<PAGE> 1
                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                    FORM 10-K

                                   (Mark One)
           [ X ] Annual report pursuant to section 13 or 15(d) of the
                        Securities Exchange Act of 1934

                   For the fiscal year ended December 31, 1999
                                             -----------------
                                       or

          [ ] Transition report pursuant to section 13 or 15(d) of the
                        Securities Exchange Act of 1934
           For the transition period from ____________ to ___________

                         Commission File Number 0-23753

                                   CDNOW, INC.

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

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

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

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

           Securities registered pursuant to Section 12(b) of the Act:

   Title of each class:            Name of each exchange on which registered:
          None                                      None
   --------------------            ------------------------------------------

           Securities registered pursuant to Section 12(g) of the Act:
                           Common Stock, no par value
           -----------------------------------------------------------

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports)  and  (2)  has  been  subject  to such  filing
requirements for the past 90 days: YES X NO

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  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-K or any amendment to this
Form 10-K. [ ]

The  aggregate  market value of the voting stock held by  non-affiliates  of the
registrant  is  approximately  $184,478,799.  Such  aggregate  market  value was
computed by  reference  to the closing  price of the Common Stock as reported on
the National  Market of The Nasdaq Stock Market on March 20, 2000.  For purposes
of this calculation only, the registrant has defined affiliates as including all
directors and executive officers. In making such calculation,  registrant is not
making a determination of the affiliate or  non-affiliate  status of any holders
of shares of Common Stock.

The number of shares of the  registrant's  Common Stock  outstanding as of March
20, 2000 was 32,796,231.

                       DOCUMENTS INCORPORATED BY REFERENCE

                                     None.

<PAGE> 2

                                   CDNOW, INC.

                             FORM 10-K ANNUAL REPORT
                     For Fiscal Year Ended December 31, 1999

                                TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I

                                                                                                  Page
                                                                                                  ----
<S>                                                                                               <C>
Item 1.  Business..................................................................................3

Item 2.  Properties...............................................................................13

Item 3.  Legal proceedings........................................................................13

Item 4.  Submission of Matters to a Vote of Security Holders......................................14


PART II

Item 5.  Market for registrant's common equity and related stockholder matters....................15

Item 6.  Selected financial data..................................................................16

Item 7.  Management's discussion and analysis of financial condition and results of operations....17

Item 7A. Qualitative and quantitative disclosure about market risk................................22

Item 8.  Financial statements and supplementary data..............................................22

Item 9.  Changes in and disagreements with accountants on accounting and financial disclosure.....22


PART III

Item 10. Directors and executive officers of the registrant.......................................22

Item 11. Executive compensation...................................................................24

Item 12. Security ownership of certain beneficial owners and management...........................25

Item 13. Certain relationships and related transactions...........................................27

PART IV

Item 14. Exhibits, financial statement schedules, and reports on form 8-K........................ 27
</TABLE>


<PAGE> 3

This document  contains certain  forward-looking  statements that are subject to
risks and uncertainties.  Forward-looking statements include certain information
relating to trends in the electronic  commerce industry and the overall domestic
economy,  the  company's  business  strategy,  including the markets in which it
operates,  the services it provides,  its ability to attract new customers,  the
benefits of certain  technologies  the company has  acquired or plans to acquire
and the  investments  it  plans  to  make in  technology,  the  company's  plans
regarding international  expansion, the implementation of quality standards, the
seasonality  of the  company's  business,  variations  in operating  results and
liquidity,  as well as  information  contained  elsewhere in this report,  where
statements  are  preceded  by,  followed  by or  include  the words  "believes,"
"expects,""anticipates" or similar expressions. For such statements, the company
claims  the  protection  of  the  safe  harbor  for  forward-looking  statements
contained  in  the  Private  Securities  Litigation  Reform  Act  of  1995.  The
forward-looking   statements   in  this   document  are  subject  to  risks  and
uncertainties that could cause the assumptions  underlying such  forward-looking
statements and the actual results to differ  materially  from those expressed in
or implied by the statements.

                                     PART I

ITEM 1.  BUSINESS

     CDNOW,  through its Internet  site at  cdnow.com,  is a leading  electronic
commerce  retailer of  pre-recorded  music,  including  compact  discs (CDs) and
digital downloads, and other entertainment-related  products as well as a source
of  entertainment-related  content.  Its  early  entry  into  the  online  music
retailing  industry  has helped CDNOW gain a  well-recognized  brand and a large
customer base.  CDNOW strives to combine the advantages of online  commerce with
superior customer focus in order to be the  authoritative  source for the online
purchase of music.  CDNOW offers over 500,000 items for sale.  CDNOW's  Internet
site offers:

     -   broad selection and informative content;

     -   easy-to-use navigation and search capabilities;

     -   a high level of customer service;

     -   competitive pricing; and

     -   personalized merchandising and recommendations.

     Due to CDNOW's retail focus,  revenues are primarily  derived from the sale
of pre-recorded music and other entertainment-related products. CDNOW also sells
advertising  space  and  sponsorships  on its site to  companies  interested  in
promoting  their own goods and services to CDNOW's  customer  base and the large
number of visitors to CDNOW's Internet site.

     On March  17,  1999,  CDNOW and N2K Inc.  merged.  The N2K  Internet  site,
MusicBlvd.com,  which was a major  competitor  to CDNOW in online  retail  music
sales, was merged into the CDNOW site.

<PAGE> 4

     Approximately  3.2 million  customers have made purchases from either CDNOW
or Music Boulevard since the inception of CDNOW in August 1994 through  December
31, 1999. Approximately 1.6 million of these customers made their first purchase
during the year ended  December 31, 1999.  CDNOW's net sales were $147.2 million
for the year ended December 31, 1999.

     CDNOW believes it has a significant number of loyal customers.  In addition
to the rapid  increase in new customers,  CDNOW has also  generated  significant
sales  from  existing   customers.   Repeat  customer  purchases  accounted  for
approximately 63% of product sales in the year ended December 31, 1999.

     CDnow, Inc., a Pennsylvania corporation,  was incorporated in October 1998.
A  predecessor  corporation,   also  named  CDnow,  Inc.,  was  incorporated  in
Pennsylvania in 1994. CDNOW's principal offices are located at:

                    1005 Virginia Drive
                    Fort Washington, Pennsylvania 19034
                    (215) 619-9900

Recent Developments.

     On  July  12,  1999,   CDNOW  entered  into  an  Agreement  of  Merger  and
Contribution  with Sony  Corporation  of America  ("Sony")  and Time Warner Inc.
("Time  Warner") to combine its business with that of Columbia  House,  which is
owned equally by Sony and Time Warner.  On March 13, 2000, Sony, Time Warner and
CDNOW mutually consented to terminate the Merger and Contribution  Agreement and
entered into a Termination Agreement.  Under the Termination Agreement, Sony and
Time Warner purchased $21 million of CDNOW's common stock (2,405,500 shares), no
par value,  on March 16,  2000,  and  replaced  a $30  million  short-term  loan
commitment with $30 million of long-term  convertible debt, which is convertible
at the option of the holder into CDNOW common stock at $10 per share. Sony, Time
Warner,  Columbia House and CDNOW also agreed to explore the  possibilities of a
number of strategic  relationships.  Following the execution of the  Termination
Agreement,  CDNOW  retained  Allen & Company to explore  strategic  options  and
alternative financing arrangements. On March 14, 2000, CDNOW filed a report with
the Securities and Exchange Commission on Form 8-K concerning the termination of
the proposed merger with Columbia House.

     On February 1, 2000,  the CDNOW Board of  Directors  adopted the CDNOW 2000
Equity  Compensation  Plan to provide grants of options to purchase CDNOW common
stock as well as  grants of  restricted  stock to CDNOW  employees.  At the next
regular meeting of the  shareholders of CDNOW,  the Board will submit a proposal
requesting that the shareholders of CDNOW vote to approve the Plan.

     On March 20,  2000,  CDNOW  repriced  issued  and  outstanding  options  to
purchase  its common  stock,  no par  value,  held by its  employees,  including
officers  and  certain  members of its Board of  Directors,  that were set at an
exercise  price greater than the closing price of CDNOW common stock,  as listed
on the Nasdaq National Market on March 20, 2000, of $5.625, to this price.

The CDNOW Internet Site.

     CDNOW  strives  to make  the  CDNOW  site  informative  and  authoritative.
Customers  can easily learn about,  discover  and  purchase  pre-recorded  music
products,  including CDs, digital  downloads,  music-related  products and other
entertainment-related  products.  CDNOW  offers  many  attractive  features  for
shoppers. Customers can focus their searches, browse among top sellers and other
featured  titles,  read  reviews,  listen  to  music  samples,   participate  in
promotions and check order status. New users may access an information page that
CDNOW specifically  designed to give shoppers a quick understanding of the CDNOW
site and its many features.

<PAGE> 5

Merchandising.

     CDNOW currently offers more than 500,000 products including:

     -  CDs;

     -  movie and music videos on tape and DVD; and

     -  other products, including:

        -  T-shirts;

        -  music accessories; and

        -  periodic offers of audio and video equipment, such as CD recorders
           and DVD players.

     To encourage  purchases,  CDNOW features  various  promotions on a rotating
basis throughout its site,  adjusts pricing  strategies and tactics as necessary
to maintain  competitiveness  and generally  prices recent  releases and popular
titles  aggressively.  CDNOW also reduces  shipping  costs for larger  orders to
encourage customers to purchase multiple titles.

Personalization.  CDNOW  provides  customers with  customized  and  personalized
features  through its "My CDNOW"  service.  CDNOW  believes that these  features
increase  customer  retention,  likelihood of repeat purchases and average order
size. As part of the "My CDNOW" service, CDNOW offers:

     -   recommendations using artificial intelligence technology;

     -   the ability to rate albums the customer has purchased;

     -   a "wish list" capability to keep track of products the customer
         intends to purchase at a later date;

     -   a gift registry that allows visitors to purchase gifts for
         participating customers;

     -   automatic  login to avoid  requiring  the customer to enter his/her
         userid and password each time they access the site;

     -   a favorite artists list;

     -   order history; and

     -   frequent buyer points.

Searching.  Through CDNOW's "FastFind" search engine,  customers can quickly and
easily navigate the site to find music and other products of interest. Customers
can search for music products based on artist,  album title, song title,  record
label, or musical genre, and for movie videos based on title, actor or director.
CDNOW's search engine uses Verity, Inc.'s K2 search technology.  This technology
helps  customers  make  successful  searches even with  incomplete or misspelled
artists'  names.  By clicking  on the album  title,  a visitor can browse  among
CDNOW's database of reviews, cover art, sound samples and album notes.

<PAGE> 6

Content  and Music  Discovery.  CDNOW  believes  that  effective  use of content
encourages  purchases  by  customers  who may be  browsing  the site  without  a
specific  title  in  mind.  CDNOW's  site  contains  music  samples,   extensive
information with regard to titles, reviews, editorials,  ratings and articles on
music topics and other information. To help customers browse and discover music,
the CDNOW store is organized into genre-specific music spaces. Within each genre
space, customers can browse sale items, new releases, advance orders and charts,
read reviews, listen to music samples and purchase music recommended by CDNOW.

Custom  Compilations.  CDNOW offers its customers the  opportunity to create and
purchase  customized CDs.  Customers can build  full-length CDs from theme-based
collections  of  music,   including   holidays   (Christmas  and  Chanukah)  and
Valentine's  Day  collections.  Customers  select their  favorite  songs,  add a
personalized  title and write their own liner notes.  CDNOW  expects to continue
offering  custom CD  collections on a regular  basis.  In addition,  CDNOW sells
branded  custom CDs to other  companies for corporate  promotions,  in volume as
well as  on-demand.  CDNOW  manufactures  and  ships  custom  CDs  from its Fort
Washington,  Pennsylvania facility and on occasion uses third parties to provide
manufacturing and shipping.

Digital Download. Beginning in July 1999, CDNOW began offering promotional music
tracks that its customers can digitally download directly to their computers. In
August 1999, CDNOW began selling music tracks in digital download format both as
individual  songs  and  albums.  CDNOW  intends  to  continue  offering  various
promotional  digital  downloads in the future as well as digital  downloads that
its  customers  can  purchase  as  individual  songs,  albums  or  CDNOW-defined
compilations.

Video. In December 1999, CDNOW expanded its video store selling movies and music
videos in both VHS and DVD  formats.  CDNOW  expects to continue  enhancing  the
product offerings and content of its video store.

Purchasing  Product.  Once a customer selects a product, he or she simply clicks
on the price to add products,  including  advance  orders of yet-to-be  released
products,  to his or her virtual  shopping  cart.  Customers  can add and remove
products  from  their  shopping  carts as they  browse,  prior to making a final
purchase.  The shopping cart page displays each item that has been placed in the
cart,  including  title,  price and any applicable  discount.  To complete their
purchase,  customers  select the ship to address,  shipping and payment methods,
gift wrapping and a personalized message if desired, then the customer clicks on
the "Place Order" button. Customers can also create a wish list of products they
may want to purchase on future visits. The wish list is a special section of the
"My CDNOW" service where items may be stored between visits.

Payment.  Customers  can pay for orders with credit  cards,  personal  checks or
money orders.  For  convenience,  CDNOW  enables  customers to store credit card
information on CDNOW's secure server, thereby avoiding the need to re-enter this
information  when making future  purchases.  CDNOW offers customers a variety of
shipping options,  including  overnight delivery.  CDNOW automatically  confirms
each order by e-mail within  minutes after the order is placed and  subsequently
confirms  shipment  of each order by e-mail.  CDNOW  offers a 30-day  money-back
return policy.
<PAGE> 7

Inventory  and Filling  Orders.  CDNOW's  inventory is owned and held by outside
vendors who ship  directly to CDNOW's  customers.  The breadth of the  inventory
offered by these vendors  provides CDNOW with the ability to maintain high order
fill rates.  CDNOW updates its site daily with  inventory  information  received
from its vendors,  which enables customers to check the availability of products
before ordering. CDNOW electronically transmits orders to its outside vendors at
least once daily.  These  vendors  ship orders  using a CDNOW label and invoice,
often within a day after an order is placed with CDNOW.

Multilingual  Capabilities.  CDNOW generated  approximately 19% of its net sales
from  international  markets for the year ended December 31, 1999. CDNOW derived
29% of its net revenues in 1997 and 21% in 1998 from international  sales. CDNOW
offers foreign language versions of its site that contain translation of account
registration  and ordering  instructions,  and CDNOW supports its  international
sales efforts with customer service  representatives  fluent in these languages.
CDNOW currently offers versions of its site in the following languages:

         -    Dutch,
         -    French,
         -    German,
         -    Italian,
         -    Japanese,
         -    Spanish, and
         -    Portuguese.

Marketing and Promotion.  CDNOW designs its marketing and promotion  strategy to
broaden awareness of the CDNOW brand,  increase customer traffic to CDNOW's site
and  encourage  new and repeat  purchases.  CDNOW markets and promotes its brand
using  marketing  agreements,  online  and  traditional  advertising,  affiliate
programs  that provide  commissions  for sales  referrals  and direct  marketing
through  e-mails to customers and  prospective  customers.  CDNOW  believes that
using these multiple  marketing  channels  reduces reliance on any one source of
customers,  maximizes  brand awareness and lowers average  customer  acquisition
cost.

Marketing  Agreements.  CDNOW believes that marketing  agreements  with Internet
portals and content providers and global  entertainment-oriented media companies
can be a significant  source of new customers.  For example,  under an agreement
with America Online,  CDNOW and America Online share revenues generated from the
sale  of  advertising,  sponsorships,  CDs and  related  merchandise.  CDNOW  is
featured as the exclusive  online music retailer  within America  Online's Music
Space  channel,  receives  a featured  position  on  America  Online's  Shopping
Channel,  participates in a variety of banner  advertising  opportunities and is
assigned specific keywords within the America Online service.  CDNOW's marketing
arrangement with America Online continues through August 31, 2000.

Online and Traditional Advertising.

     CDNOW  promotes  its brand using a  combination  of online and  traditional
advertising.  CDNOW advertises on the sites of many Internet content and service
providers.  As part of these  arrangements,  CDNOW  typically  purchases  banner
advertisements on Internet sites relevant to CDNOW's  products.  When a consumer
clicks onto the banner advertisement they are immediately transferred to CDNOW's
site.  CDNOW also  purchases  the right to be displayed on search  results pages
that are generated by Internet search engines when a user makes a search using a
specific  keyword,  such  as  "jazz."  The  significant  flexibility  of  online
advertising  allows CDNOW to quickly adjust its advertising plans in response to
seasonal and promotional activities.
<PAGE> 8

     CDNOW  believes  that  traditional  advertising,  such as print,  radio and
television,  is a key ingredient in building brand recognition and promoting the
benefits of online retail shopping.  Traditional advertising can be an effective
means of creating  widespread brand awareness and attracting  traditional retail
consumers  to CDNOW's  site,  including  consumers  with little or no history of
online purchases.  CDNOW's  traditional  advertising efforts have included radio
advertising in major markets,  print  advertising in music-related  publications
and  television  advertising.  CDNOW has  purchased  television  advertising  on
programs such as MTV's 1998 Video Music  Awards,  VH1's Behind the Music and the
1998,  1999 and 2000 Grammy  Awards.  In  addition,  CDNOW has been  featured in
television and print advertising  campaigns of third parties when CDNOW conducts
joint promotions with such parties.

     Co-Marketing  advertising has also become an important  concept in building
brand awareness and driving traffic to CDNOW. In January of 2000, CDNOW launched
a highly  integrated  promotion  with Pizza Hut.  Consumers who bought a Big New
Yorker Pizza at Pizza Hut received an access code to make their own custom CD at
cdnow.com.  The promotion was offered through in-store advertising,  radio spots
and network television commercials,  including television commercials that aired
in January and  February  2000,  and a  commercial  during the XXXIV Super Bowl,
which aired in January 2000.

Affiliate  Programs.  Through its affiliate  programs,  as of December 31, 1999,
CDNOW maintains  arrangements with over 230,000 web sites,  including many small
fan sites devoted to particular  music artists.  CDNOW provides these sites with
embedded  hyperlinks  through  which  potential  customers  can  immediately  be
connected  to  the  CDNOW  site.  CDNOW  pays  participants  in  these  programs
commissions  in store  credit or cash based upon the dollar  amount of purchases
made by persons using the link. These sites are a significant  source of traffic
and new  customers  for  CDNOW.  CDNOW  rewards  the  best  sites  with  special
incentives.

Direct Marketing.  CDNOW uses direct marketing techniques to target prospective,
new and existing  customers  with  communications  and  promotions.  CDNOW sends
personalized e-mails to its customers.  These e-mails may contain information on
a variety of topics,  including purchase  recommendations  based on demonstrated
customer  preferences and prior purchases,  information  concerning new releases
and other  types of  promotions  and sales.  CDNOW also  sends  directed  e-mail
communications  to persons who have registered at CDNOW's site but have not made
purchases  and to customers  who have not made recent  purchases.  Through these
customized  programs,  CDNOW hopes to further stimulate demand,  increase repeat
purchases, build customer loyalty and better understand customer preferences.

Customer  Service.  CDNOW  believes  that a high level of  customer  service and
support is critical to retaining  and expanding  its user base.  CDNOW  customer
service  representatives  are available  24-hours-a-day,  seven-days-a-week,  to
provide  assistance  via  e-mail,  phone or fax.  CDNOW  strives  to answer  all
inquiries  within 24 hours.  CDNOW  currently  has  approximately  140  customer
service  representatives,  including  representatives  fluent  in  nine  foreign
languages.  Customer  service  representatives  handle  questions  about orders,
assist  customers in finding music titles and other  music-related  products and
register a  customer's  credit card  information  over the  telephone.  Customer
service  representatives  are a  valuable  source  of  feedback  regarding  user
satisfaction.
<PAGE> 9

Inventory and Filling Orders.

     CDNOW does not carry inventory,  except limited  inventories related to its
custom  compilation  business and  specialized  products such as audio and video
equipment.  CDNOW  relies on third  party  vendors to carry  inventory  and fill
orders.  CDNOW believes that this  distribution  strategy  allows it to offer an
extensive selection while avoiding the high fixed costs and capital requirements
associated  with owning and  warehousing  product  inventory and the significant
operational  effort  associated  with  order  fulfillment  and  shipment.  CDNOW
typically experiences a return rate of between 1% to 2% of all merchandise sold.

     CDNOW  uses  Valley  Media as its  primary  vendor  to fill  orders.  CDNOW
transmits  data to Valley  Media  through a secure  network  to ensure  customer
security and data integrity. Valley Media picks, packs and ships customer orders
and  charges  CDNOW for the cost of the  merchandise,  as well as  shipping  and
handling. In the majority of cases, products are shipped within one business day
after an order is placed. CDNOW processes customer billing through a third party
credit card processor.  To date,  Valley Media has generally  satisfied  CDNOW's
requirements  on a timely  basis.  For the year ended  December 31, 1999,  costs
incurred for products shipped from Valley Media accounted for  approximately 85%
of CDNOW's cost of sales. In addition to Valley Media, CDNOW:

     -   has initiated a relationship with Alliance Group to also fulfill orders
         for CDs, cassettes and vinyl records produced in the United States;

     -   uses MSI of Miami Corp. to fill orders for CDs produced by foreign
         labels, including 60,000 international titles from a fulfillment
         center in the Netherlands servicing primarily European markets; and

     -   fulfills orders for videos and DVDs through Baker & Taylor.

Technology.

     CDNOW  has  developed  technologies  and  implemented  systems  to  support
distributed,   reliable  and  expandable   online  retailing  in  a  secure  and
easy-to-use   format.   Using  a  combination  of   proprietary   solutions  and
commercially available, licensed technologies, CDNOW has deployed systems for:

     -   online content dissemination;

     -   online transaction processing;

     -   customer service;

     -   market analysis; and

     -   electronic data interchange.

     Store Architecture.  CDNOW's hardware and software systems are based upon a
distributed   transaction  processing  model  that  allows  applications  to  be
distributed among multiple parallel  servers.  Many of the software  components,
and the pages of CDNOW's  store,  are developed  using a proprietary  technology
that extends  HTML,  the typical  computer  software  language for Internet site
development,  with  product,   transaction,   retail  and  advanced  programming
constructs.  This technology results in the separation of the page look and feel
from the individual data elements and their  associated  database  look-ups thus
reducing  software  updates  for  changes to  CDNOW's  site and  minimizing  the
engineering required to maintain a growing amount of items and content.
<PAGE> 10

     Interfaces.  CDNOW  has  developed  technologies  and  tools  for  managing
interfaces with Internet service and content  providers.  A linking interface is
made  available  to  businesses   with  which  CDNOW  has  developed   marketing
arrangements.  These  technologies and tools and the linking interface allow the
linking  of  external  Internet  sites,  banners  and  promotions  to items  and
functions  contained  in  CDNOW's  site.  CDNOW's  online  marketing  group uses
proprietary  tools to manage  marketing and  affiliate  programs in an efficient
manner.  CDNOW has  developed  and  licensed  similar  systems and tools for its
customer service department.  The ability to manage customer accounts and orders
enables CDNOW's customer service  department to add capacity  effectively and to
communicate  efficiently,  thereby responding to most inquiries within 24 hours.
These systems automate many routine communications and allow customers to better
manage their accounts and orders.

     Fault Tolerance and Scalability. CDNOW's hardware servers, storage systems,
Internet   connections   and  networks  allow  its  online  systems  to  operate
continuously and enable it to maintain a 24-hour-a-day,  seven-day-a-week retail
store.  CDNOW runs its databases  and web servers on a series of Sun  Enterprise
servers.  CDNOW uses  multiple  servers and  redundant  data storage  systems to
minimize store  performance  degradation or downtime in the event of software or
hardware failures.  CDNOW maintains dedicated  connections to the Internet lines
provided by multiple Internet service providers. This technology,  combined with
the architecture of the systems, allows CDNOW to increase capacity by adding new
components  or servers while  maintaining  performance  and cost  effectiveness.
CDNOW uses both  proprietary  and  commercially  available  tools to monitor and
manage these systems with minimal operator participation.

     Security.   CDNOW  employs  both  commercial  and   proprietary   firewalls
integrated into the architecture of its system to keep its Internet  connections
secure.  CDNOW uses the  Netscape  SSL  Commerce  Server  for secure  electronic
transactions over the Internet and uses proprietary  electronic data interchange
interfaces  and  private  networks  to ensure the  security  of  customer  order
information and credit card transactions shared with its vendors and credit card
processor.

     Advanced  Technologies.  CDNOW continually  evaluates emerging technologies
and new  developments  in many areas  including  electronic  commerce,  database
management and networking.  Since April 1997,  CDNOW has been using  information
gathered about a customer's  preferences  and recent  purchases to make personal
music recommendations to its customers.

Competition.

     Online commerce is new, rapidly evolving and intensely  competitive.  CDNOW
expects competition to further intensify.  Barriers to entry are minimal,  and a
competitor  can launch a new site at a relatively  low cost.  In  addition,  the
broader retail music industry is intensely competitive. CDNOW currently competes
with a variety of companies, including:

     -   online vendors of music, music videos and other related products;

     -   online service providers which offer music products directly or in
         cooperation with other retailers;
<PAGE> 11

     -   traditional retailers of music products, including specialty music
         retailers;

     -   other   retailers   that   offer   music   products,   including   mass
         merchandisers,  superstores,  discount  stores and consumer  electronic
         stores; and

     -   non-store retailers such as music clubs.

Many of these  traditional  retailers also have dedicated web sites that compete
directly with CDNOW.

     CDNOW believes that the principal  competitive factors in its online market
are:

     -   brand recognition;

     -   selection;

     -   price;

     -   effectiveness of advertising and other customer acquisition efforts;

     -   variety of value-added services;

     -   ease of use;

     -   site content; and

     -   quality of service and technical expertise.

     Some of CDNOW's current and potential competitors have:

     -   longer operating histories;

     -   larger customer bases;

     -   greater brand recognition; and

     -   significantly greater financial, marketing, technological and other
         resources than CDNOW.

     CDNOW is  aware  that  several  of its  competitors  have  adopted  and may
continue to adopt  aggressive  pricing or  inventory  availability  policies and
devote  substantially more resources to site and systems development than CDNOW.
Increased  competition may result in reduced operating  margins,  loss of market
share and a diminished brand franchise.

     There can be no assurance  that CDNOW will be able to compete  successfully
against current and future  competitors.  New  technologies and the expansion of
existing  technologies  may increase  the  competitive  pressures on CDNOW.  For
example, applications that compare specific titles from a variety of sites based
on factors such as price may channel  customers to online retailers that compete
with CDNOW.
<PAGE> 12

Intellectual Property.

     CDNOW  regards its  trademarks,  trade  secrets  and  similar  intellectual
property as valuable to its business, and relies on trademark and copyright law,
trade secret protection and  confidentiality  and/or license agreements with its
employees,  partners and third parties to protect its  proprietary  rights.  The
steps taken by CDNOW,  however,  may not adequately prevent  misappropriation or
infringement of its intellectual property.

     CDNOW has  licensed  in the past,  and  expects  that it may license in the
future,  some of its  proprietary  rights,  such as  trademarks  or  copyrighted
material,  to third parties.  While CDNOW attempts to ensure that the quality of
its brand is maintained by such licensees, these licensees may take actions that
might  significantly  decrease  the  value  of  CDNOW's  proprietary  rights  or
reputation, which could harm CDNOW.

Seasonality.

     CDNOW  expects  that  it  will  experience  seasonality  in  its  business,
reflecting  a  combination  of  seasonal  fluctuations  in  Internet  usage  and
traditional  retail  seasonality  patterns affecting sales of pre-recorded music
and other entertainment-related  products. Sales in the traditional retail music
industry are  significantly  higher in the fourth calendar quarter of each year,
which corresponds to the holiday season,  than in the preceding  three-quarters.
Additionally,  retail music sales are traditionally  hits-driven through popular
releases by well-known and emerging artists.  The presence or absence of hits in
any one quarter tends to affect music sales.

     To date,  CDNOW's  limited  operating  history  and  rapid  growth  make it
difficult to ascertain the effects of  seasonality  on its business,  especially
with regard to products  other than the sale of music CDs.  CDNOW  believes that
period-to-period  comparisons  of its  historical  results  are not  necessarily
meaningful and should not be relied upon as an indication of future results.

Environmental  Compliance.  As the lessee of real property,  CDNOW is subject to
laws and regulations  governing protection of the environment,  human health and
safety, and the use, management and disposal of hazardous substances. These laws
can impose significant costs and liabilities, including the costs of cleaning up
contaminated properties.  CDNOW believes that it substantially complies with all
applicable environmental laws and regulations.

Financial  Information  About Geographic  Areas. In 1999, CDNOW generated 81% of
its  revenues  from U.S.  purchases  and 19% of its revenues  from  purchases in
foreign countries.

Employees.  As of March 20,  2000,  CDNOW  had 502  full-time  and 35  part-time
employees.  CDNOW  also  employs  independent  contractors  and other  temporary
employees in its editorial,  operations and  administrative  functions.  None of
CDNOW's employees are represented by a labor union under a collective bargaining
agreement.  CDNOW considers its employee  relations to be good.  Competition for
qualified personnel in CDNOW's industry is intense,  particularly among software
development  and other technical  staff.  CDNOW believes that its future success
will  depend  in part on its  continued  ability  to  attract,  hire and  retain
qualified personnel.
<PAGE> 13

ITEM 2.  PROPERTIES

     CDNOW's  executive  offices are located  in, and  substantially  all of its
operating  activities  are conducted  from,  leased office space located in Fort
Washington,  Pennsylvania.  CDNOW  has  leased  this  facility,  which  contains
approximately  77,000  square  feet,  under a lease  that  expires  in 2006.  In
addition,  CDNOW  leases  small  amounts of office  space in New York City,  San
Francisco, Los Angeles, London and Yokohama,  Japan. CDNOW does not own any real
estate.

ITEM 3.  LEGAL PROCEEDINGS

     N2K and its directors  were  defendants in a consolidated  purported  class
action in the U.S. District Court for the Southern District of New York entitled
In re N2K Inc.  Securities  Litigation (Docket No. 98 CIV 3304 (HB)). The action
consolidated  two  purported  class  actions,  entitled  Kuhn v. N2K Inc. et al.
(Docket No. 98 CIV 4360 (HB)) and Bender v. Rosen et al. (Docket No. 98 CIV 3304
(HB)) that were previously discussed in N2K's Quarterly Reports on Form 10-Q for
the  quarterly  periods ended  September  30, 1998,  June 30, 1998 and March 31,
1998, and CDNOW's Quarterly Report on Form 10-Q for the quarterly periods, ended
March 31, June 30, and September 30, 1999, respectively. The consolidated action
was a  purported  class  action on behalf  of common  shareholders  and seeks to
recover  unspecified  damages and other  relief,  as well as costs and expenses,
stemming  from alleged  violations of the  Securities  Act of 1933 in connection
with the public  offering of the shares of N2K's common stock in April 1998. The
consolidated  action alleged that, among other things,  the defendants failed to
disclose N2K's first quarter financial results in the registration statement for
the April 1998 public offering. The defendants moved to dismiss the complaint on
August 31, 1998 for  failure to state a claim  and/or for failure to plead fraud
with the  requisite  particularity.  On May 21, 1999,  Judge Baer  dismissed the
plaintiff's  complaint  with  prejudice.  On June 22, 1999,  plaintiffs  filed a
Notice of Appeal to the U.S. Court of Appeals for the Second  Circuit,  which is
located in New York City. On February 7, 2000,  the Second  Circuit upheld Judge
Baer's dismissal of the plaintiff's complaint.

     On or about November 4, 1998, an action entitled Ticketmaster Ticketing Co.
v. N2K Inc. (Docket No.  BC200194) was filed against N2K in California  Superior
Court for the County of Los Angeles.  The  Ticketmaster  action alleges that N2K
breached a marketing  and  advertising  contract  dated  April 23, 1998  between
Ticketmaster and N2K, which N2K terminated  effective October 31, 1998, based on
alleged  breaches of the  agreement by  Ticketmaster  as well as other  tortious
conduct.  Ticketmaster seeks damages in an amount not less than $8,000,000, plus
pre-  and  post-judgment  interest,  as well  as fees  and  costs.  N2K  filed a
cross-complaint  for  affirmative  relief.  The  parties  are in the  process of
conducting discovery in preparation for trial.

     N2K and 17 other  entities  have been named as defendants in a civil action
entitled Interactive Gift Express v. Compuserve, Inc., et al. (Docket 95 CV 6871
(BSJ)), which is pending in the U.S. District Court for the Southern District of
New York. N2K has also been named as defendant in a civil action entitled Parsec
Sight/Sound,  Inc. v. N2K Inc. (Docket 98 CV 0118), which is pending in the U.S.
District Court for the Western District of Pennsylvania.  The plaintiffs in each
of these actions allege  infringement of intellectual  property rights, and each
seeks  treble  damages  and  costs in an  unspecified  amount,  as well as other
declaratory and injunctive relief. In the Interactive Gift action, the court has
issued a preliminary ruling favorable to defendants. The plaintiffs consented to
entry of judgment  against  them in order to speed  their  appeal of the court's
ruling.  The parties have  appealed the matter to the U.S.  Court of Appeals for
the Second Circuit.  In the Parsec action,  CDNOW has answered the complaint and
discovery is ongoing.

     CDNOW and N2K have  been  named  defendants  in an  action  brought  by BPW
Rhythmic Records, L.L.C. for breach of contract and other related claims arising
out of a label agreement  entered into between N2K Inc. and Rhythmic  Records on
March 27, 1998.  The plaintiff,  Rhythmic  Records,  seeks direct,  punitive and
exemplary damages,  costs,  including  attorney's fees, and a constructive trust
against CDNOW's assets.  Plaintiff  originally filed the action in a Texas state
court.  CDNOW and N2K  removed  the  action to the U.S.  District  Court for the
Northern  District of Texas,  and filed a motion to have the case  dismissed  or
moved to the  federal  trial court in New York City.  Subsequently,  the federal
court  in Texas  transferred  the  action  to the U.S.  District  Court  for the
Southern  District  of New York in New York City.  The  parties are in the early
stages of this litigation and have not yet begun formal pre-trial discovery.

     On July 14,  1999,  CDNOW filed a complaint  against  Lycos,  Inc.  and its
wholly-owned  subsidiary  Tripod,  Inc., in the U.S.  District  Court located in
Philadelphia, Pennsylvania. The complaint alleges that Lycos and Tripod breached
their  respective  obligations  to CDNOW as specified  in the linking  agreement
entered  into among  CDNOW,  Lycos and  Tripod on March 26,  1998.  CDNOW  seeks
damages in excess of $75,000 and a declaratory  judgment terminating the linking
agreement.  On  November  15,  1999,  Lycos  and  Tripod  filed  an  answer  and
counterclaim alleging breach of contract, quantum meruit and restitution, breach
of implied covenant of good faith and fair dealing and unfair and deceptive acts
and practices. Lycos and Tripod seek dismissal of the complaint, attorneys' fees
and damages as established at trial. The parties are in the early stages of this
litigation and have not yet begun formal pre-trial discovery.
<PAGE> 14

     CDNOW is a party to other lawsuits and proceedings  arising in the ordinary
course of its business,  none of which, in CDNOW's opinion,  is likely to have a
material adverse effect on operations.

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

         None.
<PAGE> 15

                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
         ---------------------------------------------------------------------

     CDNOW's  common stock trades on the National  Market  segment of the Nasdaq
Stock Market under the symbol  "CDNW." The following  table sets forth,  for the
periods  indicated,  the high and low sales prices as quoted on the Nasdaq Stock
Market.

<TABLE>
<CAPTION>
Period                                          High           Low
------                                         ------         ------
<S>                                            <C>            <C>
Fiscal 1999:
--------------
First Quarter                                  $24.94         $13.63
Second Quarter                                 $22.25         $13.25
Third Quarter                                  $23.27         $11.38
Fourth Quarter                                 $18.13          $9.88

Fiscal 1998:
--------------
First Quarter (beginning February 10, 1998)    $27.25         $18.25
Second Quarter                                 $39.00         $16.00
Third Quarter                                  $27.50          $7.00
Fourth Quarter                                 $39.25          $7.06
</TABLE>

     As of March 20,  2000  there were 354  holders of record of CDNOW's  common
stock,  although it believes that the number of beneficial holders of its common
stock exceeds twenty thousand.  On March 20, 2000, the closing sale price of the
common stock as reported by the Nasdaq Stock Market was $5.625.

     CDNOW has never  declared or paid any cash  dividends on its capital stock.
CDNOW currently  intends to retain any earnings it may realize to finance future
growth and working capital needs and, therefore,  does not anticipate paying any
cash dividends in the foreseeable future.
<PAGE> 16

ITEM 6.  SELECTED FINANCIAL DATA

     The following  selected  financial data are derived from CDNOW's  financial
statements  of the  company.  The  data  should  be  read  in  conjunction  with
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations"  in Item 7 and the  consolidated  financial  statements  and related
notes thereto included in Item 8.

<TABLE>
<CAPTION>
                                                                Year Ended December 31,

                                            1999             1998             1997             1996             1995
                                      ---------------- ---------------- ---------------- ---------------- ----------------
<S>                                   <C>              <C>              <C>              <C>              <C>
Statement of Operations Data:

Net sales............................ $   147,189,405  $    56,394,606  $    17,372,795  $     6,300,294  $     2,176,474
Cost of sales........................     118,037,621       45,250,328       13,847,773        5,074,087        1,815,672
                                      ---------------- ---------------- ---------------- ---------------- ----------------
Gross profit.........................      29,151,784       11,144,278        3,525,022        1,226,207          360,802
Operating expenses:
Operating and development............      23,421,062        8,000,023        2,541,434          669,280          149,982
Sales and marketing................        89,734,790       44,572,304        9,607,603          765,156          229,912
General and administrative...........      11,736,503        4,244,194        1,953,078          563,593          180,573
Amortization of goodwill and other
    intangibles .....................      25,786,261          202,801               --               --               --
Dispute settlement...................              --               --               --        1,024,030               --
                                      ---------------- ---------------- ---------------- ---------------- ----------------
Total operating expenses.............     150,678,616       57,019,322       14,102,115        3,022,059          560,467
                                      ---------------- ---------------- ---------------- ---------------- ----------------
Operating loss.......................    (121,526,832)     (45,875,044)     (10,577,093)      (1,795,852)        (199,665)
Interest income (expense), net.......       2,297,807        2,106,123         (170,312)         (14,556)          (1,248)
                                      ---------------- ---------------- ---------------- ---------------- ----------------
Net loss.............................    (119,229,025)     (43,768,921)     (10,747,405)      (1,810,408)        (200,913)
Accretion of preferred stock to
     redemption value................              --         (115,542)        (410,103)              --               --
                                      ---------------- ---------------- ---------------- ---------------- ----------------
Net loss applicable to common
     shareholders.................... $  (119,229,025) $   (43,884,463) $   (11,157,508) $    (1,810,408) $      (200,913)
                                      ================ ================ ================ ================ ================
Net loss per common share............ $         (4.32) $         (2.79) $         (1.42) $         (0.29) $         (0.03)
                                      ================ ================ ================ ================ ================
Weighted average number of common
     shares outstanding..............      27,618,917       15,712,857        7,845,684        6,139,072        6,000,000
                                      ================ ================ ================ ================ ================

<CAPTION>
                                            1999             1998             1997             1996             1995
Balance Sheet Data:                   ---------------- ---------------- ---------------- ---------------- ----------------
<S>                                   <C>              <C>              <C>              <C>              <C>
Cash and cash equivalents............ $    20,612,706  $    49,041,370  $    10,686,001  $       775,865  $        43,812
Working capital (deficit)............     (37,152,771)      42,408,170       (1,218,005)         231,455         (235,478)
Total assets.........................     118,801,757       69,043,043       16,448,425        1,575,459          268,468
Long-term debt, excluding current
     portion.........................       2,629,359        1,750,892          962,144           91,133            9,519
Redeemable convertible preferred
     stock...........................              --               --        9,492,594               --               --
Total shareholders' equity (deficit).      44,765,289       51,138,937       (9,752,450)         514,017          (99,362)
</TABLE>

<PAGE> 17

ITEM 7.

               MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                      CONDITION AND RESULTS OF OPERATIONS
               -------------------------------------------------

Overview.

     CDNOW is a leading  electronic  commerce  retailer of  pre-recorded  music,
including CDs and digital downloads, and other  entertainment-related  products.
Its early entry into the online music retailing industry has helped CDNOW gain a
well-recognized  brand and a large customer  base.  CDNOW strives to combine the
advantages of online  commerce with superior  customer  focus in order to be the
authoritative  source for the online purchase of music.  CDNOW's  Internet site,
cdnow.com, offers broad selection,  informative content,  easy-to-use navigation
and search capabilities,  a high level of customer service,  competitive pricing
and personalized merchandising and recommendations. Due to CDNOW's retail focus,
revenues are primarily  derived from the sale of pre-recorded  music and related
products.  CDNOW also sells  advertising  space and  sponsorships  to  companies
interested  in promoting  their own goods and services to CDNOW's  customer base
and the large number of visitors to CDNOW's Internet site.

     CDNOW has  grown  rapidly  since its  founding  in 1994.  Since  inception,
approximately  3.2 million  customers  have made  purchases from either CDNOW or
from Music  Boulevard,  the Internet music retail store  previously  operated by
N2K,  which was  integrated  into the  cdnow.com  Internet site on May 17, 1999.
Approximately  1.6 million customers made their initial purchase during the year
ended  December 31, 1999.  CDNOW's net sales grew to $147.2  million  during the
year ended  December 31, 1999,  compared to $56.4 million  during the year ended
December 31, 1998.

     In addition to the sales  generated  from Music  Boulevard  customers  as a
result of the  acquisition  of N2K and the rapid  acquisition  of new customers,
CDNOW has also  generated  significant  sales from  existing  customers.  Repeat
customers  accounted  for  approximately  63% of net sales during the year ended
December 31, 1999, up from  approximately 56% during the year ended December 31,
1998.

     CDNOW  believes  that the key factors  affecting  its  long-term  financial
success  include  its  ability  to secure  financing  arrangements,  obtain  new
customers at reasonable costs,  retain customers and encourage repeat purchases.
CDNOW seeks to expand its customer  base through  multiple  marketing  channels,
which  include  (i)  marketing  campaigns  using a  combination  of  online  and
traditional  offline  marketing,  consisting  of  print,  television  and  radio
advertising,  (ii)  continuing  marketing  agreements  with one or more Internet
content and service  providers,  (iii) entering into linking  arrangements  with
other Internet sites as part of its affiliate website  programs,  and (iv) using
direct  marketing   techniques  to  target  new  and  existing   customers  with
personalized communications. CDNOW periodically enters into marketing agreements
with various Internet portals and online content providers.  CDNOW presently has
marketing agreements in place with, among others, AOL, Excite and MTV/VH1.

     Since  inception,  CDNOW has  incurred  significant  net losses  and, as of
December 31, 1999, had accumulated losses of $174.3 million.  CDNOW expects that
it will continue to incur losses and generate negative cash flow from operations
for the foreseeable  future.  Since it has relatively low product gross margins,
the ability of CDNOW to  generate  and enhance  profitability  depends  upon its
ability  to   substantially   increase  its  net  sales.   To  the  extent  that
significantly higher net sales and/or alternative financing arrangements are not
realized, CDNOW will be materially adversely affected. There can be no assurance
that CDNOW will be able to generate  sufficient  revenues to achieve or maintain
profitability  on a  quarterly  or annual  basis or secure  adequate  funding to
continue its operations.

Results of Operations.

   Year Ended December 31, 1999 Compared to the Year Ended December 31, 1998
   -------------------------------------------------------------------------

Net Sales. Net sales primarily reflect the sale of pre-recorded  music and other
entertainment-related   products,  net  of  estimated  returns  and  promotional
discounts.  Net sales  include  coupons  redeemed  to purchase  merchandise  and
outbound shipping and handling charges.  Revenues from the sale of both cash and
barter  advertising on CDNOW's Internet site are also included in net sales. Net
sales were $147.2 million for the year ended December 31, 1999,  representing an
increase  of 161% over the year  ended  December  31,  1998.  This  increase  is
attributable to continued growth of CDNOW's customer base,  increased sales from
repeat  customers  (including  former Music  Boulevard  customers) and increased
advertising  revenue.  For  the  year  ended  December  31,  1999,  CDNOW  added
approximately 1.6 million new customers,  compared to 686,000 new customers that
were  added  during  the  year  ended   December  31,  1998.   The  addition  of


<PAGE> 18
approximately  1.6 million new  customers  for the year ended  December 31, 1999
brings the total number of customers who have made  purchases at either CDNOW or
Music  Boulevard since each site's  respective  inception to  approximately  3.2
million as of December  31,  1999.  During  1999,  CDNOW  continued  to devote a
substantial  portion of its  marketing  efforts  to the  retention  of  existing
customers.  Repeat customer purchases  represented  approximately 63% of product
sales for the year ended December 31, 1999,  compared to  approximately  56% for
the year ended December 31, 1998.  Advertising  revenue was $8.8 million for the
year ended  December  31, 1999,  representing  an increase of 626% over the year
ended December 31, 1998.

     CDNOW  includes the amount of coupons  redeemed to purchase  merchandise in
net sales. As a percentage of net sales, coupons redeemed were 4.9% for the year
ended  December 31, 1999 compared to 3.2% for the year ended  December 31, 1998.
For the years ended  December  31, 1999 and 1998,  the total  amount of redeemed
coupons included in net sales was  approximately  $7.2 million and $1.8 million,
respectively. CDNOW also includes the revenue associated with barter advertising
transactions in net sales. As a percentage of net sales, barter revenue was 1.3%
for both the years ended  December 31, 1999 and 1998. The total amount of barter
revenue  included in net sales was  approximately  $1.9 million and $753,000 for
the years ended December 31, 1999 and 1998, respectively.

     International  sales  represented  19% of net  sales  for  the  year  ended
December 31, 1999  compared to 21% for the year ended  December  31,  1998.  The
decrease in international sales as a percentage of net sales is primarily due to
a proportionally  larger increase in U.S. sales resulting from  heavily-promoted
shipping  discounts for U.S.  customers  during the fourth  quarter of 1999. The
decrease is also due to a  proportionally  larger  increase  in U.S.  sales from
Music Boulevard  customers obtained as a result of the acquisition of N2K, which
derived a smaller  percentage  of its sales from  international  customers  than
CDNOW. Nevertheless, international sales increased to $27.6 million for the year
ended December 31, 1999, from $11.7 million in the year ended December 31, 1998.

Cost of Sales. Cost of sales consists  primarily of the cost of merchandise sold
to customers,  including product  fulfillment and outbound shipping and handling
charges.  Cost of sales  increased  161%,  to $118.0  million for the year ended
December 31, 1999,  from $45.3 million for the year ended December 31, 1998. The
increase in percentage terms is identical to the 161% increase in net sales, and
hence  CDNOW's  gross margin  remained  consistent  at 19.8% for the years ended
December 31, 1999 and 1998.  During 1999, CDNOW pursued more aggressive  pricing
policies  and  promotions  than in 1998,  but the  effects  were  offset  by the
increase in advertising revenue, which has a higher margin than product sales.

Operating and Development  Expense.  Operating and  development  expense consist
primarily  of  payroll  and  related  expenses  for  store  management,  design,
development and network  operations  personnel,  systems and  telecommunications
infrastructure  and fees  paid by CDNOW in  return  for  licensing  of  ratings,
reviews,  sound  samples  and other  information.  Store  maintenance  costs are
charged to expense as incurred.  Operating and development  expense increased by
$15.4  million,  or 193%, to $23.4 million for the year ended  December 31, 1999
compared to $8.0 million for the year ended  December 31, 1998.  As a percentage
of net sales,  operating  and  development  expense was 15.9% for the year ended
December 31, 1999  compared to 14.2% for the year ended  December 31, 1998.  The
increase in both dollar and percentage terms is attributable to costs of systems
and telecommunications infrastructure necessary to support increased traffic and
transaction  volume on CDNOW's online site, some of which is attributable to the
merger  with  N2K,  to  increased  staffing  and  associated  costs  related  to
maintaining  the  features  and   functionality   of  CDNOW's  online  site  and
transaction-processing systems and to increased investments in store content.

Sales and Marketing  Expense.  Sales and  marketing  expense  includes  expenses
related to marketing  agreements,  advertising and promotions,  including barter
advertising and coupon  promotions,  payroll and related  expenses for personnel
engaged in marketing,  selling,  and customer service activities and credit card
processing fees. Sales and marketing expense increased by $45.1 million to $89.7
million for the year ended  December 31, 1999  compared to $44.6 million for the
year ended December 31, 1998. As a percentage of net sales,  sales and marketing
expense was 61.0% for the year ended December 31, 1999 compared to 79.0% for the
year ended  December 31, 1998.  The increase in absolute  dollars was  primarily
attributable to increased costs  associated with CDNOW's  marketing  agreements,
including  those assumed by it as a result of the  acquisition  of N2K and those
entered  into  partway  through  1998.  In addition,  CDNOW  incurred  increased
staffing  and  related  costs  in  connection  with  the  implementation  of its
marketing  strategy and  customer  service  activities  necessary to support its
increased  customer base, and increased  credit card  processing fees related to
the growth of revenues.  The increase is also due to increased  advertising  and
promotional  expenditures.  The decrease as a  percentage  of sales is primarily
attributable  to the increased  percentage of CDNOW's sales from repeat customer
purchases,  which are  relatively  less expensive than the cost of acquiring new
customers, and marketing efficiencies gained from the merger with N2K.

General and Administrative Expense.  General and administrative expense consists
of payroll and related  expenses for  executive  and  administrative  personnel,
insurance,  professional fees and other general and corporate expenses.  General
and administrative  expense increased by $7.5 million, or 177%, to $11.7 million
for the year ended December 31, 1999 compared to $4.2 million for the year ended

<PAGE> 19

December 31,  1998.  As a percentage  of net sales,  general and  administrative
expense  increased to 8% for the year ended  December 31, 1999  compared to 7.5%
for the year ended December 31, 1998. The increase in both dollar and percentage
terms is primarily due to merger-related  expenses of approximately $2.4 million
incurred in connection with CDNOW's terminated Merger and Contribution Agreement
to combine its business with Columbia House, the hiring of additional  personnel
to support overall growth of CDNOW, and increased professional fees.

Amortization  of Goodwill and Other  Intangibles.  Amortization  of goodwill and
other  intangibles  related to the acquisition of N2K and superSonic  Boom, Inc.
were  approximately  $25.8 million for the year ended December 31, 1999 compared
to $203,000 for the year ended December 31, 1998. As the  acquisition of N2K was
completed  in March  1999,  amortization  expense  in 1998 only  related  to the
acquisition of superSonic Boom, Inc.

Net Loss  Applicable  to Common  Shareholders.  CDNOW's net loss  applicable  to
common  shareholders  was $119.2  million for the year ended  December  31, 1999
compared to $43.9 million for the year ended December 31, 1998.

   Year Ended December 31, 1998 Compared to the Year Ended December 31, 1997
   -------------------------------------------------------------------------

Net Sales.  Net sales were $56.4  million for the year ended  December 31, 1998,
representing  an increase of 225% over the year ended  December  31,  1997.  The
increase is attributable to continued growth of CDNOW's customer base and repeat
purchases from existing  customers who have  typically  purchased more units per
order  than new  customers.  Net sales  were  favorably  affected  by  increased
advertising  and  promotional   activities,   including   CDNOW's   purchase  of
advertising  during the 1998 Grammy Awards and 1998 MTV Video Music  Awards,  as
well as the continued  implementation of its marketing agreements.  For the year
ended  December  31,  1998,  CDNOW added  approximately  686,000 new  customers,
compared to 209,000 new customers that were added during the year ended December
31, 1997.

     For the  years  ended  December  31,  1998 and 1997,  the  total  amount of
redeemed  coupons included in net sales was  approximately  $1.8 million and $0,
respectively.  The  total  amount of barter  revenue  included  in net sales was
approximately  $753,000  and $0 for the years ended  December 31, 1998 and 1997,
respectively.

     International  sales  represented  21% of net  sales  for  the  year  ended
December 31, 1998  compared to 29% for the year ended  December  31,  1997.  The
decrease in international sales as a percentage of net sales is primarily due to
a  proportionally  larger  increase in domestic  sales  resulting from increased
spending  in  domestic   marketing  and  advertising   programs.   Nevertheless,
international  sales  increased to $11.7 million for the year ended December 31,
1998, from $5.0 million in the year ended December 31, 1997.

Cost of Sales.  Cost of sales  increased  by $31.4  million,  or 227%,  to $45.3
million for the year ended December 31, 1998,  compared to $13.8 million for the
year ended  December 31, 1997.  CDNOW's gross margin  decreased to 19.8% for the
year ended  December  31, 1998 from 20.3% for the year ended  December 31, 1997.
The  decline in gross  margin was  attributable  to more  aggressive  pricing of
recent releases and popular titles, as well as increased sales discounts.

Operating and Development  Expense.  Operating and development expense increased
by $5.5  million or 215% to $8.0  million for the year ended  December  31, 1998
compared to $2.5 million for the year ended  December 31, 1997.  The increase is
attributable  to increased  staffing and costs related to enhancing the features
and functionality of CDNOW's on-line store and transaction-processing systems as
well as increased  investment in store content,  systems and  telecommunications
infrastructure.  As a percentage of net sales, operating and development expense
remained  relatively  constant  at 14.2% for the year ended  December  31,  1998
compared to 14.6% for the year ended December 31, 1997.

Sales and  Marketing  Expense.  Sales and marketing  expense  increased by $35.0
million to $44.6  million for the year ended  December 31, 1998 compared to $9.6
million for the year ended  December  31, 1997.  As a  percentage  of net sales,
sales and marketing  expense grew to 79.0% for the year ended  December 31, 1998
compared to 55.3% for the year ended  December  31,  1997.  The increase in both
absolute dollars and as a percentage of net sales was primarily  attributable to
increased  online and traditional  advertising,  including  CDNOW's  purchase of
advertising  during the 1998 Grammy  Awards and the 1998 MTV Video Music Awards,
and costs  associated  with its marketing  agreements and promotional and public
relations expenditures. CDNOW increased its advertising expense to $33.7 million
for the year ended  December  31,  1998,  compared to $6.8  million for the year
ended  December 31, 1997. In addition,  CDNOW  incurred  increased  staffing and
related costs in connection with the  implementation  of its marketing  strategy
and customer service activities necessary to support its increased customer base
and increased credit card processing fees related to the growth of revenues.

<PAGE> 20
General and Administrative Expense. General and administrative expense increased
by $2.3 million,  or 117% to $4.2 million for the year ended  December 31, 1998,
compared to $2.0 million for the year ended  December 31, 1997.  The increase in
general and administrative expense was primarily due to the hiring of additional
personnel and  increases in  professional  fees as well as the costs  associated
with  becoming a public  company.  As a  percentage  of net sales,  general  and
administrative  expense  decreased to 7.5% for the year ended December 31, 1998,
compared  to 11.2%  for the  year  ended  December  31,  1997,  as  general  and
administrative expenses were spread over a larger revenue base.

Amortization  of Goodwill and Other  Intangibles.  Amortization  of goodwill and
other intangibles of approximately $203,000 for the year ended December 31, 1998
relates to the May 1998 acquisition of superSonic Boom, Inc.

Net Loss  Applicable  to Common  Shareholders.  CDNOW's net loss  applicable  to
common  shareholders  was $43.9  million for the year ended  December  31, 1998,
compared to $11.2 million for the year ended December 31, 1997.

Liquidity and Capital Resources.

     At December 31, 1999,  CDNOW's cash and cash equivalents were $20.6 million
compared  to $49.0  million at  December  31,  1998.  In  February  1998,  CDNOW
consummated  its initial  public  offering by selling an  aggregate of 4,561,250
shares of common stock and raising net proceeds of approximately  $67.1 million.
In July 1998, CDNOW consummated a second public offering by selling an aggregate
of 1,250,000  shares of common  stock and raising net proceeds of  approximately
$21.5 million.  Prior to February 1998, CDNOW primarily  financed its operations
through  private  sales of capital  stock  (which,  through  December  31, 1997,
totaled  $10.5  million,  including  $9.3  million  raised in July and August of
1997),  the private  sale of $5.8  million of Series A Notes in  November  1997,
internally-generated cash flows, advances from related parties and certain other
short-term loans.

     Net cash used in operating  activities  of $51.8 million for the year ended
December 31, 1999 was primarily attributable to a net loss of $119.2 million, of
which $31.8 million was a non-cash charge for  depreciation and amortization and
$1.1  million was a non-cash  charge for  accelerated  option  vesting,  options
issued to non-employees,  and common stock issued to employees.  Additional uses
of cash  included a $1.7  million  increase  in  accounts  receivable  due to an
increase in fourth quarter  revenues  compared to 1998.  These uses of cash were
partially offset by a $7.7 million decrease in prepaid expenses and other assets
primarily  due to the  expense  of  prepaid  marketing  agreements,  a net $27.9
million  increase in accounts payable and accrued expenses due to an increase in
accrued merchandise costs and accrued advertising  expenses,  and a $1.8 million
increase in deferred revenue and deferred rent liability. The changes in working
capital  exclude  the  impact of the  acquisition  of the  assets  acquired  and
liabilities assumed as a result of the acquisition of N2K on March 17, 1999. Net
cash used in operating  activities of $40.4 million for the year ended  December
31,  1998 was  primarily  attributable  to a net loss of  $43.8  million  and an
increase of $3.7 million in prepaid expenses  partially offset by a $5.1 million
increase  in  accounts  payable  and  accrued  expenses,  and  depreciation  and
amortization of $2.1 million.

     Net cash  provided by investing  activities  was $23.9 million for the year
ended December 31, 1999,  which  consisted of $27.8 million in net cash acquired
from the  acquisition  of N2K,  partially  offset by purchases of equipment  and
leasehold  improvements of $3.9 million.  Net cash used in investing  activities
was $3.8  million  for the year  ended  December  31,  1998,  and  consisted  of
purchases of equipment and leasehold  improvements  of $4.4 million and $424,000
for the acquisition of  superSonicBoom,  Inc.,  partially  offset by the sale of
short-term investments of $1.0 million.

     Net cash used in  financing  activities  was  $526,000  for the year  ended
December 31,  1999.  During the year ended  December  31, 1999,  CDNOW made $1.3
million of payments under capital lease and term loan obligations  including the
payoff of the capital leases and loans assumed as a result of the acquisition of
N2K.  This use of cash was  partially  offset  by the  receipt  of  $819,000  of
proceeds  from  exercised  warrants and options.  Net cash provided by financing
activities was $82.6 million for the year ended December 31, 1998, and consisted
largely of net proceeds of approximately  $88.6 million from CDNOW's 1998 public
offerings,  offset by the  retirement of $5.8 million of the company's  Series A
Notes.

     As  of  December  31,  1999  CDNOW's  principal  commitments  consisted  of
obligations  under its marketing  agreements  and  obligations  associated  with
leased office space and capital financing arrangements. CDNOW is required to pay
aggregate minimum fixed fees under its marketing agreements of $10.9 million and
$2.8 million during the years ended December 31, 2000 and 2001, respectively.

     In connection with CDNOW's Merger and Contribution  Agreement with Sony and
Time  Warner on July 12,  1999,  to combine its  business  with that of Columbia
House,  it received a short-term  loan  commitment  from Sony and Time Warner to
provide  $30  million in working  capital  financing,  based on certain  working
capital  minimums,  drawable on or after  December 16, 1999.  On March 13, 2000,
Sony,  Time Warner and CDNOW  mutually  consented  to  terminate  the Merger and

<PAGE> 21
Contribution  Agreement  and entered  into a  Termination  Agreement.  Under the
Termination  Agreement,  Sony and Time  Warner  purchased  $21  million of CDNOW
common stock and converted the $30 million  short-term  loan commitment from the
Merger and Contribution Agreement,  into long-term convertible debt. As of March
16, 2000, CDNOW has made borrowings under the long-term  convertible debt of $20
million.  Following execution of the Termination Agreement, the company retained
Allen  &  Company  to  explore  strategic  options  and  alternative   financing
arrangements.  CDNOW  believes  that its current cash and cash  equivalents  are
sufficient to meet its payment  obligations  until  approximately  September 30,
2000.  CDNOW is  actively  seeking  third  party  financing  or  another  merger
transaction.  However,  CDNOW  cannot  assure that it will be able to obtain the
financing necessary to continue supporting its business.

Seasonality.

     CDNOW  expects  that  it  will  experience  seasonality  in  its  business,
reflecting  a  combination  of  seasonal  fluctuations  in  Internet  usage  and
traditional  retail  seasonality  patterns affecting sales of pre-recorded music
and other entertainment-related  products. Sales in the traditional retail music
industry are  significantly  higher in the fourth calendar quarter of each year,
which corresponds to the holiday season,  than in the preceding  three-quarters.
Additionally,  retail music sales are traditionally  hits-driven through popular
releases by well-known and emerging artists.  The presence or absence of hits in
any one quarter tends to affect music sales.

     To date,  CDNOW's  limited  operating  history  and  rapid  growth  make it
difficult to ascertain the effects of  seasonality  on its business,  especially
with regard to products  other than the sale of music CDs.  CDNOW  believes that
period-to-period  comparisons  of its  historical  results  are not  necessarily
meaningful and should not be relied upon as an indication of future results.

Factors  Affecting  CDNOW's Business and Prospects.  CDNOW expects to experience
significant  fluctuations  in its future  quarterly  operating  results due to a
variety of  factors,  many of which are outside its  control.  Factors  that may
affect CDNOW's quarterly  operating  results include:  (i) its ability to secure
alternative  financing  arrangements,   (ii)  its  ability  to  retain  existing
customers,  attract new customers and maintain customer satisfaction,  (iii) its
competitors, (iv) price competition or higher wholesale prices, (v) the level of
use of the Internet and consumer  acceptance of the Internet for the purchase of
CDNOW's products, (vi) seasonal fluctuations in sales of CDNOW's products, (vii)
its ability to maintain  its systems and  infrastructure  and attract  qualified
personnel,   (viii)   technical   difficulties,   system  downtime  or  Internet
performance  problems not  attributable to CDNOW,  (ix) the amount and timing of
operating costs relating to the maintenance of CDNOW's business,  operations and
infrastructure,  (x) the timing of CDNOW promotions and sales programs, (xi) the
level of merchandise returns  experienced by CDNOW, (xii) government  regulation
and (xiii) general economic  conditions and economic  conditions specific to the
Internet, the online sale of products and the entertainment industry.

Risks Associated with the Year 2000.

     The Year 2000 issue is the result of computer  programs being written using
two digits  rather  than four to define the  applicable  year.  In other  words,
date-sensitive  software may recognize a date using "00" as the year 1900 rather
than the year 2000.  CDNOW's computer systems and those of its key suppliers and
service   providers  may  fail,   which  could  result  in  system  failures  or
miscalculations  causing disruptions to operations,  including,  among others, a
temporary inability to process transactions,  create and send invoices or engage
in similar normal business activities,  which may adversely affect it. CDNOW has
developed  detailed plans for resolving problems related to the year 2000 issue.
To date, CDNOW has not experienced any Year 2000 problems in computer systems or
operations. However, latent Year 2000 problems could be experienced.

     CDNOW  actively  worked with and  encouraged  its suppliers to minimize the
risks of business  disruptions  resulting  from Year 2000  issues and  developed
contingency plans where necessary.

     CDNOW  estimates that, as of December 31, 1999, the cost of remediating its
internal  systems has been  approximately  $250,000.  These  efforts were funded
through normal working capital.

Recently  Issued  Accounting   Pronouncements.   See  Note  2  "Recently  Issued
Accounting Pronouncements" in the Consolidated Financial Statements.
<PAGE> 22

ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
         ---------------------------------------------------------

Foreign  Currency Risk.  CDNOW's revenues and expenses are denominated in United
States  dollars,  with the  exception of revenues  and  expenses  related to its
Japanese internet site. Therefore, the only current exposure to foreign currency
risk relates to  international  sales. For the years ended December 31, 1999 and
December 31, 1998,  international  sales accounted for approximately 19% and 21%
of net sales,  respectively.  To the extent that the value of the United  States
dollar  increases  relative  to foreign  currencies,  it may be more  costly for
international customers to make purchases.  Therefore, changes in exchange rates
may impact the amount of CDNOW's international sales.

Interest  Rate Risk.

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

     As of December 31, 1999, all of CDNOW's funds were cash equivalents. Due to
the average  maturity and  conservative  nature of its investment  portfolio,  a
sudden change in interest rates would not have a material effect on the value of
the  portfolio.  Management  estimates  that had the  average  yield of  CDNOW's
investments  decreased  by one percent,  its interest  income for the year ended
December 31, 1999 would have decreased by approximately  $350,000. This estimate
assumes  that the  decrease  occurred  on the first day of 1999 and  reduced the
yield of each investment instrument by one percent. The impact on CDNOW's future
interest income from future changes in investment  yields will depend largely on
the gross amount of its investments.  (See the "Liquidity and Capital Resources"
section of this report).

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     CDNOW's financial statements are filed under this Item 8, beginning on page
F-1 of this report.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
         AND FINANCIAL DISCLOSURE
         -----------------------------------------------------------
         None.


                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

CDNOW's executive officers and directors are as follows:
<TABLE>
<CAPTION>
Name                         Age   Position
----                         ---   --------
<S>                          <C>   <C>
Jason Olim.................  30    President and Chief Executive Officer
Jonathan V. Diamond .......  41    Chairman of the Board of Directors
Matthew Olim...............  30    Technical Lead and Director
Rod Parker (1).............  56    Senior Vice President of Product Management and Marketing
Joel Sussman...............  51    Vice President and Chief Financial Officer
Michael Krupit.............  36    Chief Operating Officer
Robert Saltzman............  48    Vice President of Corporate Sales and Development
David Capozzi..............  43    Vice President, General Counsel and Secretary
Steve Dong (4).............  41    Vice President of Operations
James E. Coane.............  59    Director
Patrick  Kerins (2) (3)....  44    Director
John Regan (2) (3).........  40    Director
</TABLE>

(1)      Mr. Parker resigned in July 1999.
(2)      Member of the Audit Committee of the Board of Directors.
(3)      Member of the Compensation Committee of the Board of Directors.
(4)      Mr. Dong resigned as of March 20, 2000.

     Jason Olim  co-founded  CDNOW in February 1994 and has been President since
inception and Chief Executive Officer since November 1997. Previously,  Mr. Olim
was employed in the  Professional  Services group of Soft-Switch,  Inc. where he
designed and built software  systems for routing mail and documents for domestic
and  international  clients.  Mr. Olim has a Bachelor of Arts degree in Computer
Science from Brown University.
<PAGE> 23

     Jonathon  V.  Diamond  has been  CDNOW's  Chairman  of the Board  since the
effective  date of the merger with N2K on March 17, 1999.  Mr. Diamond served as
Vice Chairman and a director of N2K from  February 1996 to March 17, 1999.  From
June 1995 to February  1996,  Mr. Diamond served as Co-Chairman of New York N2K.
Mr.  Diamond was an investor in and  director  of Telebase  Systems,  Inc.  from
September 1994 to February 1996. Mr. Diamond founded and was Chairman, from 1991
to 1995, of the J. Diamond Group, a holding  company which acquired and launched
six media and  entertainment  companies  in the U.S.  and the U.K.  From 1984 to
1990,  Mr.  Diamond  served as a director and Executive Vice President of GRP, a
jazz record  label,  where he was  responsible  for its business  and  financial
strategy.  Prior to his  association  with  GRP,  Mr.  Diamond  founded  Diamond
Investments,  which acquired or launched  companies in the media,  entertainment
and broadcasting areas. Mr. Diamond holds a B.A. in Economics and Music from the
Honors  College  of the  University  of  Michigan  and an M.B.A.  from  Columbia
University's Graduate School of Business.

     Matthew Olim co-founded CDNOW in February 1994 and has been responsible for
the development of CDNOW's system  architecture  and transactions  systems.  Mr.
Olim has a Bachelor of Arts degree in Astrophysics from Columbia University.

     Rod Parker was Senior Vice  President of Product  Management  and Marketing
from June 1997 through July 1999.

     Joel Sussman has been a Vice President and CDNOW's Chief Financial  Officer
since  September  1997.  From June 1995 to September  1997,  Mr.  Sussman was an
independent   financial  management  consultant  and  served  as  Interim  Chief
Financial  Officer of a number of companies,  including CDNOW. From July 1994 to
June 1995, Mr. Sussman was Vice President, Finance and Administration, and Chief
Financial Officer of Personnel Data Systems,  Inc. From January 1991 to December
1994, Mr. Sussman was Vice President of Finance and Chief  Financial  Officer of
The Devereux Foundation.  Prior to January 1991, Mr. Sussman served for 10 years
as Treasurer of Decision  Data,  Inc.  and six years in  commercial  banking and
leasing.  Mr. Sussman is a Certified Public Accountant and Certified  Management
Accountant  and  holds a  Masters  degree in  Business  Administration  from the
Wharton School of the University of Pennsylvania.

     Michael Krupit was CDNOW's Vice  President of Technology  from October 1997
through  January 31, 2000 and was the Director of Technology  from April 1997 to
October 1997. Mr. Krupit was promoted to Chief Operating  Officer on February 1,
2000.  Mr.  Krupit was the Director of  Technology  and Product  Development  at
Infonautics,  Inc., a provider of searching, viewing, and retrieval applications
for the  Internet,  from  February  1994  to  March  1997.  Mr.  Krupit  was the
Development  Manager  at Verity,  Inc.,  a provider  of online  information  and
archive services, from October 1989 to November 1993.

     Robert  Saltzman  has  been  the  Vice  President  of  Strategic   Business
Development since December 1997. Mr. Saltzman served as the Director of Business
Development at Bell Atlantic Network  Integration from November 1995 to December
1997. From 1987 to 1995, Mr. Saltzman held various sales and marketing positions
with Unisys Corporation.

     David  Capozzi has been a Vice  President  and General  Counsel since April
1998. From February 1996 to April 1998, Mr. Capozzi was an attorney with the law
firm of  Morgan,  Lewis & Bockius  LLP.  Mr.  Capozzi  also has over 14 years of
experience in varying  capacities in software design and development,  including
seven years with Marriott Corporation.  Mr. Capozzi holds a Juris Doctorate from
The  American  University,  Washington  College of Law,  a Masters  in  Business
Administration  from the Katz Graduate  School of Business of the  University of
Pittsburgh and a Bachelor of Science in Computer  Science from the University of
Pittsburgh.

     Steve Dong was Vice  President of Operations  from May 1998 until March 20,
2000.

     James E. Coane has been a member of CDNOW's  Board of  Directors  since the
effective  date of the merger with N2K on March 17,  1999.  Mr.  Coane served as
President,  Chief  Operating  Officer and a director of N2K from  February  1996
through March 17, 1999.  From April 1987 to February  1996,  Mr. Coane served as
President  and Chief  Executive  Officer of N2K and as  Chairman of the Board of
Directors from 1993 until February 1996.  From 1984 to 1987, Mr. Coane served as
President  and Chief  Operating  Officer of Morris  Decision  Systems,  Inc.,  a
marketer and supplier of microcomputers and related peripherals.  Mr. Coane is a
Phi Beta  Kappa  graduate  of Duke  University  with an A.B.  in  Economics  and
Business Administration.

     Patrick  Kerins has been a director  since  August  1997.  Mr.  Kerins is a
Managing Director of Grotech Capital Group IV, LLC. From 1987 to March 1997, Mr.
Kerins  served  in  the  Investment  Banking  Division  of  Alex.  Brown  & Sons
Incorporated, most recently as a Managing Director beginning in January 1994.

<PAGE> 24
     John Regan has been a director  since July 1997.  Since  February 1995, Mr.
Regan has been a Vice President of Keystone Venture IV Management Company,  L.P.
which is the general partner of Keystone  Venture IV, L.P. From 1989 to February
1995,  he  was  an  associate  and  then  general  partner  of  Apex  Management
Partnership, a venture capital partnership.

     CDNOW's  Amended and Restated  Bylaws  divide the Board of  Directors  into
three classes,  and each director will serve for a staggered three-year term. At
each  meeting  of  shareholders,  a class of  directors  will be  elected  for a
three-year  term to succeed the directors of the same class whose terms are then
expiring.  To date, CDNOW has not assigned its directors to specific classes. To
the  extent  there  is an  increase  in  the  number  of  directors,  additional
directorships resulting therefrom will be distributed among the three classes so
that,  as nearly as  possible,  each  class will  consist of an equal  number of
directors.

     CDNOW's  executive  officers  are elected by, and serve at the pleasure of,
the Board of Directors. Jason Olim and Matthew Olim are brothers.

ITEM 11. EXECUTIVE COMPENSATION

Director Compensation. CDNOW reimburses its directors for out-of-pocket expenses
incurred in  connection  with their  rendering of services as  directors.  CDNOW
currently  does not  intend  to pay cash fees to  directors  for  attendance  at
meetings.  Directors  who are not  currently  receiving  compensation  as  CDNOW
officers  or  employees  are  eligible to receive  options  under the CDNOW 1999
Equity  Compensation  Plan.  To date,  no such  options  have  been  granted  to
directors under either of these plans.

Compensation Committee Interlocks and Insider Participation.  Since August 1997,
recommendations  concerning the aggregate  compensation  of CDNOW employees were
made to the  Compensation  Committee  by  CDNOW's  President.  The  Compensation
Committee was formed in August 1997. The members of the  Compensation  Committee
are Patrick Kerins and John Regan.  Prior to August 1997,  decisions  concerning
the compensation of CDNOW employees, including its executive officers, were made
by the Board of Directors, which included Jason Olim and Matthew Olim.

Executive Compensation
<TABLE>
<CAPTION>
                                                                           Long Term
                                                                          Compensation
                                        Annual Compensation                  Awards
                              ---------------------------------------      Securities
                              Fiscal                     Other Annual      Underlying     All Other
Name and Principal Position    Year    Salary    Bonus   Compensation       Options      Compensation
---------------------------   ------  --------  -------  ------------     ------------  --------------
<S>                           <C>     <C>       <C>      <C>              <C>           <C>
Jason Olim                     1999   $193,077  $    --  $         --     $         --  $        2,822 (6)
  President and Chief          1998    147,858       --            --               --           2,286
  Executive Officer            1997     89,583       --            --               --           1,272
------------------------------------------------------------------------------------------------------
Jonathan Diamond
  Chairman of the Board        1999    200,384       --         6,720 (7)           --              --
  of Directors (1)
------------------------------------------------------------------------------------------------------
Rod Parker                     1999    153,859       --        12,574 (3)       10,000           1,154 (6)
  Senior Vice President (2)    1998    212,412   55,000        37,218               --           2,525
                               1997    130,730       --         3,879          120,000           1,335
------------------------------------------------------------------------------------------------------
Robert Saltzman                1999    152,489       --            --           60,000           1,333 (6)
  Vice President (4)           1998    147,998       --            --               --              --
                               1997     10,301       --            --           75,000              --
------------------------------------------------------------------------------------------------------
James Coane
  Director (5)                 1999    151,442       --        10,094 (7)           --           1,575 (6)
</TABLE>
(1)      Mr. Diamond became the Chairman of the Board of Directors on the N2K
         merger effective date on March 17, 1999.
(2)      Mr. Parker commenced employment with CDNOW in June 1997 and resigned
         in July 1999.  Mr. Parker has a one-year severance agreement, which
         expires in July 2000.
(3)      Other Annual Compensation for Mr. Parker includes reimbursement for an
         apartment in Pennsylvania and travel expenses.  Mr. Parker's residence
         is in Connecticut.
(4)      Mr. Saltzman commenced employment with CDNOW in December 1997.
(5)      Mr. Coane became a member of the CDNOW Board of Directors on the N2K
         merger effective date on March 17, 1999.
(6)      Represents CDNOW contribution to 401(k) Plan.
(7)      Represents automobile allowance.

     The following table sets forth information  regarding stock options held as
of December 31, 1999 by  executive  officers  named in the Summary  Compensation
Table.  The dollar values are based on closing sales price per share on December
31, 1999 as reported on the Nasdaq National Market.  The closing price per share
on that date was $9.88.
<PAGE> 25

                                            Fiscal Year-End Option Values
<TABLE>
<CAPTION>
                                                Number of Securities
                                               Underlying Unexercised      Value of Unexercised In-The-Money
                                             Options at December 31, 1999     Options at December 31, 1999
                    Shares        Value     ------------------------------  ---------------------------------
         Name      Exercised     Received    Exercisable    Unexercisable    Exercisable       Unexercisable
----------------  ----------- ------------  -------------  ---------------  --------------    ---------------
<S>               <C>         <C>           <C>            <C>              <C>               <C>
Jonathan Diamond           --           --        310,770           11,428   $   1,001,011     $       66,275
Rod Parker            120,000   $1,782,900          5,000            5,000              --                 --
Robert Saltzman            --           --         40,625          119,375              --                 --
James Coane             5,903   $   70,723        102,714               --   $     375,776                 --
</TABLE>

Equity Compensation Plans.

     CDNOW has adopted the 1996 Equity  Compensation  Plan (the "1996 Plan") and
the 1999 Equity  Compensation  Plan (the "1999  Plan")  (together  the  "Plans")
pursuant  to which it has  awarded  stock  options to its  employees,  officers,
non-employee  directors and certain  independent  contractors  and  consultants.
CDNOW ceased  granting  stock options  pursuant to the 1996 Plan as of March 17,
1999. Since that date, stock options and restricted stock have been granted only
pursuant to the 1999 Plan.

     The  1996  Plan  provides  for  the  issuance  to  employees,  non-employee
directors  and  eligible  independent  contractors  and  consultants  of  up  to
1,600,000  shares of common  stock  pursuant  to the  grant of  incentive  stock
options (ISOs),  non-qualified stock options (NQSOs),  Stock Appreciation Rights
(SARs)  and  restricted  stock.  The 1999  Plan  provides  for the  issuance  to
employees,  non-employee  directors  and eligible  independent  contractors  and
consultants  of up to 2,500,000  shares of common stock pursuant to the grant of
ISOs,   NQSOs,  and  restricted  stock.  Both  Plans  are  administered  by  the
Compensation  Committee of the Board of Directors,  which currently  consists of
Messrs.  Kerins  and  Regan.  Subject  to  the  provisions  of  the  Plans,  the
Compensation Committee has the authority to determine to whom stock options will
be  granted  and the terms of any such  grant,  including  the  number of shares
subject to, the exercise price and the vesting provisions of the award.  Subject
to the terms of the Plans, the  Compensation  Committee may also amend the terms
of any outstanding award. Effective upon the CDNOW/N2K merger on March 17, 1999,
CDNOW assumed the equity  compensation  plans formerly  administered by N2K (the
"N2K Plans").

     As of March 20, 2000,  options to purchase a total of  3,441,080  shares of
common stock were outstanding.  Of these options,  options to purchase 1,207,853
shares of common stock were fully vested and  exercisable  as of March 20, 2000.
As of March 20, 2000,  the company had an  additional  541,908  shares of common
stock available for future grants under the 1996 Plan and an additional  496,460
shares of common stock  available for future  grants under the 1999 Plan.  CDNOW
has made no grants  under any of the N2K Plans it assumed and will not be making
any grants in the future under the N2K Plans.

     The option  price per share of common  stock under the Equity  Compensation
Plans is  determined  by the  Compensation  Committee at the time of each grant,
provided,  however,  that the option price per share for any ISO may not be less
than the fair  market  value of the common  stock at the time of the  grant.  In
addition,  if a person who owns 10 percent  or more of CDNOW's  common  stock (a
"10% Shareholder") is granted an ISO, the exercise price for such ISO may not be
less than 110% of the fair market  value on the date of grant.  The term of each
stock  option may not exceed ten years;  in the case of a 10%  shareholder,  the
term may not exceed  five years.  Payment  for the  exercise of an option may be
made by cash or check.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth information regarding the beneficial ownership of
CDNOW common stock for the following persons or entities as of March 20, 2000:

-  Each person known to CDNOW to    -  The chief executive officer
   own beneficially more than 5%       and four other most highly
   of the outstanding shares of        compensated executive
   CDNOW common stock;                 officers of CDNOW; and

-  Each director of CDNOW;          -  All directors and executive
                                       officers of CDNOW as a group.

Unless  otherwise  indicated,  to CDNOW's  knowledge,  all persons and  entities
listed below have sole voting and investment  power with respect to their shares
of common stock, except to the extent authority is shared by spouses.
<PAGE> 26

<TABLE>
<CAPTION>
                                                                          Beneficial Ownership
                                                                          of CDNOW common stock
                                                         --------------------------------------------------------
                                                                         Options/
Name of Beneficial Owner                                   Shares        Warrants         Total         Percent
-----------------------------------------------          -----------    -----------    -----------    -----------
<S>                                                      <C>            <C>            <C>            <C>
Executive Officers and Directors
--------------------------------
Jason Olim                                                2,960,025             --      2,960,025          9.0%
Matthew Olim                                              2,960,025             --      2,960,025          9.0%
Jonathan V. Diamond                                         663,382        335,646        999,028          3.0%
James E. Coane                                               94,090         97,526        191,616           *
Patrick Kerins                                                1,000          1,569          2,569           *
John Regan (1)                                                1,819             --          1,819           *
Joel Sussman                                                    981         36,750         37,731           *
Steve Dong                                                      729         61,100         61,829           *
Michael Krupit                                               11,474         18,875         30,349           *
Robert Saltzman                                              33,508         50,937         84,445           *
All executive officers and directors as a
  group (11 persons)                                      6,725,214        633,440      7,358,654         22.4%

Five Percent Holders
--------------------
Carlos Slim Helu (2),
Grupo Sanborns, S.A. de C.V. (3),
Grupo Carso, S.A. de C.V. (4), collectively               2,000,000             --      2,000,000          6.1%
Time Warner Inc. (5) (7)                                  2,211,100             --      2,211,100          6.7%
Sony Music Entertainment Inc. (6) (7)                     2,211,100             --      2,211,100          6.7%
</TABLE>

*  Less than one percent.

(1)  Includes 1,819 shares held by Keystone Ventures IV, L.P., a partnership of
     which Mr. Regan is a Vice President of the general partner.
(2)  The address of Carlos Slim Helu is Paseo de las Palmas 736, Col. Lomas de
     Chapultepec, Mexico, D.F., 11000, Mexico.  Mr. Slim and members of his
     immediate family, directly and through their ownership of a majority of the
     voting and economic interests in a trust, own a majority of the outstanding
     voting equity securities of Grupo Carso.  Accordingly, Mr. Slim may be
     deemed to beneficially own 2,000,000 shares of common stock.
(3)  The address of Grupo Sanborns, S.A. de C.V., is Av. San Fernando No. 649,
     Col. Pena Pobre, Tlalpan, Mexico, D.F. 14060, Mexico.
(4)  The address of Grupo Carso, S.A. de C.V., is Insurgentes Sur No. 3500, Col.
     Pena Pobre, Tlalpan, Mexico, D.F. 14060, Mexico.  Grupo Carso is the parent
     of Grupo Sanborns and therefore beneficially owns 2,000,000 shares of CDNOW
     common stock.
(5)  The address of Time Warner Inc. is 75 Rockefeller Plaza, New York,
     New York 10019.
(6)  The address of Sony Music Entertainment, Inc. is 550 Madison Avenue,
     New York, New York 10022.
(7)  On March 15, 2000 and in connection with the termination of the merger
     agreement among CDNOW, Time Warner Inc., Sony Music Entertainment, Inc. and
     Columbia House, CDNOW issued 1,202,750 shares of common stock, no par
     value, to each of TWI CDNOW Holdings Inc., a wholly owned subsidiary of
     Time Warner, Inc., and Sony Music Entertainment Inc. in consideration of
     cash payments of $10.5 million each.  Additionally, each of Time Warner
     Inc. and Sony Music Entertainment Inc. have a right at any time to convert
     long-term debt in the amount of $10 million plus accrued interest of
     $83,500, as of March 20, 2000, to CDNOW's common stock, no par value, at a
     price of $10 per share.

Compliance  with Section 16(a) of the Securities  Exchange Act of 1934.  Section
16(a) of the Securities  Exchange Act of 1934 requires a company's directors and
executive  officers  and  persons  who  beneficially  own more  than 10% of that
company's  common stock to file  reports of  ownership  and changes in ownership
with the Securities and Exchange Commission. These directors, executive officers
and greater than 10%  stockholders  are required by regulation of the Securities
and Exchange  Commission  to furnish to the company  copies of all Section 16(a)
forms they file.  Initial  Statements of  Beneficial  Ownership of Securities on
Form 3 for the  following  directors  and  executive  officers of CDNOW were not
filed on a timely basis: Patrick Kerins,  Michael Krupit, Joel Sussman, David A.
Capozzi,  Matthew Olim, Rod Parker,  Steven Dong, Jason Olim, John Regan, Robert
Saltzman,  Robert  David  Grusin and James E.  Coane.  An Initial  Statement  of
Beneficial  Ownership  of  Securities  on Form 3 for Jonathan V. Diamond has not
been filed with the Securities and Exchange  Commission.  A Form 4 was not filed
on a timely basis for James E. Coane.

<PAGE> 27

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
           ----------------------------------------------

           None.

                                     PART IV
                                     -------

ITEM 14.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

Financial Statements and Financial Statement Schedules
------------------------------------------------------
  1. See Index to Financial Statements at page F-1.

     All other schedules have been omitted  because the required  information is
     included in the consolidated financial statements or the notes there to, or
     is not applicable or required.

Reports on Form 8-K
-------------------
  None

Exhibits
--------
  None

<PAGE> 28


                                   CDNOW, INC.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S>                                                                             <C>
Report of Independent Public Accountants                                        F - 1
Consolidated Balance Sheets                                                     F - 2
Consolidated Statements of Operations                                           F - 3
Consolidated Statements of Redeemable Convertible Preferred Stock
   and Shareholders' Equity (Deficit)                                           F - 4
Consolidated Statement of Cash Flows                                            F - 5
Notes to Consolidated Financial Statements                                      F - 6
</TABLE>

<PAGE> 29

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To CDnow, Inc.:

We have audited the accompanying  consolidated  balance sheets of CDnow, Inc. (a
Pennsylvania Corporation) and Subsudiaries as of December 31, 1999 and 1998, and
the  related  consolidated  statements  of  operations,  redeemable  convertible
preferred stock and  shareholders'  equity  (deficit) and cash flows for each of
the  three  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  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all  material   respects,   the  financial  position  of  CDnow,  Inc.  and  its
subsidiaries  as of  December  31,  1999  and  1998,  and the  results  of their
operations  and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with generally accepted accounting principles.

The  accompanying  financial  statements  have been  prepared  assuming that the
company  will  continue  as a  going  concern.  As  discussed  in  Note 1 to the
financial statements, the company has suffered recurring losses from operations,
has a working capital deficiency and significant payments due in 2000 related to
marketing agreements that raises substantial doubt about its ability to continue
as a going  concern.  Management's  plans in  regard to these  matters  are also
described in Note 1. The  financial  statements  do not include any  adjustments
that might result from the outcome of this uncertainty.

                                             /s/ Arthur Andersen LLP

Philadelphia, Pa.
January 28, 2000 (except with
  respect to matters discussed
  in Note 1, as to which the
  date is March 16, 2000)

                                      F-1
<PAGE> 30

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

                                                                          December, 31
                                                            --------------------------------------
                                ASSETS                            1999                  1998
                                ------                      -----------------    -----------------
CURRENT ASSETS:
<S>                                                         <C>                  <C>
  Cash and cash equivalents                                 $     20,612,706     $     49,041,370
  Accounts receivable, net                                         4,068,700              839,672
  Prepaid expenses and other                                       5,580,241            8,322,889
                                                            -----------------    -----------------
    Total current assets                                          30,261,647           58,203,931

  Property and equipment, net                                     17,216,980            6,643,995
  Goodwill and other intangibles, net                             70,121,321              833,735
  Other assets                                                     1,201,809            3,361,982
                                                            -----------------    -----------------
                                                            $    118,801,757     $     69,043,643
                                                            =================    =================

                 LIABILITIES AND STOCKHOLDERS' EQUITY
                 ------------------------------------
CURRENT LIABILITIES:
  Current portion of long term debt                         $      1,670,838     $        822,043
  Accounts payable                                                46,431,122           10,306,323
  Accrued merger costs                                             1,384,679                   --
  Accrued expenses and other current liabilities                  17,927,779            4,667,395
                                                            -----------------    -----------------
    Total current liabilities                                     67,414,418           15,795,761

  Long term debt                                                   2,629,359            1,750,892
  Common stock subject to put rights                               2,999,995                   --
  Deferred rent liabilities                                          992,696              358,053

COMMITMENTS AND CONTINGENCIES (Note 10)

STOCKHOLDERS' EQUITY:
  Preferred stock, no par value, 50,000,000 and 20,000,000
    shares authorized, no shares issued and outstanding                   --                   --
  Common stock, no par value, 200,000,000 and 50,000,000
    shares authorized, 30,355,948 and 17,842,975 issued
    and outstanding                                              204,573,908          102,137,536
  Additional paid-in capital                                      14,589,814            4,325,817
  Deferred compensation                                              (61,905)            (216,913)
  Accumulated deficit                                           (174,336,528)         (55,107,503)
                                                            -----------------    -----------------
    Total stockholders' equity                                    44,765,289           51,138,937
                                                            -----------------    -----------------
                                                            $    118,801,757     $     69,043,643
                                                            =================    =================
</TABLE>

The accompanying notes are an integral part of these statements.

                                      F-2
<PAGE> 31

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

                                                                                    December 31,
                                                                ------------------------------------------------------
                                                                     1999                1998               1997
                                                                ----------------   ----------------   ----------------
<S>                                                             <C>                <C>                <C>
Net Sales                                                       $   147,189,405    $    56,394,606    $    17,372,795
Cost of Sales                                                       118,037,621         45,250,328         13,847,773
                                                                ----------------   ----------------   ----------------
    Gross profit                                                     29,151,784         11,144,278          3,525,022

OPERATING EXPENSES:
  Operating and development                                          23,421,062          8,000,023          2,541,434
  Sales and marketing                                                89,734,790         44,572,304          9,607,603
  General and administrative                                         11,736,503          4,244,194          1,953,078
  Amortization of goodwill and other intangibles                     25,786,261            202,801                 --
                                                                ----------------   ----------------   ----------------
    Total operating expenses                                        150,678,616         57,019,322         14,102,115
                                                                ----------------   ----------------   ----------------
  Operating loss                                                   (121,526,832)       (45,875,044)       (10,577,093)

Interest and other Income                                             2,688,882          2,742,581            201,650
Interest expense                                                       (391,075)          (636,458)          (371,962)
                                                                ----------------   ----------------   ----------------
    NET LOSS                                                       (119,229,025)       (43,768,921)       (10,747,405)

Accretion of preferred stock to redemption value                             --           (115,542)          (410,103)
                                                                ----------------   ----------------   ----------------
Net loss applicable to common shareholders                      $  (119,229,025)   $   (43,884,463)   $   (11,157,508)
                                                                ================   ================   ================
Basic and diluted loss per common share:
  Net loss per common share                                     $         (4.32)   $         (2.79)   $         (1.42)
                                                                ================   ================   ================
Weighted average number of shares outstanding                        27,618,917         15,712,857          7,845,684
                                                                ================   ================   ================
</TABLE>

The accompanying notes are an integral part of these statements.

                                      F-3
<PAGE> 32

                          CDNOW, INC. AND SUBSIDIARIES
            CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND

                         SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
                                                                               Shareholders' Equity (Deficit)
                                                           -------------------------------------------------------------------------
                                                Redeemable
                                               Convertible      Common Stock      Additional
                                                Preferred  ----------------------   Paid-in    Deferred   Accumulated
                                                  Stock     Shares       Amount     Capital      Comp.      Deficit        Total
                                              ----------- ---------- ------------ ----------- ---------- ------------- -------------
<S>                                           <C>         <C>        <C>          <C>         <C>        <C>           <C>
BALANCE AT DECEMBER 31, 1996                  $        --  7,845,684 $    579,549 $        --  $      -- $     (65,532)$    514,017
 Sale of redeemable Series A and B
   convertible preferred stock, net of
   expenses and value of warrants issued        9,082,491         --           --     170,000         --            --      170,000
 Value of warrants issued with Series A
   convertible notes                                   --         --           --     404,425         --            --      404,425
 Grant of common stock option below deemed
   fair value for accounting purposes                  --         --           --     751,392   (751,392)           --           --
 Amortization of deferred compensation                 --         --           --          --    316,616            --      316,616
 Accretion of preferred stock to
   redemption value                               410,103         --           --          --         --      (410,103)    (410,103)
 Net loss                                              --         --           --          --         --   (10,747,405) (10,747,405)
                                              ----------- ---------- ------------ ----------- ---------- ------------- ------------
BALANCE AT DECEMBER 31, 1997                    9,492,594  7,845,684      579,549   1,325,817   (434,776)  (11,223,040)  (9,752,450)
 Accretion of preferred stock to
   redemption value                               115,542         --           --          --         --      (115,542)    (115,542)
 Mandatory conversion of redeemable Series
   convertible preferred stock to common       (9,608,136) 2,790,131    9,608,136          --         --            --    9,608,136
 Issuance of common stock from consummation
   of IPO, net of offering costs                       --  4,561,250   67,077,862          --         --            --   67,077,862
 Issuance of common stock from secondary
   offering, net of offering costs                     --  1,250,000   21,473,044          --         --            --   21,473,044
 Issuance of common stock                              --    222,952    3,634,198          --         --            --    3,634,198
 Cashless exercise of warrants                         --  1,039,674           --          --         --            --           --
 Exercise of warrants                                  --     32,727       59,890          --         --            --       59,890
 Exercise of options                                   --    100,557      224,896          --         --            --      224,896
 Remeasurement of value of shares issued to
   Lycos (Note 10)                                     --         --     (520,039)         --         --            --     (520,039)
 Amortization of deferred compensation                 --         --           --          --    217,863            --      217,863
 Issuance of warrants                                  --         --           --   3,000,000         --            --    3,000,000
 Net loss                                              --         --           --          --         --   (43,768,921) (43,768,921)
                                              ----------- ---------- ------------ ----------- ---------- ------------- ------------
BALANCE AT DECEMBER 31, 1998                           -- 17,842,975  102,137,536   4,325,817   (216,913)  (55,107,503)  51,138,937
 Equity issued in connection with the
   purchase of N2K                                     -- 12,159,249  101,833,713   9,281,189         --            --  111,114,902
 Employee compensation                                 --      6,397      102,335          --         --            --      102,335
 Exercise of warrants                                  --      2,521       30,000          --         --            --       30,000
 Exercise of options                                   --    344,806      788,925          --         --            --      788,925
 Compensation expense due to option
   acceleration                                        --         --           --     903,000         --            --      903,000
 Consulting expense related to options
   issued                                              --         --           --      79,808         --            --       79,808
 Remeasurement of value of shares issued to
   Lycos (Note 10)                                     --         --     (318,601)         --         --            --     (318,601)
 Amortization of deferred compensation                 --         --           --          --    155,008            --      155,008
 Net loss                                              --         --           --          --         --  (119,229,025)(119,229,025)
                                              ----------- ---------- ------------ ----------- ---------- ------------- ------------
BALANCE AT DECEMBER 31, 1999                  $        -- 30,355,948 $204,573,908 $14,589,814 $  (61,905)$(174,336,528)$ 44,765,289
                                              =========== ========== ============ =========== ========== ============= ============
</TABLE>

The accompanying notes are an integral part of these statements.
                                      F-4
<PAGE> 33


                          CDNOW, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>

                                                                              Year Ended December 31,
                                                              --------------------------------------------------------
                                                                    1999               1998                 1997
                                                              ----------------    ----------------    ----------------
<S>                                                           <C>                 <C>                 <C>
OPERATING ACTIVITIES:
  Net loss                                                    $  (119,229,025)    $   (43,768,921)    $   (10,747,405)
  Adjustments to reconcile net loss to net cash used in
  operating activities
    Depreciation and amortization                                  31,815,364           2,129,703           1,066,815
    Accelerated common stock option vesting                           903,000                  --                  --
    Common stock issued to employees                                  102,335                  --                  --
    Common stock options issued to non-employees                       79,808                  --                  --
  Increase (decrease) in operating assets and liabilities
    Accounts receivable                                            (1,726,926)           (510,181)           (193,974)
    Prepaid expenses and other                                      7,720,665          (3,676,843)         (2,401,794)
    Accounts payable                                               31,083,120           1,246,991           8,545,748
    Accrued expenses                                               (3,152,884)          3,896,255             472,455
    Deferred rent liability                                           634,643             301,336              56,717
                                                              ----------------    ----------------    ----------------
      Net cash used in operating activities                       (51,769,900)        (40,381,660)         (3,201,438)

INVESTING ACTIVITIES
  Net cash acquired in (used in) acquisition                       27,783,893            (423,694)                 --
  Purchases of property and equipment                              (3,916,706)         (4,407,477)           (912,560)
  Sales and maturities of short-term investments                           --           1,003,045             248,097
  Purchases of short-term investments                                      --                  --          (1,005,501)
                                                              ----------------    ----------------    ----------------
      Net cash provided by (used in) investing activities          23,867,187          (3,828,126)         (1,669,964)

FINANCING ACTIVITIES
  Payments on term loans payable                                      (67,470)            (54,194)            (28,179)
  Payments on capitalized lease obligations                        (1,277,406)           (438,843)            (64,043)
  Proceeds from options exercised                                     788,925             224,896                  --
  Proceeds from warrants exercised                                     30,000              59,890                  --
  Proceeds from issuance of common stock, net                              --          88,550,906                  --
  Proceeds from issuance (repayment) of Series A notes                     --          (5,777,500)          5,602,706
  Borrowings on term loans payable                                         --                  --             218,563
  Payments on notes payable                                                --                  --            (200,000)
  Proceeds from sales of preferred stock                                   --                  --           9,252,491
                                                              ----------------    ----------------    ----------------
      Net cash provided by (used in) financing activities            (525,951)         82,565,155          14,781,538
                                                              ----------------    ----------------    ----------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                  (28,428,664)         38,355,369           9,910,136
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                       49,041,370          10,686,001             775,865
                                                              ----------------    ----------------    ----------------
CASH AND CASH EQUIVALENTS, END OF YEAR                        $    20,612,706     $    49,041,370     $    10,686,001
                                                              ================    ================    ================

</TABLE>
The accompanying notes are an integral part of these statements.

                                      F-5
<PAGE> 34

                          CDNOW, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  THE COMPANY

     CDNOW is a leading  electronic  commerce  retailer of  pre-recorded  music,
including    compact    discs   (CDs)   and   digital    downloads   and   other
entertainment-related  products.  CDNOW's  revenues are derived from the sale of
pre-recorded music, other entertainment-related  products and advertising on the
cdnow.com site. CDNOW contracts with outside vendors for fulfillment services to
deliver its products to customers.

     On October 22, 1998, CDNOW and N2K Inc.  ("N2K"),  a Delaware  corporation,
entered into an Agreement and Plan of Merger.  CDNOW and N2K survived the merger
and became  wholly-owned  subsidiaries of CDnow/N2K,  Inc. At the closing of the
merger on March 17, 1999,  each  outstanding  share of common stock of CDNOW was
converted into one share of CDNOW/N2K and each outstanding share of common stock
of N2K was converted into .83 shares of CDNOW/N2K. As a result, the shareholders
of CDNOW owned approximately 60% of the combined company and the stockholders of
N2K owned approximately 40% of the combined company as of March 17, 1999. Also
on that date, CDnow/N2K was renamed CDNOW, Inc.

     On July 12, 1999,  CDNOW  entered into an Agreement of Merger  Contribution
with Sony  Corporation of America  ("Sony") and Time Warner Inc. ("Time Warner")
to combine its business with that of Columbia  House,  which is owned equally by
Sony and Time Warner.  On March 13, 2000,  Sony,  Time Warner and CDNOW mutually
consented to terminate the Merger and Contribution  Agreement and entered into a
Termination  Agreement.  Under the Termination  Agreement,  Sony and Time Warner
purchased $21 million of CDNOW's common stock (2,405,500  shares), no par value,
on March 16, 2000, and replaced a $30 million  short-term  loan  commitment with
$30 million of long-term convertible debt, which is convertible at the option of
the holder into CDNOW  common  stock at $10 per share (see Note 7).  Sony,  Time
Warner,  Columbia House and CDNOW also agreed to explore the  possibilities of a
number  of  strategic  relationships.  Following  execution  of the  Termination
Agreement, the company retained Allen & Company to explore strategic options and
alternative  financing  arrangements.  CDNOW  believes that its current cash and
cash  equivalents  are  sufficient  to  meet  its  payment   obligations   until
approximately  September  30,  2000.  CDNOW  is  actively  seeking  third  party
financing or another merger transaction.  However,  CDNOW can not assure that it
will be able to obtain  the  financing  necessary  to  continue  supporting  its
business. On March 14, 2000 CDNOW filed a report on Form 8-K with the Securities
and Exchange  Commission  concerning the termination of the proposed merger with
Columbia House.

     Since inception (February 12, 1994), CDNOW has incurred significant losses,
and as of December 31, 1999 had accumulated  losses of $174.3  million.  For the
years ended December 31, 1999, 1998 and 1997,  CDNOW's net losses  applicable to
common  shareholders  were $119.2  million,  $43.9  million  and $11.2  million,
respectively.  In addition, CDNOW has a working capital deficit of $37.2 million
as of December 31, 1999.  CDNOW  believes it will continue to incur  substantial
operating  losses for the foreseeable  future.  Because CDNOW has relatively low
product  gross  margins,  achieving  profitability  depends  upon its ability to
generate and sustain  substantially  increased revenue and gross margins.  There
can be no assurance that CDNOW will be able to generate  sufficient  revenues or
gross margins to achieve or sustain  profitability  in the future.  In addition,
CDNOW has significant payments due in 2000 related to marketing agreements.

     CDNOW is currently  financing  its working  capital needs with cash derived
from revenues,  funds from the equity investment of $21 million by Sony and Time
Warner and the long-term  convertible debt facility available from Sony and Time
Warner (see Note 7).  CDNOW is  actively  engaged in  pursuing  other  financing
arrangements.  However,  CDNOW can not assure that it will be able to obtain the
financing necessary to continue to support its business.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

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

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

                                      F-6
<PAGE> 35
Net Loss Per Common Share.

     CDNOW has  presented  net loss per common share amounts for the years ended
December 31, 1999,  1998 and 1997 pursuant to Statement of Financial  Accounting
Standards  ("SFAS") No. 128 "Earnings Per Share" and the Securities and Exchange
Commission Staff Accounting Bulletin No. 98.

     Basic and diluted  loss per common  share was computed by dividing net loss
applicable to common  shareholders  by the weighted  average number of shares of
common  stock  outstanding.  Diluted  loss per share is the same amount as basic
earnings per share because the impact on loss per share using the treasury stock
method is anti-dilutive due to CDNOW's losses.

Cash and Cash  Equivalents.  Cash  equivalents  are carried at cost plus accrued
interest,  which  approximates  fair value.  CDNOW  considers  all highly liquid
investments  with an original  maturity  date of three months or less to be cash
equivalents.  CDNOW's cash and cash equivalents were $20,612,706 and $49,041,370
at December 31, 1999 and 1998, respectively, and primarily included money market
funds.

Short-Term  Investments.  At December 31, 1999 and 1998, CDNOW had no short-term
investments.  The  gross  proceeds  from  sales  and  maturities  of  short-term
investments  were  $1,003,045  and $248,097  during the years ended December 31,
1998  and  1997,   respectively.   These  short-term  investments  consisted  of
government  mortgage-backed  bonds with a maturity date of less than a year. For
the purpose of  determining  gross  realized  gains and losses,  the cost of the
securities sold was based upon specific identification.

Prepaid  Expenses.

     CDNOW  follows the  American  Institute  of  Certified  Public  Accountants
(AICPA)  Statement of Position  93-7  "Reporting  for  Advertising  Costs" ("SOP
93-7") to account for its marketing agreements.  Under SOP 93-7, CDNOW amortizes
the costs associated with its marketing agreements over the contract terms, with
the amortization  method primarily based on the rate of delivery of a guaranteed
number of  impressions  to be received  during the contract  term. To the extent
additional   payments  are  required  to  be  made  based  on  factors  such  as
click-throughs and new customers generated, such payments are charged to expense
as incurred.  CDNOW  evaluates  the  realizability  of assets  recorded,  and if
necessary, writes down the assets to its net realizable value.

     Prepaid expenses include $3,888,309 and $7,278,116 at December 31, 1999 and
1998, respectively,  related to marketing agreements (see Note 10). Other assets
include the long-term portion of marketing agreements of $803,791 and $2,208,036
at December 31, 1999 and 1998, respectively.

Property and Equipment.  Property and equipment are stated at cost. Depreciation
and amortization are provided using the straight-line  method over the estimated
useful lives of the assets or the lease term, whichever is shorter.

Internally  Developed  Systems  and  Software.  CDNOW has adopted  Statement  of
Position  98-1  "Accounting  for the Costs of  Computer  Software  Developed  or
Obtained for Internal  Use" ("SOP 98-1"),  effective for fiscal years  beginning
after December 15, 1998.  Accordingly,  the costs of computer software developed
or obtained  for  internal  use have been  capitalized  and  amortized  over the
estimated  useful life of three years.  At December 31,  1999,  net  capitalized
computer software developed or obtained for internal use was $1,391,961.

Common Stock  Subject to Put Rights.  America  Online,  Inc.  ("AOL") and N2K, a
predecessor-in-interest   to  and,  as  of  the  merger  of  CDNOW  and  N2K,  a
wholly-owned  subsidiary of CDNOW,  entered into an agreement  pursuant to which
AOL agreed to  purchase  at N2K's  initial  public  offering  price per share of
$19.00 (less  underwriting  discounts and  commissions)  an aggregate  amount of
approximately  $3.0  million or 169,779  shares of N2K's  common stock (the "AOL
Purchase").  Subsequent to the Merger,  the price per share  converted to $22.89
and the number of shares  converted to 140,916 shares of CDNOW common stock. N2K
granted  AOL certain  shelf and other  registration  rights with  respect to the
shares  purchased by AOL,  including  the right to require N2K to register  such
shares for resale, to have such registration  statement declared effective on or
before April 16, 1998 and to maintain  the  effectiveness  of such  registration
statement for a period of two years from the  consummation  of the AOL Purchase.
As N2K had not caused such  registration  statement to be declared  effective by
April 16, 1998, AOL has the right to require CDNOW,  as a  successor-in-interest
to N2K,  to  repurchase  such shares for cash at a price equal to the greater of
the original purchase price or the then-current fair market value.  Accordingly,
the value of these shares is not included in stockholders' equity.  Presently,
                                      F-7
<PAGE> 36
these shares have not been  registered  and AOL has not exercised its put right.
The common stock subject to put rights on CDNOW's  consolidated  balance  sheets
will be accreted to its fair market value based upon the price of CDNOW's common
stock at each reporting date. The fair market value will be recorded as a charge
to retained  earnings at each reporting date and will reduce earnings  available
to common  shareholders.  The fair market  value of CDNOW's  common  stock as of
December 31, 1999 was $9.88 per common share. As of December 31, 1999, there was
no charge as the  market  value of  CDNOW's  common  stock was below  $22.89 per
common share.

Revenue  Recognition.

     Net  sales,  which  consist  primarily  of  pre-recorded  music  and  other
entertainment-related  products  sold via the  Internet,  include  shipping  and
handling charged to customers,  and are recognized net of promotional  discounts
when the products are shipped.  CDNOW records a reserve for  estimated  returns,
which is based on  historical  return  rates.  Revenue from the sale of cash and
barter  advertising  on the cdnow.com  site is recognized as the  advertising is
run.

     CDNOW  includes the amount of coupons  redeemed to purchase  merchandise in
net sales.  For the years ended  December  31,  1999,  1998 and 1997,  the total
amount of redeemed coupons included in net sales was approximately $7.2 million,
$1.8 million, and $0,  respectively.  CDNOW also includes the revenue associated
with barter  advertising  transactions in net sales.  The total amount of barter
revenue included in net sales was approximately $1.9 million,  $753,000,  and $0
for the years ended December 31, 1999, 1998 and 1997, respectively.

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

Sales and Marketing.  Sales and marketing  expense includes  expenses related to
marketing agreements, advertising and promotions, as well as payroll and related
expenses  for  personnel  engaged in  marketing,  selling and  customer  service
activities  and credit  card  processing  fees.  The  expenses  associated  with
redeemed coupons and barter  advertising  revenue are also included in sales and
marketing expense. Advertising costs are included in sales and marketing expense
and are charged as incurred.  Advertising costs were  $56,985,536,  $33,703,301,
and  $6,834,000,  for  the  years  ended  December  31,  1999,  1998  and  1997,
respectively.  CDNOW pays commissions in the form of merchandise  credit or cash
to the members of its Cosmic Credit and C2 affiliate programs.  Expenses related
to these programs are included in sales and marketing expenses.  CDNOW estimates
the amount of unused credits and includes this amount in accrued expenses.

Gift Certificates. Unredeemed gift certificates are recorded as deferred revenue
and  included  in accrued  expenses in the  accompanying  balance  sheets.  Gift
certificates are recognized in net sales when they are redeemed.

Supplemental  Cash Flow Information.  CDNOW paid interest of $391,075,  $636,458
and  $284,565  for  the  years  ended   December  31,  1999,   1998,  and  1997,
respectively.  CDNOW acquired fixed assets under capital lease  arrangements  in
the  amount of  $2,763,916,  $1,742,266,  and  $1,070,290  for the  years  ended
December 31, 1999, 1998 and 1997, respectively.

The following table displays the net non-cash assets that were consolidated as a
result of CDNOW's acquisition of N2K (see Note 4):

<TABLE>
<CAPTION>
  Non-cash assets (liabilities):
    <S>                                                       <C>
    Accounts receivable                                       $     1,502,102
    Prepaid expenses and other                                      6,441,601
    Property and equipment                                          9,766,458
    Goodwill and other intangibles                                 91,768,692
    Term loans and capital lease obligations                         (308,223)
    Accounts payable                                               (5,041,679)
    Accrued expenses                                              (17,797,947)
    Common stock subject to put rights                             (2,999,995)
    Fair market value of options and warrants assumed              (9,281,189)
                                                              ----------------
      Net non-cash assets acquired                                 74,049,820
    Cash acquired                                                  27,783,893
                                                              ----------------
    Common stock issued                                       $   101,833,713
                                                              ================
</TABLE>
                                      F-8
<PAGE> 37

Comprehensive  Income.  In June 1997,  the FASB issued SFAS No. 130,  "Reporting
Comprehensive  Income"  ("SFAS  130").  This  statement  requires  companies  to
classify  items of other  comprehensive  income by their  nature in a  financial
statement  and display the  accumulated  balance of other  comprehensive  income
separately from retained  earnings and additional  paid-in capital in the equity
section  of a  statement  of  financial  position.  SFAS  130 is  effective  for
financial  statements issued for fiscal years beginning after December 15, 1997.
CDNOW  adopted  SFAS 130 in the first  quarter  of 1998.  CDNOW has had no other
comprehensive income items to report.

Segment and Geographic Information.  In June 1997, the FASB issued SFAS No. 131,
"Disclosure  About  Segments of an Enterprise  and Related  Information"  ("SFAS
131"). This statement establishes  additional standards for segment reporting in
the  financial  statements  and is effective  for fiscal years  beginning  after
December 15, 1997.  CDNOW  operates in one  principal  business  segment  across
domestic and international  markets. CDNOW derived 19%, 21%, and 29% of revenues
for the years ended  December  31,  1999,  1998,  and 1997,  respectively,  from
customers  outside the United States.  No foreign country or foreign  geographic
area  accounted for more than 10% of net sales in any of the periods  presented.
Substantially all of the domestic operating results and identifiable  assets are
in the United States.

Public  Offerings.  On February  13, 1998 CDNOW  consummated  an initial  public
offering  of its  Common  Stock  (the  "Initial  Public  Offering")  by  selling
4,561,250  shares of its common  stock,  no par value,  at an offering  price of
$16.00 per share. After deducting the underwriters'  discount and other offering
expenses, the net proceeds to CDNOW were $67,077,862.

On July 28, 1998 CDNOW  consummated  a secondary  public  offering of its Common
Stock  (the  "Secondary  Offering")  by selling  1,250,000  shares of its common
stock,  no par  value,  at a price of $18.50  per  share.  After  deducting  the
underwriters'  discount and other offering  expenses,  the net proceeds to CDNOW
were $21,473,044.

New  Accounting  Pronouncements.  In June 1998,  the FASB issued SFAS No.  133,"
Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). This
Statement   establishes   accounting  and  reporting  standards  for  derivative
instruments, including certain derivative instruments embedded in other contacts
and for hedging activities and is effective for all fiscal years beginning after
June 15, 2000.  Management  believes  that the adoption of SFAS 133 will have no
impact on its operating results or financial position.

     In December  1999,  the  Securities  and Exchange  Commission  issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
101").  SAB 101  summarizes  certain of the Staff's views in applying  generally
accepted  accounting  principles to recognition,  presentation and disclosure of
revenue in financial  statements.  Compliance  with SAB 101 is required no later
than the first quarter of the fiscal years  beginning  after  December 15, 1999.
Management  believes  that  SAB 101  will  not  have a  material  impact  on the
company's operating results or financial position.

3.  RISKS AND UNCERTAINTIES

     CDNOW's  future  results  of  operations  involve  a number  of  risks  and
uncertainties. Factors that may affect CDNOW's future operating results include:
(i) its ability to retain existing customers, attract new customers and maintain
customer  satisfaction,  (ii) the  introduction  of new or  enhanced  Web pages,
services, products and marketing agreements by CDNOW and its competitors,  (iii)
price  competition  or  higher  wholesale  prices,  (iv) the level of use of the
Internet  and  consumer  acceptance  of the Internet for the purchase of CDNOW's
products,  (v)  seasonal  fluctuations  in sales of CDNOW's  products,  (vi) its
ability to upgrade  and  develop  its  systems  and  infrastructure  and attract
qualified personnel,  (vii) technical difficulties,  system downtime or Internet
performance  problems not attributable to CDNOW, (viii) the amount and timing of
operating  costs and  capital  expenditures  relating  to  expansion  of CDNOW's
business, operations and infrastructure, (ix) the timing of promotions and sales
programs,  (x) the level of merchandise  returns  experienced,  (xi)  government
regulation  and  (xii)  general  economic  conditions  and  economic  conditions
specific to the  Internet,  the online sale of  products  and the  entertainment
industry.

Sufficient  Cash to Fund Its Business.  CDNOW believes that its current cash and
cash  equivalents  are  sufficient  to  meet  its  payment   obligations   until
approximately  September  30,  2000.  CDNOW  is  actively  seeking  third  party
financing or another merger  transaction.  However,  CDNOW cannot assure that it
will be able to obtain  the  financing  necessary  to  continue  supporting  its
business.
                                      F-9
<PAGE> 38
Dependence on Suppliers

     CDNOW's primary provider of order  fulfillment for recorded music titles is
Valley Media, Inc. ("Valley"). CDNOW has no fulfillment operation or facility of
its  own  and,   accordingly,   is  dependent  upon   maintaining  its  existing
relationship  with Valley or  establishing a new fulfillment  relationship  with
another fulfillment operation. During the fourth quarter of 1999, CDNOW signed a
two year contract extension with Valley. However, there can be no assurance that
the relationship with Valley will be maintained beyond the term of this contract
extension,  which expires in October 2001, or that CDNOW will be able to find an
alternative,  comparable  vendor  capable of providing  fulfillment  services on
terms  satisfactory  to CDNOW  should its  relationship  with Valley  terminate.
Valley  accounted for 85%, 85%, and 81% of the cost of sales for the years ended
December 31, 1999, 1998 and 1997,  respectively.  No other vendor  accounted for
more than 10% of the total cost of sales during 1999, 1998 or 1997.

4.  ACQUISITIONS

     On March 17, 1999, CDNOW completed its merger with N2K by acquiring 100% of
N2K's  capital  stock for  12,159,249  shares of CDNOW  common  stock  valued at
approximately  $101,834,000.  CDNOW  was the  acquiring  entity  for  accounting
purposes.  The  acquisition  has been accounted for under the purchase method of
accounting,  whereby  the  purchase  price  has  been  allocated  to the  assets
purchased and the  liabilities  assumed based on their fair market values at the
date of  acquisition.  The  excess of the  purchase  price  over the net  assets
acquired was recorded as goodwill and other  intangibles.  The  following  table
indicates  the current  allocation  of excess  purchase  price and  amortization
periods of goodwill and other intangibles related to the acquisition of N2K:
<TABLE>
<CAPTION>
Intangible Assets                           Assigned Value        Amortization Period
-------------------------------------     -------------------    ----------------------
<S>                                       <C>                    <C>
Web site technology                       $         4,000,000            2 years
Strategic alliances/customers                      19,000,000            3 years
Assembled workforce                                 2,200,000            3 years
Goodwill                                           66,568,692            3 years
                                          -------------------
Total goodwill and other intangibles              $91,768,692
                                          ===================
</TABLE>
     CDNOW also recorded $3.3 million in deferred  acquisition  costs related to
the  acquisition of N2K, which is being  amortized over 3 years.  The balance of
accrued merger costs relating to the acquisition of N2K was  approximately  $1.4
million as of December 31, 1999 and primarily includes  severance-related  costs
and professional fees. Amortization of goodwill and other intangibles related to
the acquisition of N2K and superSonic Boom, Inc. was approximately $25.8 million
for the year  ended  December  31,  1999.  Amortization  of  goodwill  and other
intangibles  was $202,801 for the year ended  December 31, 1998 and only related
to the  acquisition  of superSonic  Boom,  Inc.  CDNOW  recorded $1.0 million of
goodwill  related to the May 1998 acquisition of superSonic Boom, Inc., which is
being amortized over 3 years.

     N2K's   results  of   operations   have  been  included  in  the  company's
consolidated financial statements since the effective date of the acquisition on
March 17, 1999. The following  table  summarizes the unaudited pro forma results
of  operations  of CDNOW as if the N2K  acquisition  had  occurred on January 1,
1998. The pro forma information does not purport to be indicative of the results
that would have been attained had the operations  actually been combined  during
the period presented.
<TABLE>
<CAPTION>
                               Year Ended December 31,
                           --------------------------------
                                1999             1998
                           ---------------  ---------------
<S>                        <C>              <C>
Net revenue                $  160,673,784   $   98,474,743
Net loss                   $ (138,366,738)  $ (120,765,396)
Loss per common share      $        (4.59)  $        (4.33)
</TABLE>

5.  PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
                                                                                    December 31,
                                                            Useful Life/   ---------------------------------
                                                             Lease Term         1999             1998
                                                           --------------- ---------------  ---------------
<S>                                                        <C>             <C>              <C>
Computers, software and equipment                              3 years     $   19,075,430   $    6,910,547
Office furniture and equipment and leasehold improvements      5 years          6,064,382        1,782,185
                                                                           ---------------  ---------------
                                                                               25,139,812        8,692,732
Less - accumulated depreciation and amortization                               (7,922,832)      (2,048,737)
                                                                           ---------------  ---------------
                                                                           $   17,216,980   $    6,643,995
                                                                           ===============  ===============
</TABLE>
                                      F-10
<PAGE> 39
     Depreciation  and  amortization  expense for the years ended  December  31,
1999, 1998 and 1997 was $5,874,095, $1,506,828 and $460,589, respectively. Total
property and equipment  under  capital  leases at December 31, 1999 and 1998 was
$5,850,621  and  $2,959,396,  less  accumulated  amortization  of $2,506,510 and
$949,076, respectively.

6.  INCOME TAXES

     Deferred  tax  assets and  liabilities  are  recognized  for the future tax
consequences   attributable  to  differences  between  the  financial  statement
carrying  amounts of existing assets and  liabilities  and their  respective tax
bases.  Deferred tax assets and liabilities are measured using enacted tax rates
expected  to apply to  taxable  income  in the  years in which  those  temporary
differences are expected to be recovered or settled.  The effect on deferred tax
assets and  liabilities  of a change in tax rates is recognized in income in the
period that includes the enactment date.

     From inception  (February 12, 1994) until April 25, 1995, CDNOW operated as
an unincorporated  entity. From April 25, 1995 until December 5, 1996, CDNOW was
incorporated  and elected to be taxed under Subchapter S of the Internal Revenue
Code. As a result,  CDNOW was not subject to federal or state income taxes,  and
the taxable loss of the company was included in the shareholders' individual tax
returns.  On December 6, 1996,  CDNOW  terminated its status as an S corporation
and is now subject to federal and state income taxes.

     Due to CDNOW's  acquisition  of 100% of the capital  stock of N2K (see Note
4),  there was a change in  ownership  as defined by Section 382 of the Internal
Revenue Code (the "Section 382  Limitation").  The Section 382 Limitation limits
CDNOW's ability to utilize N2K's net operating loss carryforwards  created prior
to the  ownership  change.  CDNOW  is  currently  analyzing  the  amount  of the
limitation.  CDNOW  estimates that the maximum net operating loss  carryforwards
available to offset future taxable income,  including those generated by N2K, is
approximately $258 million at December 31, 1999.

     The approximate income tax effect of each type of temporary  difference and
the loss carryforward is as follows:

<TABLE>
<CAPTION>
                                                              December 31,
                                                      ----------------------------
                                                          1999           1998
                                                      -------------  -------------
<S>                                                   <C>            <C>
Accruals and reserves not currently deductible        $  3,703,465   $    409,407
Benefit of net operating loss carryforward              87,590,511     18,126,168
Development expenses not currently deductible            2,933,895        124,493
Deferred revenues                                          594,331        420,144
Other                                                   (2,030,355)      (315,425)
                                                      -------------  -------------
                                                        92,791,847     18,764,787
                                                       (92,791,847)   (18,764,787)
                                                      -------------  -------------
Valuation allowance                                   $         --   $         --
                                                      =============  =============
</TABLE>
     Due to CDNOW's history of operating  losses the realization of the deferred
tax  asset  is  uncertain.  CDNOW  has,  therefore,  provided  a full  valuation
allowance against the deferred tax asset.

7.  DEBT

     In 1997,  CDNOW  obtained  three term loans from a bank for an aggregate of
$218,563.  The  proceeds  from the loans were used to  purchase  equipment.  The
equipment  purchased  collateralizes the loans.  CDNOW's two founders personally
guaranteed the loans. In 1999, CDNOW elected to prepay the balance on one of the
loans.  The  remaining two loans bear interest at rates of 8.0% and 8.5% and are
repayable in installments over 36 and 48 months, respectively.  On the remaining
two loans, annual principal repayments are $41,855 in 2000, and $26,866 in 2001.

     In November  1997,  CDNOW sold  $5,777,500  of Series A  Convertible  Notes
(Series A Notes) to  certain  investors,  including  $1,000,000  to an  existing
shareholder.  The notes bore interest at an annual rate of 12% and were due upon
consummation of the Initial Public Offering.  In connection with the sale of the
Series A Notes,  CDNOW issued warrants to these investors.  The warrants allowed
the investors to purchase  48,550 shares of common stock at an exercise price of
$11.90 to $16.00 per share.  The warrants  were valued  using the  Black-Scholes
model,  and the  Series A Notes  were  recorded  net of the  value  of  $404,425
assigned to the  warrants.  The notes were  amortized  to their face amount over
their estimated term, with $202,213 of amortization included in interest expense
for the year ended December 31, 1997 and $202,212 in the year ended December 31,
1998. The notes were repaid in February 1998. Amortization of deferred financing
costs,  related  to the  Series A  Notes,  was  $87,397  in 1998 and 1997 and is
included in interest expense.

                                      F-11
<PAGE> 40
     From November 16, 1996 through January 31, 1997, CDNOW received  short-term
loans of $250,000  from certain  unrelated  investors.  The  investors  received
warrants as part of the  consideration  for the loans (see Note 8).  These loans
bore  interest at 6% per year.  On May 15, 1997,  CDNOW  repaid  $110,000 of the
loans and, on July 16, 1997, the remaining  unpaid balance plus accrued interest
was paid.

     In connection with CDNOW's Merger and Contribution  Agreement with Sony and
Time  Warner on July 12,  1999,  to combine its  business  with that of Columbia
House,  CDNOW received a short-term loan commitment from Sony and Time Warner to
provide  it with $30  million  in working  capital  financing,  based on certain
working capital  minimums,  drawable on or after December 16, 1999. On March 13,
2000,  Sony,  Time Warner and CDNOW  mutually  consented to terminate the Merger
Contribution  Agreement  and entered  into a  Termination  Agreement.  Under the
Termination  Agreement,  Sony and Time  Warner  purchased  $21  million of CDNOW
common  stock,  no par value,  and  converted  the $30 million  short-term  loan
commitment  from  the  Merger  and   Contribution   Agreement,   into  long-term
convertible debt. Borrowings under the convertible loan bear interest at the six
month London  interbank  offered rate in effect two days prior to the  borrowing
plus 3%.  Principal and interest on the borrowings are due no later than January
15,  2003.  Sony and Time  Warner  may at any time  convert  any  portion of the
borrowings  and accrued  interest under the  convertible  loan into CDNOW common
stock at a $10  conversion  price.  As of December 31, 1999, no borrowings  were
made under the convertible loan. As of March 16, 2000, CDNOW has made borrowings
of $20 million.

8.  REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY

Preferred Stock.

     As of December 31, 1997,  CDNOW had  20,000,000  shares of preferred  stock
authorized,  254,582 of which was  designated,  issued and outstanding as no par
value  Redeemable  Series  A  Convertible  Preferred  Stock  and  1,605,505  was
designated,  issued  and  outstanding  as  no  par  value  Redeemable  Series  B
Convertible  Preferred  Stock. The Series A Preferred was sold to an investor in
July 1997 for $4.91 per share, resulting in proceeds to CDNOW of $1,152,186, net
of  expenses.  The Series B Preferred  was sold to  investors in August 1997 for
$5.45 per share, resulting in proceeds to CDNOW of $8,100,305, net of expenses.

     Each share of Series A and B Preferred was  converted  into shares of CDNOW
common stock,  no par value,  upon the  consummation  of CDNOW's  Initial Public
Offering in February 1998, on a 1.5-for-1 basis.

     The Series A and B Preferred were being accreted to their redemption values
for accounting  purposes.  The holders of Series A and B Preferred were entitled
to receive  cumulative  dividends of 8% per share per year, when and if declared
by CDNOW.

Common Stock Options.

     On June 1, 1996, CDNOW adopted the CDNOW 1996 Equity Compensation Plan (the
"1996 Plan").  Under the 1996 Plan,  incentive and  nonqualified  stock options,
restricted and stock appreciation rights may be granted to employees,  officers,
employee directors and independent contractors and consultants.  An aggregate of
1,600,000  shares of common stock have been reserved for issuance under the 1996
Plan.  All grants  made prior to the  CDNOW/N2K  merger were made under the 1996
Plan.  As of December 31, 1999,  1,256,805  options were granted  under the 1996
Plan of which 334,035 were exercised,  174,706 were cancelled and 748,064 remain
outstanding.  As of December 31, 1999,  there were options of 517,901  shares of
common stock available for grant under the 1996 Plan.

     The CDNOW 1999 Equity  Compensation Plan (the "1999 Plan") became effective
upon the CDNOW/N2K merger on March 17, 1999. Under the 1999 Plan,  incentive and
nonqualified  stock  options and  restricted  stock may be granted to employees,
including  employees  who are  officers  or members  of the Board of  Directors,
members  of the  Board  of  Directors  who are  not  employees  and  independent
contractors and  consultants.  An aggregate of 2,500,000  shares of common stock
have been reserved for issuance under the 1999 Plan. All grants made  subsequent
to the CDNOW/N2K  merger were made under the 1999 Plan. As of December 31, 1999,
2,339,075  options  were  granted  under  the 1999  Plan of which  385,564  were
cancelled and 1,953,511 remain outstanding.  As of December 31, 1999, there were
options of 546,489  shares of common  stock  available  for grant under the 1999
Plan.

     Effective  upon the CDNOW/N2K  merger on March 17, 1999,  CDNOW assumed the
equity  compensation  plans  formerly  administered  by N2K (the  "N2K  Plans").
Consistent  with  outstanding  N2K shares,  all option shares were adjusted by a
factor of .83 and all exercise prices were adjusted by an inverse factor of .83.
CDNOW  assumed  1,040,250 of options  under the N2K Plans and 302,414 of options
outside of the N2K Plans.  As of March 17, 1999,  CDNOW had made no grants under
the N2K  Plans  and will not make  future  grants  under  the N2K  Plans.  CDNOW
recorded $7.1 million in additional paid in capital for the estimated fair value
of the options assumed in connection  with the N2K acquisition  (see Note 2). As
of December 31, 1999, 648,875 options under the N2K Plans remain outstanding and
121,544 options outside the N2K Plans remain outstanding.

                                      F-12
<PAGE> 41
Information relative to all stock options is as follows:
<TABLE>
<CAPTION>

                                                         Range of          Aggregate     Weighted Average
                                           Shares     Exercise Prices   Exercise Price    Exercise Price
                                        ------------ ------------------ ---------------- ----------------
<S>                                     <C>          <C>                <C>              <C>
Outstanding January 1, 1997                      --                 --               --               --
Granted                                     721,914  $   1.33 - $10.00  $     2,157,680  $          2.99
                                        ------------ ------------------ ---------------- ----------------
Outstanding December 31, 1997               721,914  $   1.33 - $10.00        2,157,680  $          2.99
Granted                                     454,891  $   8.50 - $35.50        9,539,892  $         20.97
Exercised                                  (100,557) $   1.33 - $ 3.00         (224,896) $          2.24
Cancelled                                   (32,518) $   1.33 - $19.50         (237,566) $          7.31
                                        ------------ ------------------ ---------------- ----------------
Outstanding December 31, 1998             1,043,730  $   1.33 - $35.50       11,235,110  $         10.76
Granted                                   2,419,075  $  14.50 - $24.00       42,377,830  $         17.52
N2K options assumed                       1,342,664  $   3.13 - $39.16       19,971,574  $         14.87
Exercised                                  (344,806) $   1.33 - $14.46         (788,925) $          2.29
Cancelled                                  (988,669) $   1.33 - $39.16      (17,014,022) $         17.21
                                        ------------ ------------------ ---------------- ----------------
Outstanding December 31, 1999             3,471,994  $   1.33 - $35.50  $    55,781,567  $         16.07
                                        ============ ================== ================ ================
</TABLE>
Information  relative to CDNOW's  outstanding options as of December 31, 1999 is
as follows:
<TABLE>
<CAPTION>
                                      Options Outstanding                            Options Exercisable
                      ------------------------------------------------------ -------------------------------------
 Range of Exercise         Shares         Average Life         Average            Shares        Average Exercise
       Prices            Outstanding         (Years)        Exercise Price      Exercisable           Price
--------------------- ----------------- ------------------ ----------------- ------------------ ------------------
<S>                   <C>               <C>                <C>               <C>                <C>
$    1.33 - $10.00             603,620         6.4         $      4.39                 427,216  $       4.23
$   10.01 - $20.00           2,331,166         8.4         $     16.83                 348,279  $      15.79
$   20.01 - $30.00             411,138         7.6         $     23.27                 228,122  $      23.79
$   30.01 - $39.16             126,070         7.8         $     34.34                  56,281  $      33.71
                      ----------------- ------------------ ----------------- ------------------ ------------------
                             3,471,994         7.9         $     16.07               1,059,898  $      13.81
                      ================= ================== ================= ================== ==================
</TABLE>
     CDNOW accounts for its options using the disclosure-only  option under SFAS
No. 123, "Accounting for Stock-Based Compensation." CDNOW continues to apply APB
Opinion No. 25 and  related  interpretations  to account for its option  grants.
Accordingly, compensation has been recorded for the plans based on the intrinsic
value of the stock option at the date of grant (i.e., the difference between the
exercise price and the fair value of CDNOW's common stock on the date of grant).
Compensation,  if any, is  deferred  and  recorded  as expense  over the vesting
period. For the year ended December 31, 1997, deferred  compensation of $751,392
was recorded for options granted, of which $155,008,  $217,863, and $316,616 was
charged to compensation  expense for the years ended December 31, 1999, 1998 and
1997,  respectively.  During 1999, CDNOW incurred a severance charge of $903,000
as a result of the  acceleration  of the vesting period of common stock options.
Also during 1999,  CDNOW  incurred a charge of $102,335  related to common stock
given as  compensation  to certain  employees and a charge of $79,808 for common
stock options given to consultants in return for professional services.

     Pro forma  information  regarding  net  income  and  earnings  per share is
required by SFAS No. 123, and has been  determined as if CDNOW had accounted for
its stock option  plans under the fair value  method of SFAS No. 123.  Under the
provisions  of SFAS No. 123,  CDNOW's pro forma net loss and net loss per common
share for the years ended December 31, 1999, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
                                                                   Year Ended December 31,
                                                  -----------------------------------------------------------
                                                         1999                1998                1997
                                                  ------------------- -------------------- ------------------
<S>                                               <C>                 <C>                  <C>
Net loss applicable to common shareholders:
As reported                                       $     (119,229,025) $       (43,884,463) $     (11,157,508)
                                                  =================== ==================== ==================
Pro forma                                         $     (125,239,113) $       (45,080,868) $     (11,265,003)
                                                  =================== ==================== ==================
Net Loss per common share:
As reported                                       $            (4.32) $             (2.79) $           (1.42)
                                                  =================== ==================== ==================
Pro forma                                         $            (4.53) $             (2.88) $           (1.45)
                                                  =================== ==================== ==================
</TABLE>
                                      F-13

<PAGE> 42
The weighted  average fair value of the stock options  granted  during the years
ended  December  31,  1999,  1998  and  1997  was  $12.13,  $14.53,  and  $2.63,
respectively.  The fair value of each option  grant is  estimated on the date of
grant using the Black-Scholes  option pricing model, with the following weighted
average assumptions:
<TABLE>
<CAPTION>
                                                                   Year Ended December 31,
                                                  -----------------------------------------------------------
                                                         1999                1998                1997
                                                  ------------------- -------------------- ------------------
<S>                                               <C>                 <C>                  <C>
Risk-free interest rate based on the rates in
effect on the date of grant                          4.7% - 6.5%             5.9%             6.4% - 6.8%
Expected dividend yield                                  0.0%                0.0%                0.0%
Expected life                                          8 years              8 years             8 years
Expected volatility                                      60%                  60%                 60%
</TABLE>

Warrants.

     In August 1997,  CDNOW issued warrants to purchase 121,560 shares of Series
B Preferred  at an exercise  price of $5.45 per share,  in  connection  with its
Series B Preferred  financing.  The warrants were issued to one of the investors
in the  Series  B  Preferred  and to the  agent  who  represented  CDNOW in that
financing.  These  warrants  expire in August 2002.  Upon closing of the Initial
Public Offering,  the warrants  converted to warrants to purchase 182,341 shares
of common stock at $3.63 per share. Using the Black-Scholes  model, the warrants
were valued at $170,000. This amount was recorded as a reduction in the carrying
value of the preferred  stock and was amortized and included in the accretion to
the redemption value of the preferred stock recorded in each period.

     As  consideration  for certain loans from November 16, 1996 through January
31, 1997 (see Note 7), the  lenders  received  warrants  to purchase  59,997 and
76,365  shares of common  stock at a price of $1.83 per share until May 16, 1998
and July  16,  1998,  respectively.  Based on the  warrants'  18 month  term and
exercise  price,  the  Black-Scholes  model  calculated a minimal  value for the
warrants.

     In  connection  with the sale of the Series A Notes in  November  1997 (see
Note 7),  CDNOW  issued  warrants  to the  investors.  The  warrants  allow  the
investors  to purchase  48,550  shares of common  stock at an exercise  price of
$11.90 to $16.00 per share. As of December 31, 1999,  27,523 of the shares under
warrant   remain  to  be   purchased.   The  warrants   were  valued  using  the
Black-Scholes, and the Series A Notes were recorded net of the value of $404,425
assigned to the warrants.

     Pursuant to the May 18, 1998 binding  memorandum of terms with MTV Networks
(see Note 10),  CDNOW granted MTV Networks a warrant to purchase  226,892 shares
of CDNOW's common stock, no par value, at an exercise price of $23.28 per share.
On May 18, 1999, 75,630 shares vested and the remaining shares under the warrant
will vest annually over the remainder of the contract.

     Effective  upon the CDNOW/N2K  merger on March 17, 1999,  CDNOW assumed all
warrants issued by N2K.  Consistent with  outstanding N2K shares and options all
warranted  shares were adjusted by a factor of .83 and all exercise  prices were
adjusted by an inverse factor of .83.  Outstanding  warrants assumed from N2K by
CDNOW include 344,298 shares at a price of $14.46 with expirations  ranging from
May 2003 through  August 2004 and 153,331 shares related to the AOL agreement at
a price of  $22.89  expiring  October  2004.  CDNOW  recorded  $2.2  million  in
additional paid in capital for the estimated fair value of the warrants  assumed
in connection with the N2K acquisition.

Information relative to the warrants follows:
<TABLE>
<CAPTION>
                                                                                                 Grant Date
                                                                   Shares      Exercise Price    Fair Value
                                                                ------------- ----------------- -------------
<S>                                                             <C>           <C>               <C>
Outstanding warrants, January 1, 1997                                931,707   $         1.83
Warrants granted to lenders                                           76,365   $         1.83             --
Warrants granted to holders of Series B Preferred Stock              182,341   $         3.63   $    170,000
Warrants granted to Series A Note Holders (see Note 7)                48,550   $ 11.90-$16.00   $    404,425
                                                                ------------- -----------------
Outstanding warrants, December 31, 1997                            1,238,963   $  1.83-$16.00
Warrants exercised including 1,138,565 of cashless basis          (1,171,292)  $  1.83-$11.90
Warrants granted to MTV Networks (see Note 10)                       226,892   $        23.28   $  3,000,000
                                                                ------------- -----------------
Outstanding warrants, December 31, 1998                              294,563   $  3.63-$23.28
N2K warrants assumed                                                 497,629   $ 14.46-$22.89   $  2,181,189
Warrants exercised                                                   (2,521)   $        11.90
                                                                ------------- -----------------
Outstanding warrants, December 31, 1999                              789,671   $  3.63-$23.28
                                                                ============= =================
</TABLE>
                                      F-14
<PAGE> 43
9.  RELATED-PARTY TRANSACTIONS

A portion of  additional  paid-in  capital  represents  the deemed fair value of
services  contributed  to CDNOW by the founders in 1994,  1995 and 1996.  During
this  period,  one of the  founders  served  as  President  and  the  other  was
responsible for the development of CDNOW's system  architecture and transactions
systems.  In 1994 and 1995, the founders were paid no  compensation  and in 1996
the  founders'  compensation  was  below  market.  CDNOW's  Board  of  Directors
determined  the  fair  value  of  services  contributed  by  the  founders.   In
determining the value,  the Board  considered the founders' level of experience,
position in the company,  the  compensation  level of other  employees,  CDNOW's
financial  resources and the status of the company's  development.  In addition,
CDNOW  received a $3,261  advance  from a founder at December 31, 1996 and 1997.
This advance was repaid in 1998.

10.      COMMITMENTS AND CONTINGENCIES

Marketing Agreements.

     Yahoo!  Agreement.  On  September  2,  1998,  CDNOW  entered  into a global
merchant  agreement  with Yahoo!  Inc. , extending  and  expanding  upon earlier
agreements  with  Yahoo!  of  August  1997 and  March  1998.  Under  the  Yahoo!
Agreement:  CDNOW was (i)  granted  music-retail  exclusivity  on  music-related
search-results  pages on Yahoo!'s main directory,  www.yahoo.com (ii) integrated
into other  areas of the Yahoo!  service,  including  Yahoo!  Mail and (iii) the
premier music retailer on many of Yahoo!'s  international sites. In September of
1999,  CDNOW  elected  to  exercise  the early  termination  clause in the Yahoo
Agreement,  to terminate its  relationship  with Yahoo!  effective  December 31,
1999, and pay an early  termination  fee of $500,000.  This  termination did not
effect CDNOW's  presence on Yahoo!'s  international  sites,  which ends in March
2000. Coincident with the Yahoo!  Agreement,  Yahoo! agreed to purchase up to $2
million in  newly-issued  common shares of CDNOW common stock,  no par value, at
market price, of which $1 million was invested in September 1998. The commitment
to purchase  the  remaining $1 million on December  31, 1999 was  terminated  in
conjunction with the termination of the Yahoo! Agreement.

     Webcrawler  Agreement.  On  September  30,  1997,  CDNOW  entered  into  an
agreement with Excite, Inc., the owner of the webcrawler.com  service,  pursuant
to  which  CDNOW  became  the  exclusive  retail  music  store  sponsor  of  the
Webcrawler.com  Internet site. The  Webcrawler  Agreement  required CDNOW to pay
Excite a set-up fee, an annual exclusivity fee and an annual sponsorship fee for
ongoing programming,  links,  placements,  advertisements,  and promotions.  The
Webcrawler Agreement was terminated effective August 16, 1999.

     Lycos  Agreement.  On March 26, 1998,  CDNOW entered into an agreement with
Lycos,  Inc.,  pursuant  to which it became the  exclusive  retail  music  store
sponsor of the www.lycos.com and  www.tripod.com  Web sites. The Lycos Agreement
was  terminated  by CDNOW  effective  August 13,  1999 in  conjunction  with the
initiation  of  litigation  by the  company  against  Lycos for breach of Lycos'
contractual obligations under the agreement.

     Lycos  Bertelsmann  Agreement.  On April 2,  1998,  CDNOW  entered  into an
agreement with Lycos  Bertelsmann  GMBH & Co. KG, pursuant to which CDNOW became
the exclusive music retailer on certain Lycos  Bertelsmann  branded Web services
in Europe, as defined in the Lycos Bertelsmann Agreement.  The Lycos Bertelsmann
Agreement was amended on August 18, 1999 and expired on December 31, 1999.

     MTV Agreement.  On May 18, 1998, CDNOW entered into a binding memorandum of
terms for a three year advertising and promotion agreement with MTV Networks,  a
subsidiary  of Viacom  International,  Inc.,  pursuant to which it  committed to
purchase  advertising on the MTV and VH1 cable television  channels and obtained
the right to use certain MTV and VH1  content.  CDNOW has granted MTV Networks a
warrant to purchase  226,892  shares of its common stock at an exercise price of
$23.28 per share (see Note 8).

     America Online Agreement.  Effective upon the CDNOW/N2K merger on March 17,
1999, CDNOW assumed the Interactive  Marketing Agreement between N2K and America
Online,  Inc. dated September 1, 1997.  Pursuant to the AOL Agreement,  CDNOW is
receiving an integrated package of placements,  promotions and links through the
AOL Service.  Additionally, N2K granted AOL a warrant for the future purchase of
up to  184,736  shares of N2K common  stock at an  exercise  price  equal to the
initial public  offering price per share,  which was $19.00 per share.  Upon the
completion of the merger between CDNOW and N2K on March 17, 1999,  CDNOW assumed
the warrant at the merger adjusted figures of 153,331 shares for future purchase
at a price of $22.89 (see Note 8). The AOL Agreement  will continue until August
31, 2000.

     Excite  Agreement.  Upon the completion of the merger between CDNOW and N2K
on March 17, 1999,  CDNOW assumed the Sponsorship  Agreement dated September 23,
1997  between N2K and Excite,  Inc.,  pursuant to which it became the  exclusive
retail  music  store  sponsor of the  Excite  Web site and the Excite  Broadcast
Pages. The Excite Agreement will continue until April 30, 2000.

     Netscape Agreement. Upon the completion of the merger between CDNOW and N2K
on March 17, 1999, CDNOW assumed the Web Site Services Agreement dated September
27, 1997  between N2K and  Netscape  Communications  Corporation.  The  Netscape
Agreement will continue until May 30, 2000.

                                      F-15
<PAGE> 44
     CDNOW is required to pay aggregate  minimum fixed fees of $10.9 million and
$2.8 million  during the years ended  December 31, 2000 and 2001,  respectively,
under its  existing  marketing  agreements.  Depending  on the type of marketing
agreement,  CDNOW will expense advertising  purchased under marketing agreements
when the advertising is run or amortize the costs  associated with its marketing
agreements over the contract terms, with the amortization method primarily based
on the rate of delivery of a  guaranteed  number of  impressions  to be received
during the contract term.

     Several  of  CDNOW's   agreements  contain  provisions  which  may  require
additional  payments  to be  made  by the  company  based  on  factors  such  as
click-throughs and new customers generated. To date, the amount of such payments
has not been material.  Such payments are charged to expense as incurred.  CDNOW
will  continue  to  evaluate  the  realizability  of assets  recorded  under the
agreements above and other agreements,  and, if necessary, write down the assets
to realizable value.

Leases.  CDNOW has entered  into  various  noncancelable  operating  and capital
leases for office space,  telephones and other  equipment.  Future minimum lease
payments  under  operating  and capital  leases as of  December  31, 1999 are as
follows:
<TABLE>
<CAPTION>
                                                            Operating              Capital
                                                        -------------------    -----------------
<S>                                                     <C>                    <C>
2000                                                    $        3,325,491           $2,169,550
2001                                                             3,309,403            1,683,170
2002                                                             2,722,771            1,033,627
2003                                                             1,878,451              147,157
2004                                                             1,897,551              147,157
2005 and thereafter                                              1,975,618              159,420
                                                        -------------------    -----------------
Total minimum lease payments                            $       15,109,285            5,340,081
                                                        ===================    -----------------
Less - amount representing interest                                                  (1,108,605)
                                                                               -----------------
Present value of minimum capitalized lease payments                                  $4,231,476
                                                                               =================
</TABLE>
     Rent expense under operating leases was $1,798,623,  $676,153, and $207,724
for the years ended 1999, 1998 and 1997, respectively.

Legal Actions.

     N2K and its directors  were  defendants in a consolidated  purported  class
action in the U.S. District Court for the Southern District of New York entitled
In re N2K Inc.  Securities  Litigation (Docket No. 98 CIV 3304 (HB)). The action
consolidated  two  purported  class  actions,  entitled  Kuhn v. N2K Inc. et al.
(Docket No. 98 CIV 4360 (HB)) and Bender v. Rosen et al. (Docket No. 98 CIV 3304
(HB)) that were previously discussed in N2K's Quarterly Reports on Form 10-Q for
the  quarterly  periods ended  September  30, 1998,  June 30, 1998 and March 31,
1998, and CDNOW's Quarterly Report on Form 10-Q for the quarterly periods, ended
March 31, June 30, and September 30, 1999, respectively. The consolidated action
was a  purported  class  action on behalf  of common  shareholders  and seeks to
recover  unspecified  damages and other  relief,  as well as costs and expenses,
stemming  from alleged  violations of the  Securities  Act of 1933 in connection
with the public  offering of the shares of N2K's common stock in April 1998. The
consolidated  action alleged that, among other things,  the defendants failed to
disclose N2K's first quarter financial results in the registration statement for
the April 1998 public offering. The defendants moved to dismiss the complaint on
August 31, 1998 for  failure to state a claim  and/or for failure to plead fraud
with the  requisite  particularity.  On May 21, 1999,  Judge Baer  dismissed the
plaintiff's  complaint  with  prejudice.  On June 22, 1999,  plaintiffs  filed a
Notice of Appeal to the U.S. Court of Appeals for the Second  Circuit,  which is
located in New York City. On February 7, 2000,  the Second  Circuit upheld Judge
Baer's dismissal of the plaintiff's complaint.

     On or about November 4, 1998, an action entitled Ticketmaster Ticketing Co.
v. N2K Inc. (Docket No.  BC200194) was filed against N2K in California  Superior
Court for the County of Los Angeles.  The  Ticketmaster  action alleges that N2K
breached a marketing  and  advertising  contract  dated  April 23, 1998  between
Ticketmaster and N2K, which N2K terminated  effective October 31, 1998, based on
alleged  breaches of the  agreement by  Ticketmaster  as well as other  tortious
conduct.  Ticketmaster seeks damages in an amount not less than $8,000,000, plus
pre-  and  post-judgment  interest,  as well  as fees  and  costs.  N2K  filed a
cross-complaint  for  affirmative  relief.  The  parties  are in the  process of
conducting discovery in preparation for trial.

     N2K and 17 other  entities  have been named as defendants in a civil action
entitled Interactive Gift Express v. Compuserve, Inc., et al. (Docket 95 CV 6871
(BSJ)), which is pending in the U.S. District Court for the Southern District of
New York. N2K has also been named as defendant in a civil action entitled Parsec

                                      F-16
<PAGE> 45

Sight/Sound,  Inc. v. N2K Inc. (Docket 98 CV 0118), which is pending in the U.S.
District Court for the Western District of Pennsylvania.  The plaintiffs in each
of these actions allege  infringement of intellectual  property rights, and each
seeks  treble  damages  and  costs in an  unspecified  amount,  as well as other
declaratory and injunctive relief. In the Interactive Gift action, the court has
issued a preliminary ruling favorable to defendants. The plaintiffs consented to
entry of judgment  against  them in order to speed  their  appeal of the court's
ruling.  The parties have  appealed the matter to the U.S.  Court of Appeals for
the Second Circuit.  In the Parsec action,  CDNOW has answered the complaint and
discovery is ongoing.

     CDNOW and N2K have  been  named  defendants  in an  action  brought  by BPW
Rhythmic Records, L.L.C. for breach of contract and other related claims arising
out of a label agreement  entered into between N2K Inc. and Rhythmic  Records on
March 27, 1998.  The plaintiff,  Rhythmic  Records,  seeks direct,  punitive and
exemplary damages,  costs,  including  attorney's fees, and a constructive trust
against CDNOW's assets.  Plaintiff  originally filed the action in a Texas state
court.  CDNOW and N2K  removed  the  action to the U.S.  District  Court for the
Northern  District of Texas,  and filed a motion to have the case  dismissed  or
moved to the  federal  trial court in New York City.  Subsequently,  the federal
court  in Texas  transferred  the  action  to the U.S.  District  Court  for the
Southern  District  of New York in New York City.  The  parties are in the early
stages of this litigation and have not yet begun formal pre-trial discovery.

     On July 14,  1999,  CDNOW filed a complaint  against  Lycos,  Inc.  and its
wholly-owned  subsidiary  Tripod,  Inc., in the U.S.  District  Court located in
Philadelphia, Pennsylvania. The complaint alleges that Lycos and Tripod breached
their  respective  obligations  to CDNOW as specified  in the linking  agreement
entered  into among  CDNOW,  Lycos and  Tripod on March 26,  1998.  CDNOW  seeks
damages in excess of $75,000 and a declaratory  judgment terminating the linking
agreement.  On  November  15,  1999,  Lycos  and  Tripod  filed  an  answer  and
counterclaim alleging breach of contract, quantum meruit and restitution, breach
of implied covenant of good faith and fair dealing and unfair and deceptive acts
and practices. Lycos and Tripod seek dismissal of the complaint, attorneys' fees
and damages as established at trial. The parties are in the early stages of this
litigation and have not yet begun formal pre-trial discovery.

     CDNOW is a party to other lawsuits and proceedings  arising in the ordinary
course of its business,  none of which, in CDNOW's opinion,  is likely to have a
material adverse effect on operations.

                                      F-17
<PAGE> 46

                                   SIGNATURES

     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.

                                            CDNOW, Inc.
                                            (Registrant)

Dated:  March 20, 2000

                                            By:  /s/Jason Olim
                                                 -------------------------------
                                                 Jason Olim
                                                 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.

<TABLE>
<CAPTION>

         Signature                                   Title                                 Date
---------------------------------     -------------------------------------          -------------------
<S>                                   <C>                                            <C>
/s/Jonathan V. Diamond                Chairman of the Board                          March 20, 2000
---------------------------------
   Jonathan V. Diamond

/s/Jason Olim                         President, Chief Executive Officer             March 20, 2000
---------------------------------       and Director (principal executive officer)
   Jason Olim

/s/Joel Sussman                       Vice President and Chief Financial Officer     March 20, 2000
---------------------------------       (principal financial and accounting officer)
   Joel Sussman

/s/Matthew Olim                       Technical Lead, Secretary, Treasurer and       March 20, 2000
---------------------------------       Director
   Matthew Olim

/s/Patrick Kerins                     Director                                       March 20, 2000
---------------------------------
   Patrick Kerins

/s/John Regan                         Director                                       March 20, 2000
---------------------------------
   John Regan

/s/James Coane                        Director                                       March 20, 2000
---------------------------------
   James Coane

</TABLE>

<PAGE> 47


                                  EXHIBIT INDEX


Exhibit No.               Description
-----------   -----------------------------------------

    21        List of Subsidiaries
    23        Consent of Independent Public Accountants
    27        Financial Data Schedule


<PAGE> 48

                                   EXHIBIT 21
                              LIST OF SUBSIDIARIES
<TABLE>
<CAPTION>
                               Percent
Name fo Subsidiary              Owned        State/Country of Incorporation/Organization
-----------------------        -------       -------------------------------------------
<S>                            <C>           <C>
CDNOW Investments, Inc.          100%                      Delaware

CDNOW Trademarks, Inc.           100%                      Delaware

CDNOW Online, Inc.               100%                    Pennsylvania

superSonic Boom, Inc.            100%                      Delaware

N2K Inc.                         100%                      Delaware

CDNOW Japan Inc.                 100%                        Japan

TSI Licensing, Inc.              100%                      Delaware

</TABLE>

<PAGE> 49

                                   EXHIBIT 23

                    CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS


As independent public accountants, we hereby consent to the incorporation of our
report  included  in this  Form  10-K,  into  the  Company's  previously  filed
Registration  Statements on Form S-8 (File Nos. 333-51191 and 333-79715).

                                                  /S/ ARTHUR ANDERSEN LLP


Philadelphia, Pa.
March 28, 2000