventory consists primarily of both new and used compact discs.  All
inventory is valued at the lower of cost or market using the first-in, first-out
(FIFO) method.  The inventory is located for resale at the subsidiary's location
in Fort Worth, Texas .

     FURNITURE, FIXTURES AND EQUIPMENT

     Furniture, fixtures and equipment are stated at cost.  The provision for
depreciation has been calculated using the straight-line method.  Useful lives
range from 3 to 7 years.

     OTHER ASSETS

     Organization costs and the Company's trademark are being amortized using
the straight-line method over five and fifteen years, respectively.

     INVESTMENT IN PARTNERSHIPS

     The Company records its ownership in two minority-owned partnerships that
own CD Warehouse stores using the equity method of accounting.

     REVENUE RECOGNITION

     Franchise fees are non-refundable.  Franchise fee income is recognized upon
the opening of the related store.  The Company's commitment and obligations to
franchisees are not significant after the store is opened.  Development right
fees paid are recognized as income on a prorated basis as the franchise units
within a development agreement are opened.  Development fees are non-refundable,
but will be applied against future franchise fees and royalty fees due from
development franchisees.  Royalties are recognized when earned.  Specially
designed software is sold to the franchisees, and the related income is
recognized when earned.

     ESTIMATES

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures.  Accordingly,
actual results may differ from those estimates.


                                      F-40

<PAGE>


2.  CHANGE IN METHOD OF ACCOUNTING

     Subsequent to the original audit date of these financial statements, March
6, 1996, management of the Company changed its method of accounting for
development fee income.  In the prior financial statements, the total amount
deposited for development rights was recognized as income upon the opening of
the first franchise within a development agreement.  As Note 1 indicates, these
financial statements recognize development fee income on a prorated basis as the
franchise units within a development agreement are opened.  The change increased
income $4,095, increased development fee advances $50,321, and decreased
partners' capital $50,321, from what was originally reported in the financial
statements audited March 6, 1996.

3.  FURNITURE, FIXTURES AND EQUIPMENT

     Components of furniture, fixtures and equipment at December 31, 1995 are as
follows:

     Equipment                                             $ 28,861
     Furniture and fixtures                                  23,541
     Automobiles                                             12,386
     Leasehold improvements                                  10,101
                                                           --------
       Total                                                 74,889
     Accumulated depreciation                               (35,781)
                                                           --------
       Total                                               $ 39,108
                                                           --------
                                                           --------

4.  OTHER ASSETS

     Components of other assets at December 31, 1995 are as follows:

     Deposits                                                $3,560
     Organization costs                                       2,150
     Trademark                                                  394
                                                             ------
       Total                                                  6,104
     Accumulated amortization                                  (816)
                                                             ------
       Total                                                 $5,288
                                                             ------
                                                             ------



                                      F-41

<PAGE>


5.  INVESTMENT IN PARTNERSHIPS

     In the latter part of 1995 the Company entered into two partnership
agreements to own and operate retail CD outlets in Tulsa, Oklahoma and Memphis,
Tennessee.  At December 31, 1995, the Company has the following investments in
general partnerships:

                                                             Percentage
          Partnership                                           Owned
          -----------                                        ----------

     CD Warehouse - Tulsa                                        50

     CD Warehouse - Memphis                                      25

     At December 31, 1995, the Company's investment in partnerships and equity
in the income of these partnerships for the year then ended consist of the
following:

                                               Investment in     Partnership
                                                Partnership        Income
                                               -------------     -----------

          CD Warehouse - Tulsa                    $22,853          $  353
          CD Warehouse - Memphis                    2,378           2,545
                                                  -------          ------
                                                  $25,231          $2,898
                                                  -------          ------
                                                  -------          ------

     The following summarizes the activity of the CD Warehouse - Tulsa and
the CD Warehouse - Memphis partnerships for the year ended December 31, 1995:

                                              CD Warehouse  CD Warehouse
                                                  Tulsa        Memphis
                                              ------------  ------------
          Total assets                           $65,157       $58,722
          Total liabilities                        5,388         3,210
                                                 -------       -------
            Net assets                           $59,769       $55,512
                                                 -------       -------
          Revenues                               $24,683       $98,734
                                                 -------       -------
          Net income                             $   707       $10,180
                                                 -------       -------



                                      F-42

<PAGE>


6.  COMMITMENTS AND CONTINGENCIES

     The Company leases office space under a non-cancelable operating lease
agreement.  The agreement expires in 1997.  The Company also leases retail space
for its store operation.  This agreement expires in 1996.  Total rent expense
for the year ended December 31, 1995 was $41,027.

     The following is a schedule of future minimum lease payments for the above
leases as of December 31, 1995:

     Year ending December 31, 1996                       $27,426
     Year ending December 31, 1997                         5,694
                                                         -------
                                                         $33,120
                                                         -------

7.  INCOME TAXES

     Taxable income of the Company is includable in the income returns of the
individual partners; therefore, no provision for income taxes has been made in
the accompanying financial statements.

8.  RELATED-PARTY TRANSACTIONS

     The partners of the Company own, through a joint venture, CD Acquisitions,
"CDA." CDA sells new and used merchandise to franchisees.  The franchisees
included CD Warehouse - Fort Worth, Tulsa and Memphis.  Sales to these three
franchisees amounted to $108,800 in the year ending December 31, 1995.  CDA
operates out of the Company's location with no contribution to overhead
expenses.

     CDA owes the Company $111,316 at December 31, 1995.




                                      F-43

<PAGE>











                               CD ACQUISITIONS

                             FINANCIAL STATEMENTS

                     FOR THE YEAR ENDED DECEMBER 31, 1995

                                     WITH

                         INDEPENDENT AUDITORS' REPORT

















                                      F-44

<PAGE>



                         INDEPENDENT AUDITORS' REPORT

To the Venturers
CD Acquisitions

     We have audited the accompanying balance sheet of CD Acquisitions (A Joint
Venture) as of December 31, 1995, and the related statements of income,
venturers' capital, and cash flows for the year then ended.  These financial
statements are the responsibility of the Company's management.  Our
responsibility is to express an opinion on these financial statements based on
our audit.

     We conducted our audit in accordance with generally accepted auditing
standards.  These standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of CD Acquisitions as of
December 31, 1995, and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.


                                                        Huselton & Morgan, P.C.

Dallas, TX
February 20, 1996


                                      F-45

<PAGE>

                               CD ACQUISITIONS

                              (A JOINT VENTURE)

                                BALANCE SHEET

                              DECEMBER 31, 1995


                                    ASSETS

Current assets
  Cash                                                          $159,444
  Accounts receivable, net of allowance of $12,859               194,441
  Inventory                                                      305,757
  Prepaid insurance                                                7,913
                                                                --------

    Total current assets                                         667,555
                                                                --------
      Total assets                                              $667,555
                                                                --------
                                                                --------


                    LIABILITIES AND VENTURERS' CAPITAL

Current liabilities
  Accounts payable                                              $411,805
  Due to Compact Discs International, Ltd.                       111,316
  Advances from CD Stores                                          7,997
  Accrued insurance                                                6,430
  Sales tax payable                                                1,911
                                                                --------

    Total current liabilities                                    539,459
                                                                --------

Venturers' capital                                               128,096
                                                                --------
      Total liabilities and venturers' capital                  $667,555
                                                                --------
                                                                --------





                  THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                        OF THESE FINANCIAL STATEMENTS.


                                      F-46

<PAGE>


                               CD ACQUISITIONS

                              (A JOINT VENTURE)

                 STATEMENT OF INCOME AND VENTURERS' CAPITAL

                    FOR THE YEAR ENDED DECEMBER 31, 1995




Net Sales                                                    $2,717,043

Cost of goods sold                                            2,511,032
                                                             ----------

Gross profit on sales                                           206,011
                                                             ----------

Administrative and selling expenses                              77,918
                                                             ----------

          Net income                                            128,093

Venturers' capital, beginning of year                                 3
                                                             ----------

Venturers' capital, end of year                              $  128,096
                                                             ----------
                                                             ----------











                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                        OF THESE FINANCIAL STATEMENTS.


                                      F-47

<PAGE>


                               CD ACQUISITIONS

                              (A JOINT VENTURE)

                           STATEMENT OF CASH FLOWS

                     FOR THE YEAR ENDED DECEMBER 31, 1995



Cash flows from operating activities:
  Net income                                                      $ 128,093
  Adjustments to reconcile net income to cash
   from operating activities
     Bad debt expense                                                12,859
  (Increase) decrease in:
    Accounts receivable                                              10,342
    Inventory                                                      (145,948)
    Prepaids and other assets                                        (7,913)
  Increase (decrease) in:
    Accounts payable                                                 90,412
    Accrued expenses                                                 12,521
                                                                  ---------
    Net cash provided by operating activities                       100,366

Net increase in cash                                                100,366

Cash at beginning of year                                            59,078
                                                                  ---------
Cash at end of year                                               $ 159,444
                                                                  ---------
                                                                  ---------









                    THE ACCOMPANYING NOTES ARE AN INTEGRAL
                      PART OF THESE FINANCIAL STATEMENTS.


                                      F-48

<PAGE>

                               CD ACQUISITIONS

                              (A JOINT VENTURE)

                       NOTES TO FINANCIAL STATEMENTS

                              DECEMBER 31, 1995

1.  ACCOUNTING AND FINANCIAL REPORTING POLICIES

     CD Acquisitions (the "Company") is a joint venture among two individuals
and a limited liability company owned by one of the same individuals and his
spouse.  The principal office of operations is located in Richardson, Texas.
The Company is a wholesale distributor of new and used compact discs.

     The significant accounting policies utilized in the preparation of the
financial statements are as follows:

     RECORDS

     The financial statements are presented in accordance with generally
accepted accounting principles.

     CASH AND CASH EQUIVALENTS

     For purposes of the statement of cash flows, the Company considers all
highly liquid debt instruments purchased with a maturity of three months or less
to be cash equivalents.  There are no cash equivalents as of December 31, 1995.
All cash is held in accounts that are federally insured.

     INVENTORY

     Inventory is stated at the lower of cost or market.  Cost is determined by
using a moving average method.



                                      F-49

<PAGE>


     ESTIMATES

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures.  Accordingly,
actual results may differ from those estimates.

2.  RELATED PARTY TRANSACTIONS

     At December 31, 1995, the Company has the following balance owed to related
parties:

          Due to Compact Discs International, Ltd.               $111,316
                                                                 --------

     Leo Kane, owner of the Company, owns a 33% limited partnership interest in
Compact Discs International, Ltd. ("CDIL").  CDIL offers and sells single-unit
franchises and development rights for multi-unit franchises for the operation of
retail outlets which buy, sell and trade new and used compact discs.  All of
the Company's 1995 sales were to franchisees of CDIL.  The Company operates out
of the office and warehouse of CDIL at no charge to the Company.

3.  INCOME TAXES

     Taxable income or loss of the Company is includable in the income tax
return of the proprietor; therefore, no provision for income taxes has been made
in the accompanying financial statements.


















                                      F-50