<PAGE>

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

                                  FORM 10-KSB

(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, 1999     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)

1204 SOVEREIGN ROW, OKLAHOMA CITY, OKLAHOMA                 73108
-------------------------------------------                 -----
(Address of principal executive offices)                 (Zip Code)

      Registrant's telephone number, including area code: (405) 949-2422

<TABLE>
<CAPTION>
<S>                                                          <C>
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)
</TABLE>
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  X          No
                               ---

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 $31,912,276.

As of March 20,  2000,  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 $7,217,245.

As of March 20, 2000, there were 3,660,295 shares of Common Stock outstanding.

Transitional Small Business Disclosure Format (check one):  Yes       No  X
                                                                ---      ---
DOCUMENTS  INCORPORATED BY REFERENCE:  REGISTRANT'S PROXY STATEMENT FOR THE 2000
ANNUAL MEETING OF STOCKHOLDERS IS INCORPORATED BY REFERENCE IN PART III, ITEMS 9
THROUGH 12, OF THIS FORM 10-KSB.
<PAGE>

                                  FORM 10-KSB

                               TABLE OF CONTENTS


Item   PART I                                                               Page

1.     Description of Business                                                1

2.     Description of Property                                               12

3.     Legal Proceedings                                                     13

4.     Submission of Matters to a Vote of Security Holders                   13


       PART II

5.     Market for Common Equity and Related Stockholder Matters              14

6.     Management's Discussion and Analysis or Plan of Operation             14

7.     Financial Statements                                                  20

8.     Changes In and Disagreements With Accountants on Accounting
       and Financial Disclosure                                              20


       PART III

9.     Directors, Executive Officers, Promoters and Control Persons;
       Compliance With Section 16(a) of the Exchange Act                     20

10.    Executive Compensation                                                20

11.    Security Ownership of Certain Beneficial Owners and Management        20

12.    Certain Relationships and Related Transactions                        20

13.    Exhibits and Reports on Form 8-K                                      20

Signatures                                                                   23

Financial Information                                                Appendix A
<PAGE>

                DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

     THIS REPORT  INCLUDES  "FORWARD-LOOKING  STATEMENTS"  WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES  ACT OF 1933, AS AMENDED (THE "ACT"),  AND SECTION
21E OF THE SECURITIES  EXCHANGE ACT OF 1934, AS AMENDED.  ALL  STATEMENTS  OTHER
THAN STATEMENTS OF HISTORICAL FACTS INCLUDED IN THIS REPORT, INCLUDING,  WITHOUT
LIMITATION,  STATEMENTS  REGARDING  THE  COMPANY'S  FUTURE  FINANCIAL  POSITION,
BUSINESS  STRATEGY,  BUDGETS,  PROJECTED  COSTS  AND  PLANS  AND  OBJECTIVES  OF
MANAGEMENT FOR FUTURE OPERATIONS,  ARE FORWARD-LOOKING  STATEMENTS. IN ADDITION,
FORWARD-LOOKING   STATEMENTS   GENERALLY   CAN  BE  IDENTIFIED  BY  THE  USE  OF
FORWARD-LOOKING   TERMINOLOGY  SUCH  AS  "MAY,"  "WILL,"   "EXPECT,"   "INTEND,"
"ESTIMATE,"  "ANTICIPATE"  OR "BELIEVE" OR THE  NEGATIVE  THEREOF OR  VARIATIONS
THEREON  OR  SIMILAR  TERMINOLOGY.   ALTHOUGH  THE  COMPANY  BELIEVES  THAT  THE
EXPECTATIONS REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS ARE REASONABLE, IT CAN
GIVE NO ASSURANCE THAT SUCH EXPECTATIONS  WILL PROVE TO HAVE BEEN CORRECT.  SUCH
STATEMENTS 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.  IMPORTANT FACTORS
THAT COULD ACTUAL RESULTS TO DIFFER  MATERIALLY FROM THE COMPANY'S  EXPECTATIONS
("CAUTIONARY STATEMENTS") INCLUDE THE RISKS INHERENT GENERALLY IN THE RETAIL AND
FRANCHISING INDUSTRIES,  THE IMPACT OF COMPETITION AND PRICING,  CHANGING MARKET
CONDITIONS,  THE RISKS  DISCLOSED  UNDER  "ITEM  6-MANAGEMENT'S  DISCUSSION  AND
ANALYSIS OR PLAN OF  OPERATION"  AND  ELSEWHERE IN THIS REPORT.  ALL  SUBSEQUENT
WRITTEN AND ORAL  FORWARD-LOOKING  STATEMENTS  ATTRIBUTABLE  TO THE COMPANY,  OR
PERSONS ACTING ON ITS BEHALF,  ARE EXPRESSLY  QUALIFIED IN THEIR ENTIRETY BY THE
CAUTIONARY  STATEMENTS.  THE  COMPANY  ASSUMES  NO DUTY TO UPDATE OR REVISE  ITS
FORWARD-LOOKING   STATEMENTS   BASED  ON  CHANGES  IN  INTERNAL   ESTIMATES   OR
EXPECTATIONS  OR  OTHERWISE.  AS A RESULT,  THE READER IS CAUTIONED NOT TO PLACE
RELIANCE ON THESE FORWARD-LOOKING STATEMENTS. FURTHER, THERE CAN BE NO ASSURANCE
THAT THE HISTORICAL LEVEL OF THE COMPANY'S  REVENUES AND GROWTH WILL CONTINUE TO
BE ACHIEVED IN THE FUTURE.

                                    PART I

ITEM 1.  DESCRIPTION OF BUSINESS.

GENERAL

     CD  Warehouse,  Inc.  (together  with its wholly  owned  subsidiaries,  the
"Company") is engaged in the  franchising and ownership of music stores offering
new and pre-owned  compact discs ("CDs") and related  products under two similar
but distinct franchise systems, "CD Warehouse" and "Disc Go Round." The term "CD
Warehouse  System"  encompasses the two franchise  systems and their  respective
stores,  which variously  operate under the trade names "CD Warehouse," "Disc Go
Round",  "CD Exchange" and "Music  Trader." Since its initial public offering in
January 1997 (the  "IPO"),  the Company has engaged in a program of expansion to
achieve strong market  recognition in the retail music industry.  This expansion
has been  accomplished  primarily  through  the sale of new  franchises  and the
acquisition  and  conversion  of  independently  owned  retail  music  stores to
company-owned  stores,  as well as the  acquisition  by the  Company of existing
franchised stores.  During 1999, the most significant factor contributing to the
Company's store and revenue growth was the acquisition of Music Trader,  Inc., a
16-store retail music chain based in Southern California.  At December 31, 1999,
the CD  Warehouse  System  had an  aggregate  339  stores in 39  states  and the
District of Columbia, Canada, England, France, Guatemala and Venezuela, with 185
franchised  stores and 75 company-owned  stores operating under the CD Warehouse
concept  (utilizing  either the CD Warehouse,  CD Exchange or Music Trader trade
name)  and 79  franchised  stores  operating  under  the Disc Go  Round  concept
(utilizing  either the Disc Go Round or CD Exchange  trade  name).  The term "CD
Warehouse"  encompasses  the CD  Warehouse,  CD Exchange and Music Trader stores
operating within the CD Warehouse franchise system, and the term "Disc Go Round"
encompasses the Disc Go Round and CD Exchange stores  operating  within the Disc
Go Round franchise system.

     CD Warehouse  and Disc Go Round  stores sell their  products to the general
public in the  market  area where the  respective  store is  located.  A typical
store,  located in a high traffic strip  shopping  center,  will occupy  between
1,200 and 2,500 square feet and offer between 10,000 and 16,000 selections, with
approximately 52% of the dollar sales volume being pre-owned  selections and the
balance being new releases from the major music categories. At each CD Warehouse
and Disc Go Round store,  a customer  selects from a number of new and pre-owned
CDs and may listen to pre-owned  CDs before  purchase.  CD Warehouse and Disc Go
Round stores sell CDs, take  customers'  CDs in trade or buy  customers' CDs for
cash.  Typically,  each store  carries  the  majority of the  Billboard  Top 100
selections  as "new"  inventory,  filling  out  its  inventory  selection  with
pre-owned CDs which are purchased for $1 to $4 and remarketed for $6 to $9.

                                       1
<PAGE>

     During the year ended  December 31, 1999, the Company had total revenues of
approximately  $31,912,000,  and  net  loss  of  approximately  $1,141,000.  The
Company's expansion strategy for 2000 is to open 25 to 30 franchised stores. The
Company  also  plans  to  further   develop  and  market  its   internet   site,
HTTP://WWW.CDWAREHOUSE.COM,  which  offers  both new and  used  CDs.  See  "ITEM
1-Description of Business-Competition."

HISTORY

     The Company was formed in  September  1996 to acquire the assets of Compact
Discs International, Ltd. ("CDIL"), a Texas limited partnership which franchised
stores throughout the United States and England under the name "CD Warehouse." A
portion of the proceeds of the  Company's  IPO was used to fund the $3.2 million
acquisition (the "CDIL Acquisition"),  which was consummated simultaneously with
the  closing  of  the  IPO.  See  Item  12-Certain   Relationships  and  Related
Transactions. In a related transaction (the "MacDonald Acquisition"), which also
occurred  simultaneously  with the closing of the IPO, the Company  acquired the
equity   interests  of  Bruce  D.  MacDonald   (together  with  his  affiliates,
"MacDonald") in various partnerships or other entities which were franchisees of
an  aggregate  36  franchised   CD  Warehouse   stores.   See  Item   12-Certain
Relationships and Related Transactions.  As a result 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.

RECENT EVENTS

     On February  22,  1999,  the Company  completed  the purchase of a 16-store
retail music chain located in San Diego,  California and  surrounding  areas and
operating under the name "Music  Trader." The Company  operates the 16 stores as
company-owned  stores under the CD Warehouse  concept.  The total purchase price
for the  transaction,  which was  structured  as an  acquisition  of the  assets
relating to the 16 stores,  was $4,000,000,  comprised of $3,000,000 in cash and
$1,000,000  in  Common  Stock  of  the  Company,  valued  for  purposes  of  the
acquisition at $11.80 per share.

     Effective  January 4, 2000,  Gary D.  Johnson  resigned  his  positions  as
Director,  Executive Vice President and Chief Operating  Officer of the Company.
On March 1, 2000, the Company entered into an agreement with Mr. Johnson to sell
to him two company-owned stores, as well as a store "package" (consisting of the
furniture,  fixtures and inventory  necessary to open a CD Warehouse store), for
an aggregate  purchase  price of $425,505  (the  "Johnson  Sale").  The sale was
consummated on March 21, 2000.

BUSINESS STRATEGY

     The Company's business strategy of offering a mix of both new and pre-owned
CDs is based on its  belief  that  there is a growing  consumer  willingness  to
purchase  pre-owned  CDs,  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,  pre-owned CDs at exceptional value; (2) offering to accept as
a trade,  or buy for cash,  selected  CDs from  customers;  and (3)  selling new
releases at competitive prices.

     According to the Recording  Industry  Association  of America (the "RIAA"),
annual  CD  sales in the  United  States  for  1999  were  $12.8  billion  which
represented a 12.3% increase from 1998 domestic CD sales of $11.4  billion.  The
lack of any audible difference between new and pre-owned CDs,  durability of the
medium,  cost savings and the  accumulating  stock of available  CDs for resale,
suggest the  possibility  for rapid  market  growth in the  pre-owned CD market.
Because  the CD is encased in plastic  and read by a laser,  the playing of CDs,
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, CDs may reasonably be expected to last for decades; premium
(gold-plated) CDs may last for centuries. Such extraordinary durability, coupled
with the standard error-correction circuitry in CD players, means that pre-owned
CDs  are  essentially  indistinguishable  from  new  CDs  in  terms  of  audible
performance.  By  offering  quality  pre-owned  CDs 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.

                                       2
<PAGE>

     Management   believes   that,   in  addition  to  the   Company,   Hastings
Entertainment,  Inc. and  Wherehouse  Entertainment,  Inc. are the only national
chains selling pre-owned CDs on any significant scale. The Company believes that
it can  increase  its  market  share by  expanding  the CD  Warehouse  System in
targeted markets.  The Company's expansion strategy for 2000 is to open 25 to 30
franchised stores. To accomplish this objective,  the Company employs a business
strategy that includes the following elements:

     INVENTORY MANAGEMENT SYSTEM. The Company considers its inventory management
system,  which is a software program proprietary to the CD Warehouse concept, to
be essential to the success of its business strategy.  The program,  which has a
database in excess of 270,000  titles and includes  catalogs  from all the major
record  labels,  assists each store in  selectively  procuring  pre-owned CDs 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.  Disc Go Round stores
utilize  an  inventory  and   point-of-sale   software  that  offers  comparable
management  reporting  capability  but  lacks  the  ranking  by levels of the CD
Warehouse database.

     The Company  believes  that the  proprietary  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  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.  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  as much as 75% of the  opening  inventory  for a new  store  can be
purchased from system 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.

     The Company is finalizing an upgraded  version of its proprietary  software
system.  The  upgrade  is  expected  to  include  such  enhancements  as  (i)  a
communications  interface  that will  allow all stores to  communicate  with the
Company and with each other, and (ii) an accounting  package that will produce a
profit  and  loss  statement  from  the   information   captured  by  a  store's
point-of-sale register. The Company expects to introduce the software upgrade to
all CD Warehouse stores during 2001.

     CUSTOMER SERVICE.  The Company  emphasizes  excellent  customer service and
seeks to employ,  and to sell franchises to, motivated and energetic people. The
Company also seeks to foster enthusiasm for its customer service  philosophy and
its franchise concepts 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 franchised store
development.  The Company  concentrates its expansion of 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  historically  has  co-developed
markets with  franchisees,  divided markets among franchisees or divided markets
among  the  Company  and  franchisees,   "clustering"  both   company-owned  and
franchised  stores through the use of area  development  agreements and its site
selection  approval  process.  The  Company  believes  that  this  approach  has
contributed  to  increased  average  store  sales.  For 2000,  the  Company  has
determined to focus its efforts on market expansion through increased franchised
store development, rather than company-store development.

                                       3
<PAGE>

STORE LOCATIONS

     The table  below  shows the  location,  as of  December  31, 1999 of all CD
Warehouse  and Disc Go Round stores  (which also  includes,  for each  franchise
system,  stores  operating under the trade name "CD Exchange" or "Music Trader")
in the United States, Canada, England, France, Guatemala and Venezuela:



DOMESTIC
--------

ALABAMA
Birmingham++
Daphne++
Homewood++
Hoover++
Huntsville (2)++
Mobile (2)++

ARIZONA
Tempe++

ARKANSAS
Fayetteville++
Fort Smith++
Little Rock *
North Little Rock*

CALIFORNIA
Chula Vista*
El Cajon*
Encinitas*
Escondido*
Huntington Beach+
Oceanside*
Palm Desert+
Poway*
San Diego (8)*
San Marcos*
Santee*

COLORADO
Arvada+
Colorado Springs++
Ft. Collins*
Littelton+

DELAWARE
Newark+
Wilmington+

FLORIDA
Coral Gables*
Davie++
Daytona Beach*
Deland*
Fern Park*
Ft. Lauderdale (2)++
Ft. Myers++
Gainesville++
Jacksonville (2)*
Lake Park++
Melbourne*
Miami Lakes*
Miami*
Naples++
Neptune Beach*
North Miami*
Orange Park*
Orlando*
Orlando+
Ormond Beach*
Penbrooke Pines++
Port Charlottee++
Sanford*
Tallahassee (3)++
Tampa+
Venice++

GEORGIA
Atlanta (2)++
Atlanta+
Duluth++
Marietta (2)++
Martinez++
Morrow++

IDAHO
Idaho Falls++

ILLINOIS
Carbondale++
Chicago (2)+
Harwood Heights+
Moline+
North Riverside+
Streamwood++

INDIANA
Bloomington+
Indianapolis++
Indianapolis (3)+
Mishawaka+

IOWA
Ames+
Cedar Rapids++
Cedar Rapids+
Clive+
Davenport++
Davenport+
Des Moines (2)++
Des Moines+
Iowa City++
Sioux City++
Waterloo++
Waterloo+

KANSAS
Overland Park*
Shawnee*
Wichita++
Olathe*

KENTUCKY
Lexington++
Louisville+
Paducah++

LOUISIANA
Baton Rouge*
Baton Rouge++
Gretna++
Lafayette*
Metarie*
New Orleans++
Shreveport++
Shreveport+

MARYLAND
Elkridge++
Laurel++

MICHIGAN
East Lansing++
Grand Rapids (2)++
Holland+
Kalamazoo++

                                       4
<PAGE>

MINNESOTA
Bemidji+
Blaine++
Brooklyn Center++
Burnsville++
Duluth+
Edina++
Maple Grove+
Maplewood++
Minneapolis (2)++
Roseville++
St. Cloud++

MISSOURI
Arnold++
Ballwin++
Cape Girardeau++
Gladstone*
Independence*
Kansas City*
Lee Summit*
Maryland Heights++
O'Fallon++
Springfield*
St. Louis++

MONTANA
Bozeman++
Great Falls++

NEBRASKA
Lincoln*
Omaha*

NEVADA
Las Vegas*

NEW JERSEY
Belleville++
Freehold+
Laurel Springs++
Northfield++
Voorhees+

NEW YORK
Endicott+
Guilderland+
Huntington Station++
Rockville Center++
Wantaugh+
White Plains++

NORTH CAROLINA
Cary+
Charlotte (3)++
Durham+
Fayettville++
Goldsboro++
Raleigh+
Wilmington+
Wilson++

NORTH DAKOTA
Fargo++

OHIO
Beavercreek+
Boardman++
Canton++
Centerville+
Cincinnati(2)+
Cleveland Heights++
Columbus (4)++
Fairlawn++
Holland++
Mayfield Heights++
Mentor++
Miamisburg++
Niles++
Parma Heights++
Toledo++

OKLAHOMA
Edmond*
Midwest City*
Norman*
Oklahoma City (3)*
Shawnee*
Stillwater (2)*
Tulsa*
Tulsa++

OREGON
Beaverton+
Portland+

PENNSYLVANIA
Allentown+
Conshohocken+
Easton+
Erie+
Greensburg++
Harrisburg++
Lancaster++
Mechanicsburg++
Monroeville++
Philadelphia+
Pittsburgh (2)++
Pittsburgh+
State College++
West Mifflin++

SOUTH CAROLINA
Columbia+
Greenville (2)++

SOUTH DAKOTA
Sioux Falls+

TENNESSEE
Antioch++
Bartlett+
Clarksville++
Jackson++
Madison++
Memphis*
Murfreesboro++
Nashville++

TEXAS
Abilene*
Addison*
Arlington (3)++
Austin (4)++
Carrollton*
College Station+
Corpus Christi++
Corpus Christi+
Dallas (7)++
Denton ++
Duncanville++
El Paso*
Ft. Worth++
Garland*
Grand Prairie++
Houston (6)*
Houston+
Hurst++
Irving++
Lewisville++
Longview++
Lubbock++
Mesquite++
Midland*
North Richland Hills++
Plano*
Round Rock++
San Angelo++
San Antonio (7)++

                                       5
<PAGE>

TEXAS (con't)
San Marcos++
Sherman++
Texarkana++
Waco*
Webster*
Wichita Falls*

UTAH
Provo++
Provo+
Salt Lake City++
St. George++
Taylorsville++

VERMONT
Burlington+

VIRGINIA
Alexandria++
Fairfax++


WASHINGTON
Belleville++
Bremerton++
Kennewick+
Linwood+
Seattle++
Seattle(3)+

WISCONSIN
Appleton++
Appleton+
Brookfield++
Brookfield+
East Milwaukee+
Green Bay+
Greenfield+
Greenfield++
Janesville+
Kenosha++
Madison(3)+
Madison++
Racine++

DISTICT OF COLUMBIA
Washington++

INTERNATIONAL
-------------

CANADA
Charlottetown/PE+
Dartmouth/NS+
Halifax/NS+
Kingston/ON++
Ottawa/ON (2) ++
Thunder Bay/ON++
Winnipeg/MB (3)+

ENGLAND
Ealing++
Leeds++
London++
Watford++

FRANCE
Caen++

GUATEMALA
Guatemala City++

VENEZUELA
Caracus++

_____________________________
*   Indicates company-owned store.
++  Indicates CD Warehouse franchised store.
+   Indicates Disc Go Round franchised store.


EXPANSION STRATEGY

     The first CD Warehouse store opened in Dallas, Texas in August 1992 and, as
of December 31, 1999, the CD Warehouse  System had an aggregate 339 stores in 39
states and the District of Columbia,  Canada,  England,  France,  Guatemala  and
Venezuela,  with 185 franchised  stores and 75  company-owned  stores  operating
under the CD Warehouse concept and 79 franchised stores operating under the Disc
Go Round concept. Key elements of the Company's expansion strategy include:

     AGGRESSIVE, BALANCED GROWTH. Historically, the Company's expansion strategy
has been to increase the number of franchised stores by selective utilization of
Company-owned  stores in a particular market area. The Company believes that, in
many  cases,  the  Company has been able to take  advantage  of a promising  new
location  by  establishing  a  Company-owned  store  when a delay in  finding  a
qualified  franchisee might have jeopardized 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.
However,  the  cornerstone  of the  Company's  expansion  strategy  remains  the
addition of new  franchised  stores in the system,  which enables the Company to
expand its system more quickly with no capital investment. For 2000, the Company
has  determined  to focus its  efforts  on market  expansion  through  increased
domestic franchised store development, rather than company-store development.

                                       6
<PAGE>

     NAME  RECOGNITION  AND NEW MARKET  PENETRATION.  The Company  believes  the
visibility of its stores at high traffic,  Class A, strip  shopping  centers has
generated  good name  recognition  in the areas in which  stores  currently  are
located.  The Company's expansion strategy involves the building-out of existing
markets and the further  penetration of developing markets through clustering of
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. In determining which new markets to develop, the Company
considers many factors, including the size of the market, demographics,  cost of
media, population trends, competition and real estate availability and pricing.

     CONSIDERATION  OF ACQUISITIONS.  During 1999, the most  significant  factor
attributable  to the Company's  store and revenue growth was the  acquisition of
Music Trader,  Inc., a 16-store retail music chain based in Southern California.
The Company may consider acquisition of other local and regional pre-owned music
retailers  to  implement  its  strategy  of  building  out  current  markets and
establishing itself in new target markets.  However, it is the Company's present
intention  to  focus  its  expansion  strategy  on  domestic   franchised  store
development.

OPERATIONS

     ACQUISITION OF PRE-OWNED CDS. A key component of the two franchise concepts
within the CD  Warehouse  System is the  purchase or trade of selected  CDs from
customers;  accordingly,  the  Company  obtains  a  significant  portion  of its
pre-owned 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. 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 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.  As much as 75% of the opening  inventory for a new store
can be purchased from system 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 CDS, OTHER POINT-OF-SALE  ITEMS AND STORE  FIXTURES.  For
new music releases, the Company contracts with outside third-party distributors.
The  Company  negotiates  with  vendors on behalf 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 franchised
and Company-owned stores with supplies and related materials.

MARKETING AND ADVERTISING

     CD  WAREHOUSE  STORES.   The  Company  provides  new  stores  with  certain
pre-opening  items  and  point-of-sale  materials.   Additional   point-of-sales
materials  are  available  to all stores at no cost from the  record  companies.
Additionally,  the CD Warehouse  franchise  agreements provide for each store to
spend  2.5% of  sales  specifically  on  advertising,  with  each CD  franchisee
conducting its own marketing and advertising  activities  independently  through
newspapers and radio.  In 1999, the Company  activated a mandatory  concept-wide
advertising  fund (the "SAF").  The Company expects that the SAF will become the
primary creative and production vehicle for all marketing efforts respecting the
CD Warehouse concept.

     DISC GO ROUND STORES.  Disc Go Round franchisees  under existing  franchise
agreements are required to spend 5% of their gross sales on approved advertising
and marketing.  In addition,  all Disc Go Round  franchisees are required to pay
the Company an annual advertising production fee of $500.

     Under the current form of Disc Go Round franchise agreement, applicable for
renewals,  Disc Go Round  franchisees are required to spend during each calendar
quarter 2.5% of the store's gross sales to advertise  and promote the store,  of
which 1 3/4% is spent  directly by the store in local  market  advertising,  and
3/4% is paid to the Company to be deposited into a concept-wide advertising fund
to market the Disc Go Round concept.

                                       7
<PAGE>

FRANCHISING PROGRAM

     CD WAREHOUSE

     GENERAL.  As of December 31, 1999,  there were a total of 174 franchised CD
Warehouse  stores in 32 states  and the  District  of  Columbia,  and  eleven CD
Warehouse  stores in Canada,  England,  France,  Guatemala  and  Venezuela.  The
Company expects to open 25 to 30 new CD Warehouse  franchised  stores by the end
of 2000.  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.  Pursuant to the terms of existing area  development
agreements,  a total of 52 stores are  committed  to be opened over the next two
years.

     The CD Warehouse  franchise  agreement provides the franchisee the right to
use or be provided, as the case may be, the Company's trade names, service marks
and  trademarks;  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.

     FRANCHISE  SOURCING  AND  SELECTION.  The  majority of new  franchises  are
individuals  responding  to  advertisements  in  national  publications  such as
Entrepreneur  Magazine and The Franchise  Handbook.  Various  publications  also
publish articles or rankings of top-selling  franchises (e.g., in February 1999,
Entrepreneur Magazine ranked the Company 20th in its list of 101 fastest-growing
franchises  and  57th in its 20th  Annual  Franchise  500),  which  also  elicit
inquiries from potential 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 become a
CD Warehouse franchisee. Once an inquiry is received, the prospect is mailed the
Company's brochure and marketing  materials.  The inquiry is then followed up on
within a period of two weeks.

     The Company has  established a home page via the Internet  (World Wide Web)
that will provide detail on the franchise opportunities presented by operating a
CD   Warehouse   store.   The   Company's    homepage   can   be   accessed   at
HTTP://WWW/CDWI.COM/.


     TRAINING  AND  SUPPORT.  The  Company's  philosophy  is one of service  and
commitment to its system.  Each franchise  owner/operator and each company 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,  CD  Warehouse
franchisees  generally  pay the  Company an initial  franchise  fee of  $20,000,
royalties equal to 5% of monthly gross sales, an advertising fund fee of 3/4% of
monthly gross sales and a one-time software licensing gee of $3,000. 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

                                       8
<PAGE>

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  franchise  agreement  prohibits  the  transfer  or  assignment  of any
interest in a franchise  without the prior written  consent of the Company.  The
franchise  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 with the
payment of an amount equal to 20% of the then-existing franchise fee. All of the
franchise  agreements  assigned  to the  Company  in  connection  with  the CDIL
Acquisition will expire between 2002 and 2006.

     UNIT ECONOMICS. The Company believes that future CD Warehouse stores can be
opened for an initial investment of $132,300 to $169,000.  The estimated initial
investment is comprised of the following:


                                                MINIMUM     MAXIMUM
                                                -------     -------
       Franchise Fee                          $  20,000   $  20,000
       Software License Fee                       3,000       3,000
       Lease & Utility Deposits                   1,500       4,000
       Leasehold Improvements                    18,000      22,000
       Contractor                                11,000      15,000
       Computer Hardware                          8,000      12,000
       Fixtures and Equipment                    17,000      19,500
       Initial Inventory                         40,000      50,000
       Signage                                    6,000       7,500
       Travel & Expense of Training               1,000       1,500
       Insurance                                    500       1,000
       Miscellaneous Opening Cost                   800       2,000
       New Store Marketing & Advertising            500       1,500
       Operating Cash on Hand                     5,000      10,000
                                                  -----      ------
          Total                               $ 132,300   $ 169,000
                                                =======     =======

     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, 1999,  average unit
sales on a comparable basis were $372,000. Based on an average initial estimated
capitalization of $150,650,  the sales to capitalization  ratio to open a new CD
Warehouse store is 2.47 to 1.

     FRANCHISE  FINANCING.  Typically,  franchisees  obtain their own sources of
financing and do not require the Company's assistance.  However, the Company has
established a relationship  with GE Capital  Business Asset Funding  Corporation
whereby such company provides financing to qualifying  franchisees.  Franchisees
are not  obligated to secure  financing  from such lender,  nor is the Company a
party to any such financing ultimately obtained by the franchisee.

     DISC GO ROUND

     GENERAL.  As of December 31,  1999,  there were a total of 73 Disc Go Round
stores in 26 states and six Disc Go Round  stores in  Canada.  The  Company  has
determined  that it will not sell or offer for sale any additional Disc Go Round
franchises.  While  the  Company  will  honor  its  ongoing  obligations  as the
successor  franchisor  under  the Disc Go  Round  franchise  agreements  that it
acquired,  it intends to encourage  the existing  Disc Go Round  franchisees  to
become CD Warehouse  franchisees and to convert their Disc Go Round stores to CD
Warehouse stores.

                                       9
<PAGE>

     THE FRANCHISE AGREEMENT; TERMS AND CONDITIONS. The domestic renewal of Disc
Go Round franchises is made by a Uniform Franchise Offering Circular prepared in
accordance with federal and state laws and regulations.

     Generally, the form of franchise agreement under which substantially all of
the existing Disc Go Round  franchises  currently  operate provides that Disc Go
Round  franchisees  pay the Company (i)  royalties  equal to 5% of weekly  gross
sales, and an annual marketing fee of $500.

     Under the form of domestic franchise agreement  applicable to renewing Disc
Go Round  franchisees,  franchisees  generally  will pay the  Company  a renewal
franchise  fee of $5,000,  and  royalties  equal to 5% of monthly  gross  sales.
Franchisees  are  generally  granted  exclusive  territory  with  respect to the
operation  of Disc Go  Round  stores  only in the  immediate  vicinity  of their
stores.

     The Disc Go Round franchise  agreement requires  franchisees 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 Disc Go Round  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 Disc Go Round system.  The Company's  ability to terminate
franchise  agreements  pursuant  to such  provisions  is subject  to  applicable
bankruptcy and state laws and regulations.

     The  franchise  agreement  prohibits  the  transfer  or  assignment  of any
interest in a franchise  without the prior written  consent of the Company.  The
franchise  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.

     Existing Disc Go Round franchises may be renewed for a renewal term of five
years;  however,  franchisees  will not have the right to a  subsequent  term of
renewal.  The Company's  ability to not renew franchise  agreements  pursuant to
such provision is subject to applicable state laws and regulations.

     INTERNATIONAL FRANCHISE OPERATIONS

     There  are  11 CD  Warehouse  franchised  stores  and  six  Disc  Go  Round
franchised stores currently operating in Canada, England,  France, Guatemala and
Venezuela.  In  January  1997,  the  Company  entered  into a  master  franchise
agreement (the "Worldwide Area  Development  Agreement")  with Mark E. Kane, the
founder of CDIL. The Worldwide Area Development  Agreement provided for a period
of ten years for development of franchise  operations  worldwide,  excluding the
United  States,  Canada and Mexico,  and included a provision  which allowed 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 required that Mr. Kane open 100 stores
over the ten-year period.  In June 1998, the Company filed an arbitration  claim
against Mr. Kane,  alleging breach of the Worldwide Area  Development  Agreement
and seeking  cancellation of the agreement.  Pursuant to a settlement  agreement
between the parties  effective  March 15, 1999, the Worldwide  Area  Development
Agreement  was  terminated,  with all  development  rights under such  agreement
reverting to the Company.

COMPANY STORE PROGRAM

     Company-owned stores 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.

     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
1-Description  of Business.  The Company's  Director of 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.

                                       10
<PAGE>

     The  following  table  sets  forth the  number of stores  opened and closed
throughout the CD Warehouse System during fiscal 1999:
<TABLE>
<CAPTION>


                                  DECEMBER 31,                                     DECEMBER 31,
                                     1998         OPENED    CLOSED     TRANSFERS      1999
                                 --------------  --------  --------   -----------  -------------
<S>                              <C>            <C>      <C>         <C>          <C>
FRANCHISED STORES
  Domestic-CD Warehouse              128            22        (7)         31          174
  Domestic-Disc Go Round             120            --       (12)        (35)          73
                                     ---            --       ---         ---          ---
                                     248            22       (19)         (4)         247

  International-CD Warehouse           7             2        --           2           11
  International-Disc Go Round          8            --        --          (2)           6
                                      --            --       ---         ---          ---
                                      15             2        --          --           17

COMPANY-OWNED STORES
  Domestic-CD Warehouse               51            25        (5)          4           75
  Domestic-Disc Go Round              --            --        --          --           --
                                     ---            --       ---         ---          ---
                                      51            25        (5)          4           75
                                     ---            --       ---         ---          ---
         Total                       314            49       (24)         --          339
                                     ===            ==       ===         ===          ===
</TABLE>


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 that 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.

                                       11
<PAGE>

     According  to the RIAA,  CD sales in the  United  States  were  over  $12.8
billion in 1999.  The Company has various  competitors in the industry that sell
new recordings and music related  merchandise.  These  companies vary from those
who are specialty music stores in malls (such as Sam Goody's and Camelot), those
who utilize freestanding buildings (such as Wherehouse  Entertainment,  Inc. and
Hastings Entertainment, Inc.) and those who sell via the Internet (such as CDNow
and  Amazon.com).  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  freestanding  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 $17.99,  with the latest top 20
releases on sale for $11.99 to $13.99 per CD. None of these  "superstores"  sell
pre-owned  music  except  for  Wherehouse   Entertainment,   Inc.  and  Hastings
Entertainment, Inc.

     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 pre-owned
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 and Circuit City),  which have
generally utilized  approximately  1,000 square feet of space and discount their
new releases from $12.99 to $17.99 per item.

     Other competitors  include specialty  Internet retailers such as CDNow, and
more general  Internet  retailers,  such as Amazon.com,  which have targeted the
prerecorded music market. In response to this growth in electronic  commerce and
the future potential for on-line sales of prerecorded music product, the Company
launched its own Internet commerce site, HTTP://WWW.CDWAREHOUSE.COM, in December
1998. The website,  which experienced initial difficulties in uploading the used
inventory of company-owned  stores, became fully operational in August 1999, and
now offers both new and used product. Additionally, the Company anticipates that
the website will also be available for  participation  by  franchised  stores in
2000. The Company  believes that its ability to offer hard to find, out of print
product,  will  provide it with a  competitive  advantage  over  other  Internet
retailers of prerecorded music.  However,  the e-commerce market is new, rapidly
evolving and intensely  competitive,  and the Company  expects that  competition
will further intensify in the future. Barriers to entry are minimal, and current
and new competitors can launch new sites at a relatively low cost.

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

     In selling  franchises,  the Company also competes with many franchisors of
retail and other business opportunities.

TRADEMARKS AND SERVICE MARKS

     The names "CD Warehouse," "Disc Go Round," and "CD Exchange" are registered
with the United  States  Patent  and  Trademark  Office.  The  Company  also has
registered  its  copyright  on its  proprietary  software  system  and has  made
application  for the service  marks for the phrases "The Future of Music" and "A
New Spin on Music." The Company believes that its trademarks,  service marks and
copyright have significant value and are important to its marketing efforts.

EMPLOYEES

     The Company as of March 10, 2000 employs 285  full-time  and 150  part-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 1204  Sovereign
Row, Oklahoma City, OK 73108. The total facility is approximately  26,000 square
feet  and is held  under a  60-month  lease  with a  monthly  lease  payment  of
approximately  $14,200.  The  expiration  date of the lease is January 31, 2004.
Approximately  11,000  square feet is used for  administrative  purposes and the
balance of the space is utilized as a warehouse.

     The Company leases space for its 75 company-owned retail stores,  typically
for a fixed monthly rental and operating  costs.  Aggregate rental expense under
these store leases and the Company's  executive  offices totaled

                                       12
<PAGE>

$2,157,918  for  1999.    Total  rental  amounts  of  $6,454,200   under   these
noncancelable  leases  are  due as  follows:  2000-$1,902,896;  2001-$1,685,979;
2002-$1,363,796; 2003-$1,083,209; 2004-$403,579 and thereafter-$14,741.

ITEM 3.  LEGAL PROCEEDINGS.

     In November 1999, the Company settled an arbitration  proceeding brought by
Jimick Products,  Inc. ("Jimick") in 1998, pursuant to which Jimick had alleged,
inter alia, that certain of the Disc Go Round franchised  stores acquired by the
Company in June 1998 and located in Jimick's  development  area  encroached upon
Jimick's  development area in violation of its agreements with the Company. As a
result of the  settlement  agreement  entered into  between the parties,  Jimick
agreed to immediately pay all outstanding  obligations due to the Company and to
sell to the Company three  franchised CD Warehouse  stores located in Wisconsin.
The settlement  agreement also acknowledged the Company's right to acquire other
franchise  concepts and operate them separately from existing franchise concepts
without Jimick  asserting that either the acquisition or operation of such other
franchise  concepts in any way  violates  the terms of the now or then  existing
Franchise  Agreements  or Area  Development  Agreements.  Other  than the  three
Wisconsin stores sold to the Company,  Jimick will remain a franchisee of the CD
Warehouse system and will have certain future franchise  development  rights. In
March 2000, the parties entered into a supplemental  agreement pursuant to which
the Company agreed to pay approximately  $700,000 to Jimick in settlement of all
issues between the parties. Of such amount, approximately $225,000 is payable by
March  31,  2000,  with the  balance  of  $475,000  payable  in  twelve  monthly
installments commencing April 5, 2000 and bearing interest at a rate of 8.5% per
annum.   See  "Item  7.   Management's   Discussion  and  Analysis  or  Plan  of
Operation-Liquidity and Capital Resources."

     During 1999, the Company was also involved in various proceedings  relating
to claims arising out of its normal business  operations.  The Company  believes
that  such  litigation,  most of which had been  settled  as of the date of this
Report,  should not have a material  adverse  effect on the Company's  financial
position.  See  "Item  7.  Management's  Discussion  and  Analysis  or  Plan  of
Operation-Liquidity and Capital Resources."

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

     No matters were  submitted to a vote of security  holders during the fourth
quarter of the fiscal year covered by this report.

                                       13
<PAGE>

                                    PART II

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

MARKET FOR COMMON EQUITY

     The  Company's  Common  Stock began  trading on the NASDAQ Small Cap Market
System on January 22, 1997,  under the symbol  "CDWI."  Effective July 26, 1999,
the Company's securities began trading on the NASDAQ National Market System. The
following  table sets forth,  for the periods  indicated,  the high and low sale
price per share for the Company's Common Stock:


                                          1999                       1998
                               ------------------------  ----------------------
                                  HIGH         LOW          HIGH          LOW
                               -----------  -----------  -----------   --------
   First Quarter..............  $15.25        $9.75       $ 7.6875       $3.50
   Second Quarter.............  $10.50        $7.125      $16.75         $7.8125
   Third Quarter..............  $ 9.125       $4.625      $24.9375       $6.75
   Fourth Quarter.............  $ 6.6875      $3.25       $23.625        $5.00


     At March 20, 2000, there were approximately 68 registered holders of record
of the Common Stock.

     The  Company  has not paid cash  dividends  on its Common  Stock  since its
inception  and intends to retain  earnings  for the  continued  expansion of its
business.

RECENT SALES OF UNREGISTERED SECURITIES

     The following sets forth certain information  regarding recent sales of the
Company's securities, which were not registered under the Securities Act.

     Pursuant to an Asset Purchase  Agreement  between Compact Discs  Management
and  Music  Trader,   Inc.  ("Music   Trader"),   Jeffrey  D.  Clark  and  Debbi
McGill-Clark,  dated February 22, 1999, the Company purchased  substantially all
of the assets  related to Music  Trader's  retail  music  business.  One million
dollars  of the  $4,000,000  purchase  price was paid by the  issuance  to Music
Trader of 84,745 shares of restricted Common Stock of the Company, calculated by
dividing $1,000,000 by the average of the closing prices of the common stock, as
quoted by Nasdaq,  for the five trading days preceding the closing.  Pursuant to
the terms of the Asset  Purchase  Agreement,  Music  Trader was granted  certain
"piggyback"  registration  rights with  respect to the 84,745  shares  issued in
connection with the transaction.

     No sales commissions were paid in connection with the above stock issuance.
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.

     CERTAIN FORWARD-LOOKING STATEMENTS CONTAINED HEREIN REGARDING THE COMPANY'S
BUSINESS  AND  PROSPECTS  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,  AND OTHER RISKS. ANY  FORWARD-LOOKING  STATEMENTS  CONTAINED HEREIN
REPRESENT THE COMPANY'S  JUDGMENT AS OF THE DATE HEREOF.  THE COMPANY DISCLAIMS,
HOWEVER, ANY INTENT OR OBLIGATION TO UPDATE THESE FORWARD-LOOKING STATEMENTS. AS
A  RESULT,  THE  READER  IS  CAUTIONED  NOT TO  PLACE  UNDUE  RELIANCE  ON THESE
FORWARD-LOOKING  STATEMENTS.  AS USED IN  HEREIN,  THE WORD  "COMPANY"  MEANS CD
WAREHOUSE,  INC. AND ITS WHOLLY OWNED  SUBSIDIARIES,  COMPACT DISCS  MANAGEMENT,
INC., AND CD WAREHOUSE FINANCE COMPANY UNLESS THE CONTEXT INDICATES OTHERWISE.

                                       14
<PAGE>

STATEMENTS OF OPERATIONS

     The following table sets forth the Company's  results of operations for the
year  ended  December  31,  1999 and  1998.  The  information  should be read in
conjunction with the historical  Financial Statements included elsewhere in this
document.
<TABLE>
<CAPTION>

                                                        YEARS ENDED DECEMBER 31,
                                                             1999          1998
                                                             ----          ----
                                                   (IN THOUSANDS EXCEPT SHARE DATA)
     <S>                                               <C>           <C>
     Revenues:
       Retail store sales.............................. $  26,969     $   9,966
       Wholesale merchandise sales.....................       832         2,127
       Software income, net............................        71            92
       Royalty income..................................     3,860         2,827
       Franchise and development fees..................       180           188
       Management fees.................................        --            62
                                                         --------      --------
         Total revenues................................    31,912        15,262

     Operating costs and expenses:
       Cost of sales - retail store sales..............    16,186         5,902
       Cost of sales - wholesale merchandise sales.....       678         1,915
       Retail store operating expenses.................    10,209         3,307
       General and administrative......................     4,997         2,512
       Depreciation and amortization...................     1,516           617
                                                         --------      --------
     Total costs and expenses..........................    33,586        14,253
                                                         --------      --------

     Operating income (loss............................    (1,674)        1,009

     Other income (expense), net.......................      (151)          232
                                                         --------      --------

     Income (loss) before income taxes.................    (1,825)        1,241
     Provision (credit) for income taxes...............      (684)          466
                                                         --------      --------
     Net income (loss)................................. $  (1,141)    $     775
                                                         ========      ========
     Net income loss per share-basic................... $    (.31)    $     .27
                                                         ========      ========
     Net income loss per share-diluted................. $    (.31)    $     .25
                                                         ========      ========
     Shares used in computation-basic..................  3,642,442     2,923,090
                                                         =========     =========
     Shares used in computation-diluted................  3,642,442     3,136,485
                                                         =========     =========
</TABLE>

RESULTS OF OPERATIONS

     The  Company  derives  its  revenues  primarily  from  retail  sales of its
company-owned stores,  wholesale merchandise sales to franchisees of the Company
and royalty fees from  franchisees.  The Company  also  receives  revenues  from
initial  franchise fees,  area  development  fees,  management fees and software
income.  Retail store cost of sales and operating  expenses  relate  directly to
company-owned  retail store sales.  Wholesale  merchandise  sales and associated
cost of sales relate to the Company's  franchising  operations.  Other expenses,
such as depreciation,  amortization,  and general and  administrative  expenses,
relate to company-owned store operations,  as well as the Company's  franchising
operations. The number and sales volumes of company-owned retail stores directly
affect the  Company's  revenues and expenses.  The Company's  revenues and, to a
lesser  extent,  expenses,  also are affected by the number and sales volumes of
franchised stores. Initial franchise fees are directly affected by the number of
franchised store openings.

                                       15
<PAGE>

     The  following  table  sets  forth  the  percentage  relationship  to total
revenues, unless otherwise indicated, of certain items included in the Company's
statement of income:


                                                      YEARS ENDED DECEMBER 31,
                                                      ------------------------
                                                         1999         1998
                                                         ----         ----
   REVENUES:
     Retail store sales................................  84.5%         65.3%
     Wholesale merchandise sales.......................   2.6%         14.0%
     Software income, net..............................    .2%           .6%
     Royalty income....................................  12.1%         18.5%
     Management fees...................................    .0%           .4%
     Franchise and development fees....................    .6%          1.2%
                                                        ------        ------
         Total revenues................................ 100.0%        100.0%
   COST AND EXPENSES:
     Cost of sales - retail store sales (1)............  60.0%         59.2%
     Cost of sales - wholesale merchandise sales (2)...  81.5%         90.0%
     Retail store operating expenses (1)...............  37.9%         33.2%
     General and administrative........................  15.7%         16.5%
     Depreciation and amortization.....................   4.8%          4.0%
   OPERATING INCOME (LOSS).............................  (5.2)%         6.6%
   NET INCOME (LOSS)...................................  (3.6)%         5.1%

----------------------

  (1) As a percentage of retail store sales.
  (2) As a percentage of wholesale merchandise sales.

                                                    YEARS ENDED DECEMBER 31,
                                                    ------------------------
                                                     1999            1998
                                                     ----            ----
   Sales Data:
   System wide sales:
     CD Warehouse                               $ 81,062,313    $ 54,845,432
     Disc Go Round                                26,584,796      16,259,865 (1)
                                                ------------    ------------
                                                $107,647,109    $ 71,105,259
                                                ============    ============
   Percentage increase:
     CD Warehouse                                        48%             50%
     Disc Go Round                                       64%             (1)

   Change in comparable retail store sales (2)           11%             16%
                                                ============    ============

--------------------

  (1)    Data only reflects activity for Disc Go Round after its June 1998
         acquisition by the Company.
  (2)    Represents percentage increase only for CD Warehouse stores open in
         both periods reported, since Disc Go Round stores were acquired in June
         1998.

                                      16
<PAGE>

YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998.

     REVENUES

     Retail store sales increased  $17,003,000 to $26,969,000 for the year ended
December 31, 1999,  compared to $9,966,000 for the year ended December 31, 1998.
The 171%  increase  in retail  store  sales is the  result of having 75  company
stores in operation  during the year ended December 31, 1999 compared to only 28
during the same period in 1998.

     Wholesale  merchandise  sales  decreased 61% to $832,000 for the year ended
December  31,  1999,  compared to  $2,127,000  for the same period in 1998.  The
decrease is due to the Company discontinuing its "one-stop" warehouse operations
in May 1998,  which  acquired new CD releases  from the major record  labels and
sold  them to the  franchise  system  with  minimal  mark up.  The  Company  has
determined to focus its efforts on  warehousing  used product to open new stores
and to sell used product to the franchise system.

     Royalty  income  increased  $1,033,000  to  $3,860,000  for the year  ended
December  31,  1999,  compared  to  $2,827,000  for the same  period in 1998.  A
substantial portion of the increase is attributable to the inclusion of the Disc
Go Round  franchise  stores to the  Company's  operations  in July  1998,  which
contributed approximately $725,000 of royalty income during the first six months
of 1999.  Additionally,  same store sales for stores  operating  as CD Warehouse
increased  by 11% for the year ended  December 31,  1999,  with monthly  average
sales for all CD  Warehouse  stores  increasing  from $28,973 for the year ended
December  31, 1998 to $31,011  for the same period in 1999.  No same store sales
information  is available for Disc Go Round stores for the period  preceding the
Company's acquisition of the Disc Go Round franchise system in June 1998.

         COSTS AND EXPENSES

     Cost of sales for retail  store sales  increased  $10,284,000  for the year
ended December 31, 1999 compared to the same period in 1998.  This 174% increase
is consistent with the increase of retail store revenue discussed above. Cost of
sales as a percentage of sales remained  fairly constant at 60% of sales for the
year ended  December  31, 1999  compared to 59% for the year ended  December 31,
1998.

     Cost of sales for wholesale  merchandise  decreased  $1,237,000 to $678,000
for the year ended  December 31, 1999,  compared to $1,915,000 in 1998.  The 65%
decrease is consistent with the decrease in wholesale merchandise sales. Cost of
sales was 82% of sales for the year ended  December 31, 1999 compared to 90% for
the comparable period in 1998.

     Retail store operating expenses increased $6,902,000 to $10,209,000 for the
year ended December 31, 1999, compared to $3,307,000 for the year ended December
31,  1998.  The 209%  increase is due to the  increase of  company-owned  stores
discussed above.  Retail store operating expense was 38% of retail store revenue
for the year ended  December 31, 1999,  compared to 33% of retail store  revenue
for the same period in 1998. The increase in retail store operating expense as a
percentage of retail store revenue is  attributable  principally to (i) expenses
associated  with the Company's new advertising  campaign,  aimed to aggressively
position  itself  against its  competitors,  which have also  recently  launched
marketing  blitzes,  (ii) increased  payroll costs  associated with retail store
preparation  to upload the  stores'  used  inventory  for sale on the  Company's
E-Commerce  website,  and costs associated with absorbing the acquisition of the
16 Music Trader stores late in the first quarter of 1999.

     General and  administrative  expenses increased by $2,485,000 to $4,997,000
for the year ended December 31, 1999,  compared to $2,512,000 for the year ended
December  31,  1998.  This  increase  resulted  from  the  continued  growth  in
company-owned  stores (increase of 24 stores).  The year ended December 31, 1999
also included costs associated with operating two separate  franchise  concepts,
certain  non-recurring  legal  and  administrative   expenses  and  implementing
operations of the Company's E-Commerce site in all company stores.

     DEPRECIATION AND AMORTIZATION

     Depreciation and amortization increased $899,000 to $1,516,000 for the year
ended  December 31, 1999,  compared to $617,000 for the same period in 1998. The
increase was  attributable  to the addition of 24  company-owned  stores,  costs

                                       17
<PAGE>

associated  with  E-commerce and the  amortization  of goodwill  associated with
various  acquisitions  (discussed in the financial  statements)  effected during
1998 and 1999.

         NET INCOME (LOSS)

     The  Company  experienced  a net  loss of  $1,141,000  for the  year  ended
December 31, 1999,  compared to net income of $775,000 during the same period in
1998.  The net  loss was due  primarily  to the  increase  in  retail  operating
expenses and general and administrative costs described above. Net loss was also
affected by the  decrease in other  income of  $383,000.  This was caused by the
reduction of interest income of approximately $171,000 combined with increase of
interest expense of $228,000.

LIQUIDITY AND CAPITAL RESOURCES

     At December 31, 1999 the Company had working capital of $9,492,000 and cash
and cash  equivalents  aggregating  $1,070,000,  compared to working  capital of
$8,543,000 and cash and cash equivalents of $4,442,000 at December 31, 1998. Net
cash used by operating activities was $1,173,000 for the year ended December 31,
1999,  compared to net cash used for  operating  activities  of $325,000 for the
year ended December 31, 1998. The net cash used by operations for the year ended
December 31, 1999 relates principally to an increase in inventory of $1,512,000,
resulting from both an increase in company  stores as well as continued  planned
growth  of per  store  inventory  quantities.  This  increase  was  offset by an
increase in accounts payable of $976,000, consisting primarily of amounts due to
E-Commerce related vendors.  The net cash used for operating  activities for the
year ended December 31, 1998 was due principally to the reduction of amounts due
the major labels because of the company's  decision to discontinue its warehouse
operations relating to new CDs and increase in retail store inventory.

     Net cash used for investing  activities  was  $6,863,000 for the year ended
December  31, 1999,  compared to  $11,233,000  for the same period in 1998.  The
significant  uses  of cash  for  investing  activities  in  1999  relate  to the
acquisition of Music Trader,  Inc. in February 1999,  development costs relating
to  E-Commerce,  and continued  company  store  growth.  The use in 1998 related
primarily to the acquisition of Disc Go Round in June 1998.

     Net cash provided from  financing  activities  was  $4,663,000 for the year
ended December 31, 1999,  compared to  $14,878,000  for the same period in 1998.
The net cash provided from financing in 1999 relates to debt of $4,476,000  used
to acquire Music Trader,  Inc. and open new company stores,  as well as proceeds
from the exercise of stock  warrants  issued in  connection  with the  Company's
initial  public  offering.  The net cash provided from financing in 1998 relates
primarily to the proceeds of the private placement of 1,624,300 shares of common
stock in May 1998.

     In October 1998 the Company formed a wholly owned subsidiary,  CD Warehouse
Finance Company, to finance the growth of qualified franchisees.  As of December
31, 1999, the financing  subsidiary had funded  $228,000 for the  development or
remodel of three new  franchised  stores.  In connection  with the Company's new
credit  facility  obtained in  December  1999,  an  affiliate  of the  Company's
asset-based  lender  is  now  offering  financing  to  the  Company's  qualified
franchisees, and the Company no longer offers financing services.

     The Company is continuing  the  implementation  of its Internet  E-commerce
website (HTTP://WWW.CDWAREHOUSE.COM/).  The website "went live" in December 1998
and offers  both new and used CDs.  As  previously  reported,  the  Company  has
experienced  difficulties  in the process of expanding  its Internet  website to
include all used  inventory of its company  stores.  During 1999,  the Company's
principal  E-Commerce  partner and project  developer worked with the Company to
resolve  these  difficulties,  and the  majority of the company  stores have now
uploaded their used inventory on-line.  However, during such period, the Company
did not market or advertise its website,  and sales during 1999 from the website
were minimal.  The Company intends to seek strategic  alliances and partnerships
that will allow it to effectively market its website and to generate  sufficient
revenue to cover the costs  associated  with  operating the site.  To date,  the
Company  has  incurred  costs in  excess of  $2,000,000  in  development  of the
website,  and it is expected that  additional  costs will be incurred in further
project  development.  A significant  portion of the Company's  accounts payable
during  1999  related  to  amounts  owed to its  principal  E-Commerce  vendors;
however, as a result of funding obtained by the Company in December 1999 under a
new $15,000,000 revolving credit facility, described below, the Company has paid
or entered into  installment  payment  agreements with its principal  E-commerce
vendors with respect to the outstanding balance. The Company expects to have all
such installments paid by July 2000.

                                       18
<PAGE>

     In addition to its working  capital at December 31, 1999, the Company has a
$15,000,000  revolving  credit  facility (the  "Facility")  with an  asset-based
lender.  The  Facility,  obtained  in  December  1999,  replaced  the  Company's
$7,000,0000 credit facility with Bank One Oklahoma, N.A. As of December 31, 1999
the Company  had  $4,476,000  outstanding  under the  Facility.  The term of the
Facility  expires  in  December  2002,  at which time the  principal  and unpaid
interest are due.  Amounts  borrowed  under the Facility bear a variable rate of
interest  equal to an index rate (of  thirty-day  commercial  paper) plus 2.75%.
Borrowings  under the Facility are limited to a borrowing  base  calculation  as
determined  by stated  percentages  of  compact  discs in  inventory.  Available
borrowings  under the  Facility  as of  December  31,  1999  were  approximately
$586,000.  All  assets  of the  Company  are  pledged  as  collateral  under the
Facility.  The  Facility  requires  the  Company to maintain  certain  financial
convenants  including fixed charge  coverage,  minimum  tangible net worth,  and
limits on capital expenditures.

     As a result of the recent  settlement  of various  legal  proceedings,  the
Company is obligated to make payments totaling approximately $1,000,000 over the
next twelve months.  See "Item 3. Legal  Proceedings."  The Company  anticipates
that it will be able to make  the  first  of the  scheduled  payments  from  the
proceeds of the Johnson  Sale,  which closed on March 21, 2000,  as well as from
working capital and/or borrowings from the Facility. See "Item 1. Description of
Business-Recent Events."

     In response to the net loss  reported for the fouth quarter of 1999 and for
the year then ended, the Company implemented certain cost saving measures during
January and February of 2000. However,  since these savings were not realized in
January 2000,  operating results for this period caused the fixed coverage ratio
to fall below the requirement  imposed by the Facility.  The asset-based  lender
has agreed to waive this  covenant  until March  2000,  when  operating  results
should  reflect these cost savings.  Proceeds of the Facility were used to repay
existing  indebtedness,  including $3.5 million to retire the Company's existing
credit facility. It is the Company's opinion that the current working capital at
December 31, 1999,  combined  with the  Facility,  will be sufficient to support
ongoing activities of the Company for the foreseeable future.

YEAR 2000 ISSUES

     During 1999, the Company took various  initiatives  intended to ensure that
its computer  equipment  and software  would  function  properly with respect to
dates in the year 2000 and  thereafter.  For this  purpose,  the term  "computer
equipment and software" includes accounting,  data processing, and telephone/PBX
systems,  cash registers,  hand-held  terminals,  scanning equipment,  and other
miscellaneous systems, as well as systems that are not commonly thought of as IT
systems,  such as alarm systems, fax machines,  or other miscellaneous  systems.
Year 2000 problems were the result of computer  programs being written using two
digits (rather than four) to define the applicable year.  Computer equipment and
software and devices with imbedded technology that are time-sensitive could have
recognized  a date using "00" as the year 1900 rather  than the year 2000.  This
could have resulted in a system failure or miscalculations  causing  disruptions
of operations,  including,  among other things, a temporary inability to process
transactions, send invoices, or engage in similar normal business activities.

     Utilizing  internal  resources  for Year 2000  identification,  assessment,
remediation  and testing,  by December 31, 1999,  the Company had  completed 100
percent of the initiatives necessary to fully address potential Year 2000 issues
relating to its computer  equipment and software.  The Company also surveyed its
significant  vendors  and service  providers  to  determine  the extent to which
interfaces  with such entities  were  vulnerable to Year 2000 issues and whether
the products and services purchased from such entities were Year 2000 compliant.

     The Company funded its Year 2000 efforts primarily with internal  resources
and does not anticipate making any future expenditures in connection  therewith.
Although the Company did not separately track its internal costs related to Year
2000 efforts,  which  included  compensation  of employees  working on Year 2000
projects, it believes that such costs did not exceed $50,000.

     The  Company  believes  that the Year 2000  issue did not pose  significant
operational problems for the Company.  However, if all Year 2000 issues were not
properly  identified,  or  assessment,  remediation  and testing  were not fully
effected, there can be no assurance that the Year 2000 issue will not materially
impact the Company's  results of  operations  or adversely  affect the Company's
relationships with customers,  vendors, suppliers or franchisees.  Additionally,
there can be no assurance  that the Year 2000 issues of other  entities will not
have  a  material  adverse  impact  on  the  Company's  systems  or  results  of
operations.

                                       19
<PAGE>

     As of March 20, 2000,  management is not aware of any significant Year 2000
issues with the Company's computer equipment and software.

ITEM 7.   FINANCIAL STATEMENTS.

     The  consolidated  financial  statements of the Company are incorporated by
reference from pages F-1 through F-21 of the attached Appendix,  and include the
following:

  Consolidated Financial Statements of CD Warehouse, Inc.

    (1)  Report of Independent Auditors
    (2)  Consolidated Balance Sheet at December 31, 1999
    (3)  Consolidated Statements of Operations for the years ended December 31,
         1999 and December 31, 1998
    (4)  Consolidated Statements of Stockholders' Equity for the years ended
         December 31, 1999 and December 31, 1998
    (5)  Consolidated Statements of Cash Flows for the years ended December 31,
         1999 and December 31, 1998
    (6)  Notes to Consolidated 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

     The information required will be contained in the Company's Proxy Statement
for the 2000  Annual  Meeting  of  Stockholders  and is  incorporated  herein by
reference.

ITEM 10.  EXECUTIVE COMPENSATION.

     The information required will be contained in the Company's Proxy Statement
for the 2000  Annual  Meeting  of  Stockholders  and is  incorporated  herein by
reference.

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

     The information required will be contained in the Company's Proxy Statement
for the 2000  Annual  Meeting  of  Stockholders  and is  incorporated  herein by
reference.

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

     The information required will be contained in the Company's Proxy Statement
for the 2000  Annual  Meeting  of  Stockholders  and is  incorporated  herein by
reference.

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-21.

                                       20
<PAGE>

         (2)      The exhibits set forth on the following  Exhibit Index are
                  filed with this Report or are incorporated by reference as set
                  forth therein.

<TABLE>
<CAPTION>

  EXHIBIT
  NUMBER                                               EXHIBIT INDEX                                                     PAGE
  -------                                              -------------                                                     ----
  <S>      <C>                                                                                                           <C>
      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)......................     #

      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
           SB-2, file number 333-15139 and incorporated herein by reference)........................................     #

      4.2  See Articles IV and VIII of the Company's  Amended and Restated  Certificate of Incorporation and Article
           II of the  Company's  Amended and Restated  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  Warrant Agreement dated May 22, 1998, by and among the Company,  Comvest Partners,  Inc. and Capital West
           Securities (filed as Exhibit 4.4 to the Company's Annual Report on Form 1--KSB for the fiscal year  ended
           December 31, 1998, file number 73-1504999 and incorporated herein by reference)..........................     #

      4.5  Amended 1996 Stock Option Plan (filed as Exhibit 4.4 to the Company's  Registration Statement on Form S-8
           dated February 19, 1999, file number 333-72651 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 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).........     #

     10.3  Asset  Purchase  Agreement,  dated as of June 16,  1998,  by and  between  the  Company  and the Grow Biz
           International, Inc. (filed as Exhibit 10.1 to the Company's Form 8-K dated June 26, 1998 and incorporated
           herein by reference).....................................................................................     #

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

     10.5  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)..............................................     #

     10.6  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)........................................     #

     10.7  Lease  Agreement  dated April 17, 1997 by and between Will Rogers  Service Center Phase IV Associates and
           CD Warehouse, Inc. (filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for  the Quarter
           ended June 30, 1998 and incorporated herein by reference)................................................     #

     10.8  Loan  Agreement,  dated February 17, 1999,  between the Company and Bank One,  Oklahoma,  N.A.  (filed as
</TABLE>
                                       21
<PAGE>
<TABLE>
<CAPTION>

  EXHIBIT
  NUMBER                                               EXHIBIT INDEX                                                   PAGE
  -------                                              -------------                                                   ----
   <S>     <C>                                                                                                         <C>
           Exhibit 5.1 to the Company's Form 8-K dated February 24, 1999 and incorporated herein by reference)......     #

    *10.9  Loan and Security Agreement dated as of December 28, 1999, among General Electric Capital  Corporation as
           lender and the Company and its subsidiary, Compact Discs Management, Inc., as borrowers..................    48

    *21.1  List of subsidiaries.....................................................................................    84

    *23.1  Consent of Ernst & Young LLP.............................................................................    85

    *27.1  Financial Data Schedule..................................................................................    86

     #  Incorporated by reference.
     *   Filed herewith.

       (b)   A report on Form 8-K was filed by the Company on October 5, 1999,  reporting  under "ITEM 5 - OTHER
  EVENTS" the Company's execution of a letter of intent to merge its  operations  with CD Plus.com Ltd. A press release
 dated  December 3, 1999  announced that the Company had postponed such merger discussions.
</TABLE>
                                       22
<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 28, 2000                             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 28, 2000
--------------------
Jerry W. Grizzle
    Chairman of the Board of Directors;
    President and Chief Executive Officer

/s/ Doyle E. Motley
-------------------
Doyle E. Motley                                                 March 28, 2000
    Sr. Vice President, Chief Financial Officer,
    Secretary and Treasurer
    (Principal Financial and Accounting Officer)

/s/ Robert O. McDonald                                          March 23, 2000
----------------------
Robert O. McDonald
    Director

/s/ Christopher M. Salyer                                       March 24, 2000
-------------------------
Christopher M. Salyer
    Director

/s/ Ronald V. Perry                                             March 28, 2000
-------------------
Ronald V. Perry
    Director


                                       23
<PAGE>

                      [THIS PAGE LEFT BLANK INTENTIONALLY]


                                       24
<PAGE>

                                   APPENDIX A








                       CONSOLIDATED FINANCIAL STATEMENTS

                       CD WAREHOUSE, INC.

                       YEARS ENDED DECEMBER 31, 1999 AND 1998
                       WITH REPORT OF INDEPENDENT AUDITORS


                                       25
<PAGE>

                      [THIS PAGE LEFT BLANK INTENTIONALLY]


                                       26
<PAGE>

                              CD Warehouse, Inc.

                       Consolidated Financial Statements

                    Years ended December 31, 1999 and 1998




                                   CONTENTS

Report of Independent Auditors..........................................F-2

Consolidated Financial Statements

Consolidated Balance Sheet..............................................F-3
Consolidated Statements of Operations...................................F-4
Consolidated Statements of Stockholders' Equity.........................F-5
Consolidated Statements of Cash Flows...................................F-6
Notes to Consolidated Financial Statements..............................F-8




                                      F-1
<PAGE>

                        Report of Independent Auditors

The Board of Directors and Stockholders
CD Warehouse, Inc.

We have audited the  accompanying  consolidated  balance  sheet of CD Warehouse,
Inc.  as of  December  31,  1999,  and the related  consolidated  statements  of
operations, stockholders' equity and cash flows for each of the two years in the
period  ended   December  31,  1999.   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 audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 audits of the financial  statements provide 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 CD
Warehouse,  Inc. at  December  31,  1999,  and the  consolidated  results of its
operations  and its cash  flows  for each of the two years in the  period  ended
December 31, 1999, in conformity with accounting  principles  generally accepted
in the United States.



                                                    /s/ERNST & YOUNG LLP

Oklahoma City, Oklahoma
February 25, 2000

                                      F-2
<PAGE>

<TABLE>
<CAPTION>

                               CD Warehouse, Inc.

                           Consolidated Balance Sheet

                                December 31, 1999


ASSETS
<S>                                                                               <C>
Current assets:
   Cash and cash equivalents                                                       $   1,069,560
   Accounts receivable, net of allowance for doubtful accounts of $139,864               948,252
   Notes receivable (NOTE 4)                                                              87,159
   Merchandise inventory                                                               8,908,331
   Prepaid expenses and other                                                            237,915
   Income taxes refundable                                                               780,229
                                                                                   ----------------
Total current assets                                                                  12,031,446

Furniture, fixtures and equipment, net (NOTE 5)                                        4,911,287
Notes receivable, due after one year (NOTE 4)                                             51,112
Intangibles and other assets, net (NOTE 6)                                            11,883,905
                                                                                   ----------------
Total assets                                                                       $  28,877,750
                                                                                   ================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Accounts payable                                                                $   1,615,705
   Accrued liabilities                                                                   787,186
   Advances and deposits                                                                 137,000
                                                                                   ----------------
Total current liabilities                                                              2,539,891

Long-term debt (NOTE 7)                                                                4,475,977
Deferred income taxes (NOTE 8)                                                            47,000
Commitments and contingencies (NOTE 11)

Stockholders' equity (NOTE 9):
   Preferred stock, $.01 par value; 5,000,000 shares authorized, none issued
   Common stock, $.01 par value; 10,000,000 shares authorized,
   3,660,295 shares issued and outstanding                                                36,603
   Additional paid-in capital                                                         21,758,158
   Retained earnings                                                                      20,121
                                                                                   ----------------
Total stockholders' equity                                                            21,814,882
                                                                                   ----------------
Total liabilities and stockholders' equity                                         $  28,877,750
                                                                                   ================

SEE ACCOMPANYING NOTES.
</TABLE>

                                      F-3
<PAGE>

<TABLE>
<CAPTION>
                               CD Warehouse, Inc.

                      Consolidated Statements of Operations


                                                       YEAR ENDED DECEMBER 31,
                                                         1999           1998
                                                     ----------------------------

<S>                                                  <C>            <C>
Revenues:
   Company operations:
     Retail store sales                              $ 26,968,793    $ 9,965,694
     Wholesale merchandise sales                          832,598      2,127,025
     Software income, net                                  71,223         92,062
   Franchise operations:
     Royalty income                                     3,859,662      2,827,205
     Franchise and development fees                       180,000        187,500
     Management fees                                            -         62,417
                                                     ----------------------------
Total revenues                                         31,912,276     15,261,903

Operating costs and expenses:
   Cost of sales-retail store sales                    16,185,685      5,901,735
   Cost of sales-wholesale merchandise sales              678,144      1,914,723
   Retail store operating expenses                     10,209,365      3,307,424
   General and administrative                           4,997,385      2,511,436
   Depreciation and amortization                        1,516,061        617,250
                                                     ----------------------------
Total costs and expenses                               33,586,640     14,252,568
                                                     ----------------------------
Operating income (loss)                                (1,674,364)     1,009,335

Other income (expense):
   Interest income                                         40,017        210,635
   Interest expense                                      (227,550)            -
   Other, net                                              36,765         21,382
                                                     ----------------------------
                                                         (150,768)       232,017
                                                     ----------------------------
Income (loss) before income taxes                      (1,825,132)     1,241,352

Provision (credit) for income taxes (NOTE 8)             (684,000)       466,000
                                                      ---------------------------
Net income (loss)                                    $ (1,141,132)    $  775,352
                                                     ============================

Net income (loss) per share-basic and diluted:
   Basic                                                    $(.31)          $.27
                                                     ============================
   Diluted                                                  $(.31)          $.25
                                                     ============================

Shares used in computations:
   Basic                                                3,642,442      2,923,090
                                                     ============================
   Diluted                                              3,642,442      3,136,485
                                                     ============================

SEE ACCOMPANYING NOTES.
</TABLE>


                                      F-4
<PAGE>

<TABLE>
<CAPTION>

                               CD Warehouse, Inc.

                 Consolidated Statements of Stockholders' Equity



                                                                 ADDITIONAL
                                         COMMON STOCK             PAID-IN       RETAINED
                                   --------------------------
                                      SHARES        AMOUNT        CAPITAL       EARNINGS
                                   -------------------------------------------------------

<S>                                 <C>            <C>        <C>            <C>
Balance at December 31, 1997        1,820,000      $ 18,200    $ 5,348,543    $  385,901

Exercise of stock options               6,250            63         23,375             -

Sale of common stock (net of
  offering costs)                   1,624,300        16,243     14,838,337             -

Issuance of common stock in
  exchange for partnership
  interests                           100,000         1,000        361,500             -

Net income                                  -             -              -       775,352
                                   -------------------------------------------------------
Balance at December 31, 1998        3,550,550        35,506     20,571,755     1,161,253

Exercise of stock warrants             25,000           250        187,250             -

Issuance of common stock               84,745           847        999,153             -

Net loss                                    -             -              -    (1,141,132)
                                   -------------------------------------------------------
Balance at December 31, 1999        3,660,295      $ 36,603    $21,758,158   $    20,121
                                   =======================================================


SEE ACCOMPANYING NOTES.
</TABLE>
                                      F-5
<PAGE>

<TABLE>
<CAPTION>

                               CD Warehouse, Inc.

                      Consolidated Statements of Cash Flows


                                                                        YEAR ENDED DECEMBER 31,
                                                                          1999          1998
                                                                      ----------------------------

<S>                                                                  <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)                                                    $ (1,141,132)   $    775,352
Adjustments to reconcile net income (loss) to net cash used
   for operating activities:
     Depreciation and amortization                                      1,516,061         617,250
     Deferred income taxes                                                (51,000)         73,000
     Refundable income taxes                                             (633,000)              -
     Loss on disposal of assets, net                                       90,930          19,588
     Net changes in operating assets and liabilities, exclusive
       of business acquisitions:
         Accounts receivable, net                                          37,966        (404,450)
         Inventories                                                   (1,511,931)       (849,087)
         Prepaid expenses and other                                      (112,889)        (57,446)
         Investment in partnerships                                             -         (57,955)
         Other assets                                                    (316,009)         (4,366)
         Accounts payable                                                 975,686        (552,103)
         Accrued liabilities                                              473,936         116,343
         Advances and deposits                                             44,000         (97,000)
         Income taxes payable                                            (545,614)        193,385
         Minority interest                                                      -         (97,398)
                                                                      ----------------------------
Total adjustments                                                         (31,864)     (1,100,239)
                                                                      ----------------------------
Net cash used for operating activities                                 (1,172,996)       (324,887)

(CONTINUED ON FOLLOWING PAGE)
</TABLE>
                                      F-6
<PAGE>

<TABLE>
<CAPTION>

                               CD Warehouse, Inc.

                Consolidated Statements of Cash Flows (continued)


                                                                        YEAR ENDED DECEMBER 31,
                                                                          1999          1998
                                                                      ----------------------------

<S>                                                                 <C>              <C>
CASH FLOWS FROM INVESTING ACTIVITIES
Notes receivable:
   Advances                                                          $    (10,000)   $   (218,000)
   Collections                                                             82,695           7,034
Purchases of furniture, fixtures and equipment                         (3,142,529)     (1,434,360)
Proceeds from disposal of assets                                          107,000         115,030
Acquisition of businesses:
   Excess of purchase price over assets acquired                       (1,585,101)     (7,631,259)
   Accounts receivable                                                     (9,780)        (54,740)
   Inventory                                                           (2,029,978)     (1,743,899)
   Prepaid and other                                                       (3,765)        (10,000)
   Furniture, fixtures and equipment                                     (243,352)       (449,315)
   Other assets                                                           (28,565)        (61,978)
   Accounts payable                                                             -          87,890
   Accrued liabilities                                                          -          60,687
   Advances and deposits                                                        -         100,000
                                                                     -----------------------------
Net cash used for investing activities                                 (6,863,375)    (11,232,910)

CASH FLOWS FROM FINANCING ACTIVITIES
Notes payable:
   Advances                                                             8,475,977         280,938
   Repayments                                                          (4,000,000)       (280,938)
Proceeds from sale of common stock, net                                         -      14,854,580
Exercise of stock options and warrants                                    187,500          23,438
                                                                      ----------------------------
Net cash provided by financing activities                               4,663,477      14,878,018
                                                                      ----------------------------

Net increase (decrease) in cash and cash equivalents                   (3,372,894)      3,320,221

Cash and cash equivalents at beginning of year                          4,442,454       1,122,233
                                                                      ----------------------------
Cash and cash equivalents at end of year                             $  1,069,560    $  4,442,454
                                                                      ============================


SEE ACCOMPANYING NOTES.
</TABLE>

                                      F-7
<PAGE>

                                CD Warehouse, Inc.

                   Notes to Consolidated Financial Statements

                                December 31, 1999

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND OPERATIONS

CD Warehouse, Inc. and its wholly-owned subsidiaries,  Compact Discs Management,
Inc. and CD Warehouse  Finance  Company  (together the "Company") are engaged in
the  franchising  and ownership of retail music stores offering new and preowned
compact discs ("CDs") and related  products.  The Company was formed in Delaware
on September 5, 1996 and had only limited operations prior to its Initial Public
Offering and simultaneous  business acquisition in January 1997. At December 31,
1999,  the Company owns and operates 75 retail music stores  located  throughout
the United States  and has 247 franchised  stores throughout the  United States,
and 17 stores located in Canada, England, France, Guatemala and Venezuela.

In December 1998, the Company  established an internet  website which provides a
worldwide  electronic  store front for the sale of new and preowned CDs, related
music products, and concert and event tickets.

PRINCIPLES OF CONSOLIDATION

The accompanying  consolidated  financial  statements include the accounts of CD
Warehouse, Inc. and its wholly-owned subsidiaries.  All significant intercompany
accounts and transactions have been eliminated.

USE OF ESTIMATES

The  preparation  of  consolidated   financial  statements  in  conformity  with
generally accepted  accounting  principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

CASH EQUIVALENTS

Cash equivalents include money-market  investments and investments in commercial
paper with  maturities of three months or less when purchased.
<PAGE>

                               CD Warehouse, Inc.

             Notes to Consolidated Financial Statements (continued)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

FAIR VALUE OF FINANCIAL INSTRUMENTS

The following  methods and  assumptions  were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value.

The carrying amounts of cash and cash equivalents,  trade receivables, and trade
accounts  payable  approximate fair value because of the short maturity of those
instruments.  The  Company's  notes  receivable  from  franchisees  are at terms
consistent with market rate for the length of the note and risk of the borrower.
As such,  the  carrying  amount for notes  receivable  approximates  fair value.
Long-term debt has a floating interest rate and, therefore,  the carrying amount
of long-term debt approximates its fair value.

INVENTORY

Inventory  consists  of new and  preowned  compact  discs and is recorded at the
lower of average cost or market.

FURNITURE, FIXTURES AND EQUIPMENT

Furniture,  fixtures  and  equipment,   including  leasehold  improvements,  are
recorded at cost and are depreciated on a straight-line basis over the estimated
useful lives of the assets which range from five to ten years.

INTANGIBLES

Intangible assets relate principally to the excess cost over net assets acquired
of business and store  acquisitions.  Amortization of such costs are for periods
ranging from ten to twenty years.

LONG-LIVED ASSETS

In  accordance  with  Statement  of  Financial  Accounting  Standards  No.  121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," long-lived assets held and used by the Company are reviewed for
impairment  whenever  events  or  changes  in  circumstances  indicate  that the
carrying amount of an asset may not be  recoverable.  For purposes of evaluating
the recoverability of long-lived assets, the recoverability test is performed

                                      F-9
<PAGE>

                               CD Warehouse, Inc.

             Notes to Consolidated Financial Statements (continued)


1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

using undiscounted net cash flows of the individual stores for long-lived assets
identified  with  individual  stores,  undiscounted  net cash flows for acquired
franchises,  and consolidated undiscounted net cash flows for long-lived assets,
not  otherwise  identifiable.  During 1999,  the Company  recorded an impairment
charge to retail  store  operating  expenses of  approximately  $180,000,  which
represents  the write-down of estimated  unrecoverable  assets  associated  with
individual stores. No significant impairments were identified in 1998.

FRANCHISE FEES AND ROYALTIES

Initial  franchise fees are  nonrefundable and are recognized in income when all
material services or conditions  relating to the sale of the franchise have been
substantially  performed or satisfied by the Company.  Area development fees are
nonrefundable  and are  recognized  in  income  on a pro  rata  basis  when  the
conditions for revenue recognition under the individual  development  agreements
are met. Royalties from franchise operations are recognized in income as earned.

ADVERTISING COSTS

Costs  incurred in connection  with  advertising  and promotion of the Company's
products  are  expensed  as  incurred.  Such  costs  amounted  to  approximately
$1,053,000 and $392,000 in 1999 and 1998, respectively.

STOCK OPTIONS

The Company accounts for employee  stock-based  compensation using the intrinsic
value method  prescribed by Accounting  Principles Board ("APB") Opinion No. 25,
"Accounting  for Stock Issued to  Employees,"  and related  interpretations.  No
compensation expense is recorded with respect to stock options granted at prices
equal to the market  value of the  Company's  common stock at the date of grant.
Upon  exercise,  the  excess of the  proceeds  over the par value of the  shares
issued is credited to additional paid-in capital.

ADVERTISING FUND

The Company  operates an  Advertising  Fund which  receives  contributions  from
franchisees and the Company based on sales.  These funds are used to provide and
support  national  advertising for the CD Warehouse  brand.  These funds and the
related expenditures are not included in the accompanying consolidated financial
statements.


                                      F-10
<PAGE>

                              CD Warehouse, Inc.

             Notes to Consolidated Financial Statements (continued)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

NET INCOME PER SHARE

The Company  accounts  for earnings per share in  accordance  with  Statement of
Financial Accounting Standards No. 128 ("SFAS 128"),  "Earnings Per Share." SFAS
128 requires the  disclosure  of Basic and Diluted  Earnings per Share  ("EPS").
Basic EPS is calculated using income available to common shareowners  divided by
the weighted average of common shares  outstanding  during the year. Diluted EPS
is similar  to Basic EPS  except  that the  weighted  average  of common  shares
outstanding is increased to include the number of additional  common shares that
would have been  outstanding if the dilutive  potential  common shares,  such as
options,  had been  issued.  The  treasury  stock  method  is used to  calculate
dilutive  shares which reduces the gross number of dilutive shares by the number
of shares  purchasable  from the proceeds of the options assumed to be exercised
(NOTE 9).

SUPPLEMENTAL CASH FLOW INFORMATION

For the years ending  December 31, 1999 and 1998,  the Company had the following
noncash investing and financing activities:

     In 1999, the Company acquired the assets of Music Trader,  Inc. for cash of
     $3,000,000 and 84,745 shares of the Company's common stock valued at $11.80
     per share. The noncash portion of this transaction is as follows:

             Costs in excess of net assets acquired, net           $    985,769
             Inventory                                                2,837,312
             Furniture, fixtures and equipment                          160,000
             Accounts receivable                                          9,780
             Other assets                                                 7,139
                                                                   -------------
                                                                      4,000,000
             Less cash paid                                          (3,000,000)
                                                                   -------------
                                                                   $  1,000,000
                                                                   =============


                                      F-11
<PAGE>

                               CD Warehouse, Inc.

             Notes to Consolidated Financial Statements (continued)


1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

SUPPLEMENTAL CASH FLOW INFORMATION (CONTINUED)

     In  1998,  the  Company  purchased   partnership  interests  of  a  Company
     franchisee for cash of $173,471 and 100,000 shares of the Company's  common
     stock valued at $3.625 per share.  The noncash portion of this  transaction
     is as follows:

<TABLE>
<CAPTION>

           <S>                                                    <C>
             Costs in excess of net assets acquired, net           $     281,412
             Inventory                                                   221,208
             Furniture, fixtures and equipment                            70,080
             Other assets                                                 10,616
             Accounts payable and accrued liabilities                    (47,345)
                                                                   -------------
                                                                         535,971
             Less cash paid                                             (173,471)
                                                                   -------------
                                                                   $     362,500
                                                                   =============
</TABLE>

Income  taxes  paid  in  1999  and  1998  totaled  $545,614  and  $199,615,
respectively.  Interest paid in 1999 and 1998 totaled  $227,550 and $2,374,
respectively.

2. PUBLIC OFFERING

In May 1998, the Company  completed a private  placement  ("Placement")  of
1,624,300  shares of common  stock at $10.00 per share.  Proceeds  from the
Placement,  after deducting the placement discount and placement  expenses,
were approximately $14.8 million.  The net proceeds from the Placement were
used for  acquisitions,  expansion,  provision of financing to franchisees,
and working capital. The Company effected a Registration  Statement on Form
S-3 related to such shares in September 1998.

                                      F-12
<PAGE>

                               CD Warehouse, Inc.

             Notes to Consolidated Financial Statements (continued)

3. BUSINESS ACQUISITIONS

In  January  1998,  the  Company  purchased  five  CD  Warehouse  stores  from a
franchisee  ("ZDTMAC")  for cash of $173,471 and 100,000  shares of common stock
valued  at  $3.625  per  share  for a total  purchase  price  of  $535,971.  The
acquisition was recorded under the purchase method of accounting and resulted in
an allocation of excess of purchase  price over net assets  acquired of $281,412
which is amortized on a straight-line basis over ten years.

In June  1998,  the  Company  acquired  the  assets of three  retail  stores and
franchise  rights for 134  franchisees  of Disc Go Round  ("DGR"),  a  competing
retailer  of new  and  preowned  compact  discs,  for  cash  of  $7 million  and
assumption of liabilities of $100,000.  The  acquisition was accounted for under
the purchase  method of  accounting  and resulted in an  allocation of excess of
purchase  price over net assets  acquired of $6,830,992  which is amortized on a
straight-line basis over fifteen years.

In October 1998, the Company  acquired,  for cash of $1,737,867,  the assets and
liabilities  of three  partnerships  which  collectively  owned 16 CD  Warehouse
stores.  The  Company,  through  its  wholly-owned  subsidiary,   Compact  Discs
Management,  Inc.,  previously  owned a majority or  minority  interest in these
partnerships.  Upon the acquisition of these assets and liabilities, the related
partnerships  were  dissolved.  The  acquisition  was  accounted  for  under the
purchase  method  of  accounting  and  resulted  in an  allocation  of excess of
purchase  price over net assets  acquired of  $629,245,  which is amortized on a
straight-line basis over ten years.

In February  1999,  the Company  acquired  the assets of Music  Trader,  Inc., a
16-store retail music chain based in Southern  California for cash of $3,000,000
and 84,745 shares for the Company's  common stock for a total  purchase price of
approximately $4,000,000. The acquisition was recorded under the purchase method
of accounting and resulted in an allocation of excess of purchase price over net
assets  acquired for $985,769 which is amortized on a  straight-line  basis over
ten years.

                                      F-13
<PAGE>

                               CD Warehouse, Inc.

             Notes to Consolidated Financial Statements (continued)

3. BUSINESS ACQUISITIONS (CONTINUED)

The acquisitions described above were accounted for by the purchase method of
accounting for business combinations. Accordingly, the accompanying consolidated
statements of operations do not include any revenues or expenses related to
these acquisitions prior to the respective closing dates. The cash portions of
the acquisitions were financed through debt and proceeds from the Company's
private placement of common stock and operating cash flows. Following are the
Company's unaudited pro forma results for 1999 and 1998 assuming the
acquisitions occurred on January 1, 1998 (in thousands, except for per share
data):

                                                           1999          1998
                                                       -------------------------

         Total revenues                                $32,965,225   $28,087,676
         Net income (loss)                             $(1,063,994)  $ 1,200,947
         Net income (loss) per common share:
            Basic                                            $(.29)         $.33
            Diluted                                          $(.29)         $.31
         Weighted average common shares:
            Basic                                        3,654,747     3,635,295
            Diluted                                      3,654,747     3,848,690

These  unaudited pro forma results have been prepared for  comparative  purposes
only and include certain  adjustments,  including  amortization of goodwill as a
result of the acquisitions and do not purport to be indicative of the results of
operations  which would have  actually  resulted  had the  combinations  been in
effect on January 1, 1998, or of future results of operations.

The Company  also  acquired  the assets of five  individual  retail  stores from
franchisees  during  1999 for cash  totaling  $900,541.  The  acquisitions  were
accounted  for under the  purchase  method of  accounting  and  resulted  in the
allocation  of excess of  purchase  price over net assets  acquired  of $599,332
which is amortized on a straight-line basis over ten years.

                                      F-14
<PAGE>

                               CD Warehouse, Inc.

             Notes to Consolidated Financial Statements (continued)

4. NOTES RECEIVABLE

During  1998,  the  Company  formed CD  Warehouse  Finance  Company  to  provide
financing to new and existing franchisees. The financing is provided in the form
of notes receivable,  secured by store assets and guarantees of the franchisees.
The notes generally  require monthly payments of principal and interest,  have a
two to four year term, and bear interest at 10.05%.  Amounts  outstanding  under
these notes totaled $138,271 at December 31, 1999.

5. FURNITURE, FIXTURES AND EQUIPMENt

At December 31, 1999,  furniture,  fixtures and equipment,  including  leasehold
improvements, were comprised of the following:

         Furniture, fixtures and equipment located at:
            Corporate headquarters                              $      918,272
            Retail stores                                            2,756,151
         Internet website                                            2,052,546
                                                                ----------------
                                                                     5,726,969
         Accumulated depreciation                                     (815,682)
                                                                ----------------
                                                                $    4,911,287
                                                                ================

Depreciation   expense  totaled   $654,403  and  $162,667  for  1999  and  1998,
respectively.

6. INTANGIBLES AND OTHER ASSETS

Intangibles and other assets consist of the following at December 31, 1999:

         Excess of purchase price over net assets acquired
           in business acquisitions                             $   12,882,538

         Deposits and other                                            476,783
                                                                ----------------
                                                                    13,359,321
         Accumulated amortization                                   (1,475,416)
                                                                ----------------
                                                                $   11,883,905
                                                                ================

Amortization  of  goodwill  totaled  $861,658  and  $454,583  in 1999 and  1998,
respectively.

                                      F-15
<PAGE>

                               CD Warehouse, Inc.

             Notes to Consolidated Financial Statements (continued)

7. LONG-TERM DEBT

In December 1999, the Company executed a $15,000,000  revolving credit loan (the
"Loan") with an  asset-based  lender.  As of December 31, 1999,  the Company had
$4,475,977  outstanding under the Loan. The term of the Loan expires in December
2002, at which time the principal and unpaid  interest are due. The Loan bears a
variable rate of interest at an index rate  (thirty-day  commercial  paper) plus
2.75% (8.3% at December 31, 1999).  The borrowings under the Loan are limited to
a borrowing  base  calculation  as determined by stated  percentages  of compact
discs in  inventory.  Available  borrowings  under the Loan at December 31, 1999
were approximately $586,000. All assets of the Company are pledged as collateral
under the Loan.  The Loan  requires  the Company to maintain  certain  financial
covenants  including  fixed charge  coverage,  minimum  tangible net worth,  and
limits  capital  expenditures.  Proceeds of the Loan were used to repay existing
indebtedness including $3.5 million to retire an existing credit facility with a
bank that had been executed in February 1999.

8. INCOME TAXES

Deferred  income  taxes  reflect  the net tax effects of  temporary  differences
between the carrying  amounts of assets and liabilities for financial  reporting
purposes  and the amounts  used for income tax  purposes.  The  approximate  tax
effect of each type of temporary  difference that is used in computing  deferred
tax assets and liabilities at December 31, 1999 is as follows.

        DEFERRED TAX ASSETS
        Allowances for doubtful accounts                           $   51,750
        Inventory reserves                                             40,290
        Net operating loss carryforwards (expiring in 2019)           120,000
        Other                                                          49,960
                                                                   ----------
        Total deferred tax assets                                     262,000

        DEFERRED TAX LIABILITIES
        Tax depreciation in excess of financial                       185,967
        Tax amortization in excess of financial                       123,033
                                                                   ----------
        Total deferred tax liabilities                                309,000
                                                                   ----------
        Net deferred tax liabilities                               $   47,000
                                                                   ==========

                                      F-16
<PAGE>

                               CD Warehouse, Inc.

             Notes to Consolidated Financial Statements (continued)

8. INCOME TAXES (CONTINUED)

The  significant  components of income tax expense for the years ended  December
31, 1999 and 1998 are as follows:

                                                            1999         1998
                                                         -----------------------

     Current tax expense (credit):
        Federal                                          $(528,000)    $ 339,000
        State                                             (105,000)       54,000
                                                         -----------------------
                                                          (633,000)      393,000

     Deferred tax expense (credit):
        Federal                                            (47,000)       62,000
        State                                               (4,000)       11,000
                                                         -----------------------
                                                           (51,000)       73,000
                                                         -----------------------
                                                         $(684,000)    $ 466,000
                                                         =======================

The provision for income taxes differs from the computed  "expected"  income tax
provision  using federal  statutory  rates on income before income taxes for the
following reasons:

                                                         YEAR ENDED DECEMBER 31,
                                                            1999         1998
                                                         -----------------------

     Computed "expected" income tax (credit)             $(620,545)    $ 422,059
     Increases (decreases) in taxes resulting from:
        State income taxes, net of federal benefit         (63,203)       43,013
        Other                                                 (252)          928
                                                         -----------------------
                                                         $(684,000)    $ 466,000
                                                         =======================
                                      F-17
<PAGE>

                               CD Warehouse, Inc.

             Notes to Consolidated Financial Statements (continued)

9. STOCKHOLDERS' EQUITY

EARNINGS PER SHARE

<TABLE>
<CAPTION>
                                                            1999         1998
                                                       -------------------------
    <S>                                               <C>              <C>
     Income:
       Income (loss) available to common shareowners   $(1,141,132)     $775,352
                                                       =========================

     Weighted average shares:
       Outstanding                                       3,642,442     2,923,090
     Dilutive shares assuming:
       Exercise of stock options                                 -       276,750
       Exercise of warrants                                      -       262,430
       Less: Shares purchasable with proceeds                    -      (325,785)
                                                       --------------------------
     Total shares                                        3,642,442     3,136,485
                                                       =========================

     Basic EPS                                               $(.31)         $.27
                                                       =========================

     Diluted EPS                                             $(.31)         $.25
                                                       =========================

     Antidilutive stock options and warrants excluded      166,928             -
                                                       =========================
</TABLE>
STOCK OPTIONS

In December 1996, the Company adopted the 1996 Stock Option Plan ("Plan") which,
as  amended,  provides  for  grants of up to 600,000  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.  The Company has
agreed to grant options to purchase 10,000 shares annually to each director.  No
options were granted  through  December 31, 1996.  In 1999 and 1998,  options to
acquire 108,550 and 95,000 common shares,  respectively,  were granted under the
Plan at option  prices equal to the fair market value of the common stock on the
date of grant.  Additionally,  in 1999 and 1998,  options to acquire  25,000 and
12,000 common shares, respectively, were granted to consultants and directors at
option  prices equal to the fair market value of the common stock on the date of
grant. No expense related to options granted was recorded in 1999 and 1998.

                                      F-18
<PAGE>

                               CD Warehouse, Inc.

             Notes to Consolidated Financial Statements (continued)

9. STOCKHOLDERS' EQUITY (CONTINUED)

Stock option transactions for 1999 and 1998 are summarized as follows:

<TABLE>
<CAPTION>

                                                           1999                            1998
                                               -------------------------------  ------------------------------
                                                                WEIGHTED                        WEIGHTED
                                                                AVERAGE                         AVERAGE
                                                   SHARES       EXERCISE PRICE    SHARES        EXERCISE PRICE
                                               ---------------------------------------------------------------

     <S>                                           <C>           <C>             <C>             <C>
     Outstanding at beginning of year              361,750        $   6.01         261,000        $ 3.84
     Granted                                       133,550        $   9.23         107,000        $11.18
     Exercised                                           -                          (6,250)       $ 3.75
     Canceled, forfeited, or expired                (5,000)       $  11.75               -
                                               ---------------                 --------------
     Outstanding at end of year                    490,300        $   6.83         361,750        $ 6.01
                                               ===============                 ==============

     Exercisable at end of year                    303,084        $   6.93          88,042        $ 3.84
                                               ===============                 ==============

     Weighted average fair value of options
        granted during year                          $6.25                           $4.34
                                               ===============                 ==============
</TABLE>

Outstanding  options to acquire 490,300 shares of stock at December 31, 1999 had
exercise  prices  ranging  from  $3.13 to $12.88  per  share and had a  weighted
average remaining contractual life of 8.75 years.

The  following  pro forma  information,  as required by  Statement  of Financial
Accounting  Standards No. 123,  "Accounting for Stock Based Compensation" ("SFAS
123"),  presents net income and earnings per share information as if the Company
had  accounted  for stock  options  issued in 1999 and 1998 using the fair value
method  prescribed by the Statement.  The fair value of issued stock options was
estimated at the date of grant using a  Black-Scholes  option pricing model with
the following  assumptions  for 1999 and 1998,  respectively:  weighted  average
risk-free  interest rate of 5.03% and 5.49%;  no dividends over the option term;
stock price volatility  factor of .808 and .363, and a weighted average expected
option  life  of  five  years.  For  the  purpose  of the  following  pro  forma
information,  the estimated  fair value as determined by the model was amortized
to  expense  over  the  respective  vesting  period.  The  SFAS  123  pro  forma
information  presented  below is not  necessarily  indicative  of the pro  forma
effects to be presented in future periods.

                                      F-19
<PAGE>

                               CD Warehouse, Inc.

             Notes to Consolidated Financial Statements (continued)

9. STOCKHOLDERS' EQUITY (CONTINUED)

The SFAS 123 pro forma information is as follows:

                                                    YEAR ENDED DECEMBER 31,
                                                     1999             1998
                                               ---------------------------------

  Net income (loss):
     As reported                                 $(1,141,132)        $775,352
     Pro forma                                   $(1,734,332)        $471,769

  Basic earnings (loss) per share:
     As reported                                       $(.31)            $.27
     Pro forma                                         $(.47)            $.16

  Diluted earnings (loss) per share:
     As reported                                       $(.31)            $.25
     Pro forma                                         $(.47)            $.15

The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded  options which have no vesting  restrictions  and are fully
transferable.  In addition,  option valuation models require the input of highly
subjective  assumptions  including the expected stock price volatility.  Because
the  Company's  employee  stock  options  have   characteristics   significantly
different from those of traded  options,  and because  changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion,  the  existing  models do not  necessarily  provide a  reliable  single
measure of fair value of its stock options.

WARRANTS

In connection  with its Initial Public Offering in 1997, the Company sold to the
underwriters,  for a price of $.001 per  warrant,  warrants to purchase  100,000
shares of common stock. The underwriters'  warrants are exercisable at $7.50 per
share through  January  2002.  During 1999,  warrants were  exercised for 25,000
shares of common stock for cash of $187,500.

In connection with the Placement, the placement agents were granted warrants to
purchase 162,430 shares of common stock exercisable at $10.00 per share through
2003.

                                      F-20
<PAGE>

                               CD Warehouse, Inc.

             Notes to Consolidated Financial Statements (continued)

10. EMPLOYEE BENEFIT PLAN

In 1999, the Company adopted a 401(k) Plan (the "Plan") for eligible  employees.
Employees  who have  completed  one year of service  with the Company and are 18
years of age are eligible to  participate in the Plan.  Participating  employees
may authorize  payroll  deductions up to 15% of their annual  compensation.  The
Company matches 50% of the first 6% of the employees'  compensation  contributed
to the Plan.  Company  contributions  are  subject to vesting at the rate of 20%
each year upon  completion of two years of service,  with 100% vesting after six
years. Matching contributions of $20,615 were made by the Company during 1999.

11. COMMITMENTS AND CONTINGENCIES

The Company has entered  into  employment  agreements  with two  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  $212,000  annually for the two
individuals.

The Company has entered into  operating  leases  primarily  for its retail store
locations and corporate  facilities.  Rental  expense under these leases totaled
$2,157,918 and $801,200 for 1999 and 1998, respectively. Total rental amounts of
$6,454,200 under these noncancelable leases are due as follows: 2000-$1,902,896,
2001-$1,685,979,    2002-$1,363,796,    2003-$1,083,209,    2004-$403,579    and
thereafter-$14,741.

The Company is also involved in legal proceedings and litigation  arising in the
ordinary course of business.  In the opinion of management,  the outcome of such
proceedings  and litigation  currently  pending will not  materially  affect the
Company's consolidated financial statements.

12. BUSINESS SEGMENT INFORMATION

The  Company  is  engaged  principally  in one  line  of  business-the  sale  of
prerecorded  music compact discs and related  products in Company and franchisee
owned retail stores-which represents approximately 99% of consolidated revenues.
There are no  material  amounts  of sales  among  geographic  areas,  individual
foreign  countries,  or individual  customers.  All of the Company's  long-lived
assets are located within the domestic United States.

                                      F-21