<PAGE>

                                                                    Exhibit 13

                               ANNUAL REPORT 1997




<PAGE>


                           CAMBRIDGE SOUNDWORKS, INC.
 
To Our Stockholders:
 
Fiscal 1997 was a year of record sales for Cambridge SoundWorks. Our sales 
increase of 18% came in part because we added new stores, relocated existing 
stores and instituted an aggressive plan that resulted in significant "comp 
store" sales increases. Other initiatives in our ongoing program to expand 
sales included our sales of an OEM powered subwoofer to IBM. 1997 was also an 
outstanding year for new product introductions, with seven new speaker models 
introduced at a New York press conference in April 1997. With these new 
models, in conjunction with our existing lines, Cambridge SoundWorks now 
covers all the major segments of the home hi fi, multimedia and car stereo 
speaker markets.
 
We also plan to greatly expand our production facilities by opening a 
manufacturing factory in China. This high-volume factory will allow us to 
deliver very large quantities of our multimedia speakers and other products. 

1997 also marked the beginning of a very important new partnership with 
Creative Technology Ltd., the creators of Sound Blaster-Registered Trademark- 
sound cards and the world's leading manufacturer of multimedia computer 
products.
 
Record Sales.
 
Net sales for Fiscal 1997 increased 18% to $51.3 million compared to $43.6 
million for the same 12 month period last year.
 
New Stores, 15.3% "Comp Store" Sales Increase.
 
In Fiscal 1997, we opened five new Factory-Direct stores, and relocated four 
stores. We opened new Factory-Direct stores in the Westfarms Mall in 
Farmington, CT; the Solomon Pond Mall in Marlboro, MA; The Maine Mall in 
South Portland, ME; the Stoneridge Mall in Pleasanton, CA; and The Great Mall 
in Milpitas, CA. Relocated stores include the Concord, CA stand-alone store 
moving to the Sun Valley Mall in Concord, CA; the downtown San Francisco 
store on Van Ness moving one block to a much larger (4,000 sq. ft.), more 
visible location; the Danvers, MA stand-alone store moving to the North Shore 
Shopping Center in Peabody, MA; and the Burlington, MA stand-alone store 
moving to the Burlington Mall, Burlington, MA. These store relocations, and 
an aggressive retail and direct response promotional program during the 
holiday selling season, combined to result in a same-store sales increase of 
15.3% for 1997 versus 1996. In addition, we recently opened a new store in 
The Village at Corte Madera in Marin County, California.
 
Our store strategy is based on the success of Cambridge SoundWorks' current 
mall and high-traffic locations. These stores focus on home stereo, car 
stereo, home theater and multimedia products, presenting them in a simple, 
uncluttered layout that emphasizes both the quality of the products as well 
as Factory-Direct savings.
 
New Products.
 
At an April 1997 press conference in New York, we introduced seven new 
products, including one that we feel will have a significant impact on the 
Company, as well as the multimedia speaker industry -- PCWorksL. A compact, 
amplified subwoofer/satellite speaker system, PCWorks is the most affordable 
product we (or, we believe, any company) has ever offered that reproduces 
true high-performance, wide-range sound, including outstanding bass response. 
Priced at $99.99, complete with speaker stands and an in-line remote volume 
control, PCWorks should open new markets to the Company, especially in light 
of our new distribution agreement with Creative Technology Ltd.


                           [ART]

Our new MovieWorks 5.1 system with MultiPole surround speakers.

We also introduced new surround sound speaker products in April of '97. The 
Surround-Registered Trademark- 5.1 and The Surround II 5.1 are the first 
speakers using our new MultiPoleL technology that allows the user to switch 
between "dipole" and "bipole" operation. This flexibility makes the two 
speaker models the ideal choice for use in the surround channels of home 
theater systems that employ Dolby Digital-Registered Trademark- 5.1 
technology. MovieWorksL 5.1 is a complete high-performance surround sound 
speaker package that includes shielded main speakers, a high-output center 
speaker, a high-performance powered subwoofer, and The Surround 5.1 surround 
speakers. We also introduced MovieWorks IV, an affordable surround sound 
speaker system suitable for use in home theater systems or with multimedia 
computers. Our first car stereo speaker models, the CS5 and FS502, were also 
introduced. We expect significant revenue contributions from these new 
products in Fiscal 1998.

<PAGE>

                           CAMBRIDGE SOUNDWORKS, INC.
 
IBM Subwoofer.
 
In Fiscal 1997 we contracted with IBM to design and manufacture a powered 
subwoofer for use with their Aptiva S series of multimedia computers. This 
was the result of our ongoing program to pursue OEM business in the 
multimedia computer field.
 
New Factory In China.
 
In order to meet the growing demand for our multimedia speakers and other 
products, we plan to open a high-capacity production facility in the 
Guangdong Province of China in January of 1998. This new facility will be 
capable of high-volume, low-overhead production that will allow us to compete 
in the field of multimedia computer products. They will also allow us to 
reduce costs of certain of our existing home stereo, car stereo and home 
theater products.
 
Partnership With Creative Technology Ltd.
 
In February 1997, Cambridge SoundWorks agreed to sell approximately 20% of 
the Company to Creative Technology Ltd. of Singapore. As a result of Creative 
Technology's investment, Cambridge SoundWorks is creating a complete line of 
multimedia speakers, and they have become the exclusive worldwide distributor 
of all Cambridge SoundWorks multimedia speakers.
 
Creative Technology is the world's leading producer of advanced multimedia 
products and peripherals for personal computers. Its Sound Blaster-Registered 
Trademark- audio card which allows a personal computer to generate sound, is 
installed in nearly 30 million computers, or 75 percent of the PC audio 
systems in the world, and is carried in more than 40,000 retail outlets 
worldwide.
 
Cambridge SoundWorks has created two complete lines of speakers:

- The Creative-Registered Trademark- line consists of affordable, high-value 
  desktop speakers.

- The Cambridge SoundWorks line consists of high-performance bi-amplified 
  subwoofer/satellite speaker systems, including PCWorks, SoundWorks and 
  MicroWorks.
 
The two companies will also work together to create other innovative products 
for multimedia, to be manufactured by Cambridge SoundWorks.
 
American Express Catalog.
 
In Fiscal 1997, the Company entered into an agreement with the American 
Express company, wherein Cambridge SoundWorks speakers and systems would be 
included in catalogs mailed to American Express card holders. The first 
catalogs were mailed in early Fiscal 1998.
 
Critical Reviews.
 
The Company's products continue to attract the favorable attention of the 
industry's critics. A small sampling: 

- Boot magazine described our PCWorks speaker system, "...pure acoustic 
  heaven...delivering some of the cleanest sounds you can get for less than 100 
  bucks. You'll be hard pressed to find a better set of speakers for twice the 
  price." 

- Computer Gaming World magazine describes PCWorks saying, "...a speaker 
  system for $100 that should make some $250 systems nervous...Cambridge has 
  created what may be the shape of things to come. A set of speakers for your 
  PC that will more than fill the bill, and not crimp your budget." 

- PC magazine says about our MicroWorks system, "The only speakers you'll 
  ever need. The line between quality sound-system speakers and PC multimedia 
  speakers is about to vanish thanks to the MicroWorks system from Cambridge 
  SoundWorks. These speakers are equally at home as high-end PC speakers or as 
  room-filling stereo speakers....If you're looking for excellent sound at a 
  good price, the MicroWorks is worth looking at and listening to." 

- PC World says about MicroWorks, "The first time I heard the heavy- duty 
  sounds pumped out by the MicroWorks speakers, I assumed they were powered by 
  testosterone rather than electricity...I haven't heard better speakers at 
  this price." 

- Stereo Review magazine describes our Tower II speaker system by saying, 
  "Excellent...first-rate...gut-wrenching bass...the price is right."
 
More New Products On The Way.
 
In addition to the products mentioned, the company intends to continue to 
introduce new products and new product categories. As we enter Fiscal 1998, 
we are looking forward to continued growth.
 
BEST REGARDS,
 
Thomas J. DeVesto
President, CEO

<PAGE>

                           CAMBRIDGE SOUNDWORKS, INC.
 
SELECTED FINANCIAL DATA
 
The following information, except for the year ended July 2, 1995, has been 
derived from financial statements which have been audited by Arthur Andersen 
LLP, independent public accountants and their report is included elsewhere 
herein. The following data, insofar as it relates to the year ended July 2, 
1995, has been derived from unaudited financial data, which in the opinion of 
management, includes all adjustments, consisting only of normal recurring 
adjustments, necessary for a fair statement of the results for the year.
 
The data set forth below should be read in conjunction with the audited 
financial statements and notes thereto included herein and Management's 
Discussion and Analysis of Financial Condition and Results of Operations.
 
<TABLE>
<CAPTION>
                                                                SIX MONTHS   YEAR ENDED
             INCOME STATEMENT DATA:                YEAR ENDED      ENDED       7/2/95     YEAR ENDED   YEAR ENDED
      (IN THOUSANDS EXCEPT PER SHARE DATA)          12/31/94      7/2/95     (UNAUDITED)    6/30/96      6/29/97
-------------------------------------------------  -----------  -----------  -----------  -----------  -----------
<S>                                                <C>          <C>          <C>          <C>          <C>
Net sales........................................   $  19,432    $  15,015    $  26,928    $  43,585    $  51,285
Cost of goods sold...............................      10,133        8,697       15,043       25,872       30,965
                                                   -----------  -----------  -----------  -----------  -----------
  Gross profit...................................       9,299        6,318       11,885       17,713       20,320
                                                   -----------  -----------  -----------  -----------  -----------
Sales and marketing expenses.....................       6,890        5,830       10,406       14,254       18,320
General and administrative expenses..............       1,617        1,182        2,197        2,062        2,218
Engineering and development expenses.............         669          404          761          679          587
  Total expenses.................................       9,176        7,416       13,364       16,995       21,125
                                                   -----------  -----------  -----------  -----------  -----------
  Income (loss) from operations..................         123       (1,098)      (1,479)         718         (805)
Interest income (expense), net...................         182           10          150         (301)        (220)
                                                   -----------  -----------  -----------  -----------  -----------
  Income (loss) before provision (benefit) for
    taxes........................................         305       (1,088)      (1,329)         417       (1,025)
Provision (benefit) for income taxes.............          98         (435)        (558)         167         (410)
                                                   -----------  -----------  -----------  -----------  -----------
  Net income (loss)..............................   $     207    $    (653)   $    (771)   $     250         (615)
                                                   -----------  -----------  -----------  -----------  -----------
  Net income (loss) per common and common
    equivalent share.............................   $     .08    $    (.23)   $    (.27)   $     .09    $    (.19)
                                                   -----------  -----------  -----------  -----------  -----------
Weighed average number of common and common
  equivalent shares outstanding..................       2,461        2,873        2,870        2,922        3,194
Dividends per common share.......................          --           --           --           --           --
Balance Sheet Data:
  Working capital................................   $   9,539    $   8,363    $   8,363    $   7,912    $  11,079
  Total Assets...................................      15,947       15,029       15,029       18,130       21,098
  Total Stockholders' Equity.....................      11,703       11,108       11,108       11,361       15,384
</TABLE>

                                     2

<PAGE>

                           CAMBRIDGE SOUNDWORKS, INC.
 
MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
The Company's Common Stock is traded on the Nasdaq National Market System 
under the symbol HIFI. The following table sets forth the range of high and 
low selling prices for the Common Stock of the Company from April 13, 1994 
(the date the Company's Common Stock commenced trading on Nasdaq) for the 
fiscal periods indicated, as reported on the Nasdaq National Market. This 
information reflects inter-dealer prices, without retail mark-up, mark-down, 
or commission and may not necessarily reflect actual transactions.
 
<TABLE>
<S>                                                                           <C>        <C>
Fiscal 1994                                                                        High        Low
---------------------------------------------------------------------------------------------------
  Second Quarter (from April 13, 1994)......................................  $    8.50  $   7.125
  Third Quarter.............................................................  $   8.750  $   5.875
  Fourth Quarter............................................................  $   9.875  $   4.875

Fiscal 1995                                                                        High        Low
---------------------------------------------------------------------------------------------------
  First Quarter.............................................................  $    6.75  $   3.375
  Second Quarter............................................................  $   7.625  $   4.875

Fiscal 1996                                                                        High        Low
---------------------------------------------------------------------------------------------------
  First Quarter.............................................................  $    7.75  $    4.75
  Second Quarter............................................................  $    6.00  $    4.25
  Third Quarter.............................................................  $   6.375  $   3.625
  Fourth Quarter............................................................  $   4.625  $    3.25

Fiscal 1997                                                                        High        Low
---------------------------------------------------------------------------------------------------
  First Quarter.............................................................  $    4.75  $    3.25
  Second Quarter............................................................  $   7.125  $   3.375
  Third Quarter.............................................................  $   5.875  $   3.375
  Fourth Quarter............................................................  $    5.50  $   4.625
</TABLE>
 
On September 12, 1997, there were 73 record holders of the Company's Common 
Stock. The Company believes the actual number of beneficial owners of the 
Common Stock is greater than the stated number of holders of record because a 
large number of the shares of the Company's Common Stock is held in custodial 
or nominee accounts for the benefit of persons other than the record holder.
 
The Company has never paid a dividend on its Common Stock and does not 
anticipate paying cash dividends in the foreseeable future.

                                     3

<PAGE>
                           CAMBRIDGE SOUNDWORKS, INC.
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS 
OF OPERATIONS
 
Results of Operations 

The following table sets forth, for the periods indicated, selected income 
statement data expressed as percentages of net sales.
 
<TABLE>
<CAPTION>
                                                                YEAR ENDED      SIX MONTHS      YEAR        YEAR         YEAR
                                                               DECEMBER 31,        ENDED        ENDED       ENDED        ENDED
                                                                   1994           7/2/95       7/2/95      6/30/96      6/29/97
                                                                                          (UNAUDITED)
----------------------------------------------------------------------------------------------------------------------------------
<S>                                                           <C>              <C>            <C>        <C>          <C>
Net sales...................................................         100.0%          100.0%       100.0%      100.0%       100.0%
Cost of goods sold..........................................          52.1            57.9         55.9        59.4         60.4
----------------------------------------------------------------------------------------------------------------------------------
  Gross profit..............................................          47.9            42.1         44.1        40.6         39.6
----------------------------------------------------------------------------------------------------------------------------------
Sales and marketing expenses................................          35.5            38.8         38.6        32.7         35.7
General and administrative expenses.........................           8.3             7.9          8.2         4.7          4.3
Engineering and development expenses........................           3.5             2.7          2.8         1.6          1.2
----------------------------------------------------------------------------------------------------------------------------------
  Total expenses............................................          47.3            49.4         49.6        39.0         41.2
----------------------------------------------------------------------------------------------------------------------------------
  Income (loss) from operations.............................            .6            (7.3)        (5.5)        1.6         (1.6)
Interest income (expense), net..............................           1.0             0.0           .6         (.6)         (.4)
----------------------------------------------------------------------------------------------------------------------------------
  Income (loss) before provision (benefit) for income taxes.           1.6            (7.3)        (4.9)        1.0         (2.0)
Provision (benefit) for income taxes........................            .5            (2.9)        (2.1)         .4          (.8)
----------------------------------------------------------------------------------------------------------------------------------
  Net income (loss).........................................           1.1%           (4.4)%       (2.8%         .6%        (1.2)%
</TABLE>
 
Year Ended June 29, 1997 Compared with Year Ended June 30, 1996
 
Net sales for the twelve month period increased from $43.6 million in 1996 to 
$51.3 million in 1997, an increase of 18%. The increase in net sales was due 
primarily to the 45% increase in retail store sales. The Company continued 
its strategy of retail expansion by adding five new stores during 1997, three 
in New England and two in Northern California. The Company relocated four 
other retail stores to high traffic mall locations and closed two retail 
stores in Northern California in 1997. The Company had 26 retail stores at 
June 29, 1997, 18 in New England and eight in Northern California. Wholesale 
sales decreased 23% due to sales inactivity with Best Buy Co. Inc. (Best 
Buy). During 1997, the Company entered into an agreement with Creative 
Technology, Ltd. and began shipments under this agreement late in the fourth 
quarter of 1997. Catalog sales decreased, due in part to shifts in sales to 
the Company's retail stores.
 
Retail, catalog and wholesale sales accounted for 69%, 12% and 19% of net 
sales for the year ended June 29, 1997, respectively. For the year ended June 
30, 1996, retail, catalog and wholesale sales accounted for 55%, 16% and 29% 
of net sales, respectively. Sales of products manufactured by the Company 
accounted for 61%, and sales of stereo components manufactured by other 
companies accounted for 39% of net sales for the year ended June 29, 1997. 
For the year ended June 30, 1996, sales of products manufactured by the 
Company accounted for 72%, and sales of stereo components manufactured by 
other companies accounted for 28% of net sales. The increase in sales of 
stereo components manufactured by other companies increased as a percentage 
of sales due primarily to the decrease in wholesale sales during 1997.
 
The Company's gross margin decreased from 40.6% for the year ended June 30, 
1996, to 39.6% for the year ended June 29, 1997. The increase in retail store 
sales, which have lower overall margins than catalog sales, and retail 
pricing competition particularly with stereo components manufactured by other 
companies, had a negative impact on the Company's gross margin. The Company 
does not expect a significant change in gross margin as the Company adds 
retail stores and as wholesale sales increase at their projected levels.
 
Sales and marketing expenses increased from $14.3 million for the year ended 
June 30, 1996 (32.7% of net sales) to $18.3 million (35.7% of net sales) for 
the year ended June 29, 1997. The hiring of additional retail store 
personnel, and increased advertising and retail store operating costs, 
accounted for a substantial portion of the increase. General and 
administrative expenses for the year increased from $2.1 million (4.7% of net 
sales) in 1996 to $2.2 million (4.3% of net sales) in 1997. Engineering and 
development expenses for the year decreased from $680,000 (1.6% of net sales) 
in 1996 to $587,000 (1.2% of net sales) in 1997.
 
Interest expense of $220,000 and $301,000 for the years ended June 29, 1997 
and June 30, 1996 results from the Company's use of its line of credit.
 
The Company's effective income tax rate for the years ended June 29, 1997 and 
June 30, 1996 was 40.0%.
 
The Company incurred a net loss of $615,000 for the year ended June 29, 1997 
compared to net income for the year ended June 30, 1996 of $251,000. The 
decrease in net income resulted primarily from sales inactivity in the fourth 
quarter with Best Buy and, due to the timing of orders, from Creative 
Technology, Ltd., the Company's new multimedia partner.
 
Year Ended June 30, 1996 Compared with Year Ended July 2, 1995
 
Net sales for the twelve month period increased from $26.9 million in 1995 to 
$43.6 million in 1996, an increase of 62%. The increase in net sales was due 
primarily to the Company's continuing strategy of retail and wholesale 
expansion, which included shipments in connection with an exclusive reseller 
agreement with Best Buy. The Company opened six retail stores, including five 
stores in New England and one in Northern California, bringing the total 
number of retail stores to 23 at the year ended June 30, 1996. Catalog sales 
decreased, due in part to shifts in sales to the Company's retail stores.
 
Retail, catalog and wholesale sales accounted for 55%, 16% and 29% of net 
sales for the year ended June 30, 1996, respectively. For the year ended July 
2, 1995, retail, catalog and wholesale sales accounted for 55%, 32% and 13% 
of net sales, respectively. Sales of products manufactured by the Company 
accounted for 72%, and sales of stereo components manufactured by other 
companies accounted for 28% of net sales for the year ended June 30, 1996. 
For the year ended July 2, 1995, sales of products manufactured by the 
Company accounted for 69%, and sales of stereo components manufactured by 
other companies accounted for 31% of net sales. The increase in products 
manufactured by the company as a percentage of net sales results from the 
expansion of its wholesale channels of distribution.
 
The Company's gross margin decreased from 44.1% for the year ended July 2, 
1995, to 40.6% for the year ended June 30, 1996. The increase in retail store 
sales, which have lower overall margins than catalog sales, retail pricing 
competition particularly with stereo components manufactured by other 
companies, and the increased sales volume in the wholesale expansion had a 
negative impact on the Company's gross margin. The Company does not expect a 
significant change in gross margin as the Company adds retail stores and as 
wholesale sales increase at their projected levels.

                                     4

<PAGE>

                           CAMBRIDGE SOUNDWORKS, INC.
 
Sales and marketing expenses increased from $10.4 million for the year ended 
July 2, 1995 (38.6% of net sales) to $14.3 million (32.7% of net sales) for 
the year ended June 30, 1996. The hiring of additional retail store personnel 
and retail store operating costs, along with selling costs associated with 
the Company's wholesale division accounted for a substantial portion of the 
increase. General and administrative expenses for the twelve month period 
decreased from $2.2 million (8.2% of net sales) for 1995 to $2.1 million 
(4.7% of net sales) in 1996. Engineering and development expenses for the 
twelve month period decreased from $761,000 (2.8% of net sales) in 1995 to 
$680,000 (1.6% of net sales) in 1996.

Interest income amounted to $165,000 in 1995 from investments in United 
States Treasury Securities purchased with the net proceeds of the Company's 
initial public offering, which was completed in April 1994. Interest expense 
of $301,000 for the year ended June 30, 1996 results from the Company's use 
of its line of credit.
 
The Company's effective income tax rate for the year ended June 30, 1996 was 
40.0% as compared to 41.9% for the year ended July 2, 1995.
 
The Company posted net income for the year ended June 30, 1996 of $251,000 
(.6% of net sales), compared to a net loss of $771,000 (2.8% of net sales) 
for the year ended July 2, 1995. The increase in net income resulted 
primarily from the Company's ability to increase sales in its retail and 
wholesale divisions with a minimal increase to operating expense.
 
Year Ended July 2, 1995 Compared with Year Ended December 31, 1994
 
Net sales for the twelve month period increased from $19.4 million for the 
year ended December 31, 1994 to $26.9 million for the year ended July 2, 
1995, an increase of 39%. The increase in net sales was due primarily to the 
opening of new retail stores and initial shipments in connection with an 
exclusive reseller agreement with Best Buy. Catalog sales decreased due in 
part to shifts in sales to the Company's retail stores.
 
In February 1995, the Company announced the signing of a definitive sales 
agreement with Best Buy. The Company's products became available in more than 
200 Best Buy stores by July 2, 1995. The gross margin on sales of the 
Company's speakers to Best Buy is significantly lower than on sales of the 
Company's speakers through its catalog or at its Company-owned retail stores. 
However, operating expenses as a percentage of net sales are significantly 
lower on the Company's sales to Best Buy than on its catalog and retail store 
sales.
 
Retail, catalog and wholesale sales accounted for 55%, 32%, and 13% of net 
sales for the year ended July 2, 1995, respectivley. For the year ended 
December 31, 1994, retail stores accounted for 52%, and catalog sales 
accounted for 48% of net sales. Sales of products manufactured by the Company 
accounted for 69%, and sales of stereo components manufactured by other 
companies accounted for 31% of net sales for the year ended July 2, 1995. For 
the year ended December 31, 1994, sales of products manufactured by the 
Company accounted for 62%, and sales of stereo components manufactured by 
other companies accounted for 38% of net sales. The increase in sales of 
products manufactured by the Company as a percentage of net sales results 
from the initial shipments under the exclusive reseller agreement with Best 
Buy.
 
The Company's gross margin decreased from 47.9% for the year December 31, 
1994, to 44.1% for the year ended July 2, 1995, due to the increase in retail 
store sales and the initial wholesale shipments, which have lower overall 
margins than catalog sales.
 
Sales and marketing expenses increased from $6.9 million for the year ended 
December 31, 1994 (35.5% of net sales) to $10.4 million (38.6% of net sales) 
for the year ended July 2, 1995. The hiring of additional personnel, 
increased advertising expenses, and amortization of pre-opening costs 
associated with the Company's entrance into the West Coast region late in 
1994 accounted for a substantial portion of the increase. General and 
administrative expenses increased from $1.6 million for the year ended 
December 31, 1994 (8.3% of net sales) to $2.2 million (8.2% of net sales) for 
the year ended July 2, 1995. Professional fees, insurance and overhead 
expenses associated with the Company's retail expansion have resulted in a 
substantial portion of the increase in general and administrative expenses. 
Engineering and development expenses increased from $669,000 (3.5% of net 
sales) for the year ended December 31, 1994 to $761,000 (2.8% of net sales) 
for the year ended July 2, 1995.
 
Interest income of $182,000 for the year ended December 31, 1994 and $165,000 
for the year ended July 2, 1995 resulted from investments in United States 
Treasury Securities purchased with the net proceeds of the Company's initial 
public offering, which was completed in April 1994.
 
The Company's effective income tax rate increased to 41.9% for the year ended 
July 2, 1995 from 32.1% for the year ended December 31, 1994.
 
The Company reported net income for the year ended December 31, 1994 of 
$207,000 (1.1% of net sales), compared to a net loss of $771,000 (2.8% of net 
sales) for the year ended July 2, 1995. The decrease in net income resulted 
primarily from a decrease in the Company's gross margin as noted above, and 
the amortization of pre-opening costs associated with the Company's entrance 
into the West Coast region late in calendar 1994.
 
LIQUIDITY AND CAPITAL RESOURCES
 
Prior to 1994, the Company financed its growth primarily from cash generated 
from operations and seasonal bank borrowings. In April 1994, the Company 
completed an initial public offering which generated net proceeds to the 
Company of $9,935,000. A portion of the proceeds, $4,212,334 was used to 
purchase fixed assets and leasehold improvements for the Company's new retail 
stores and its new manufacturing, warehousing and administrative office 
facilities in Newton, Massachusetts.
 
With the introduction of wholesale sales in March 1995, and the continued 
expansion of retail stores, total inventories increased from $2.4 million at 
April 1994 to $14.8 million at June 1997.
 
In April 1995, the Company obtained a demand discretionary line of credit 
with a bank in order to finance its increased investment in inventories and 
support continued sales growth. Advances are made against the line based on a 
lending formula on receivables and inventory. The line of credit is secured 
by all the Company's assets with interest payable at the bank's base rate 
(8.5% at June 29, 1997) plus 1/4%.
 
As of June 29, 1997 subsequent amendments to the agreement increased the 
maximum borrowings under the line of credit to $8 million. The Company had 
$3.7 million in excess availability on the line of credit at June 29, 1997. 
The Company believes that its resources are adequate to fund its operations 
through the end of fiscal 1998.
 
CAUTIONARY STATEMENTS
 
The Private Securities Litigation Reform Act of 1995 contains certain safe 
harbors regarding forward-looking statements. From time to time, information 
provided by the Company or statements made by its directors, officers, or 
employees may contain "forward-looking" information which involve risk and 
uncertainties. Any statements in this report that are not statements of 
historical fact are forward-looking statements (including, but not limited 
to, statements concerning the characteristics and growth of the Company's 
market and customers, the Company's objectives and plans for future 
operations, possible aquisitions, and the Company's expected liquidity and 
capital resources). Such forward-looking statements are based on a number of 
assumptions and involve a number of risks and uncertainties, and accordingly, 
actual results could differ materially. Factors that may cause such 
differences include, but are not limited to: the continued and future 
acceptance of the Company's products and services; the rate of growth in the 
industries of the Company's customers; the presence of competitors with 
greater technical, marketing and financial resources; the Company's ability 
to promptly and effectively respond to technological changes which meet 
evolving customer needs; capacity and supply constraints or difficulties; and 
the Company's ability to successfully integrate new operations.
 
                                       5
<PAGE>
                           CAMBRIDGE SOUNDWORKS, INC.
 
BALANCE SHEETS
 
<TABLE>
<CAPTION>
ASSETS                                                                               JUNE 30, 1996  JUNE, 29 1997
-------------------------------------------------------------------------------------------------------------------
<S>                                                                                  <C>            <C>
CURRENT ASSETS:
  Cash.............................................................................  $      87,421  $      58,043
  Accounts receivable, net.........................................................      2,431,670        719,855
  Income tax refund receivable.....................................................             --        404,434
  Inventories......................................................................     11,405,352     14,816,618
  Prepaid expenses.................................................................        187,247        181,150
  Deferred tax asset...............................................................        570,000        613,653
-------------------------------------------------------------------------------------------------------------------
  Total Current Assets.............................................................     14,681,690     16,793,753
-------------------------------------------------------------------------------------------------------------------

PROPERTY AND EQUIPMENT, AT COST:
  Production equipment and tooling.................................................        407,925        580,192
  Office equipment and furniture...................................................      1,148,610      1,367,080
  Leasehold improvements...........................................................      2,544,495      3,938,224
  Motor vehicles...................................................................        180,290        250,252
-------------------------------------------------------------------------------------------------------------------
                                                                                         4,281,320      6,135,748

  Less Accumulated depreciation and amortization...................................      1,135,478      1,995,287
-------------------------------------------------------------------------------------------------------------------
    Net Property and Equipment.....................................................      3,145,842      4,140,461
-------------------------------------------------------------------------------------------------------------------
OTHER ASSETS.......................................................................        302,880        163,990
-------------------------------------------------------------------------------------------------------------------
  Total Assets.....................................................................  $  18,130,412  $  21,098,204
-------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY 
-------------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES:
  Borrowings under line of credit..................................................  $   3,395,557  $   1,915,713
  Accounts payable.................................................................      2,123,773      2,148,399
  Accrued expenses.................................................................        979,689        914,978
  Customer prepayments and other current liabilities...............................        270,707        735,279
-------------------------------------------------------------------------------------------------------------------
    Total Current Liabilities......................................................      6,769,726      5,714,369
-------------------------------------------------------------------------------------------------------------------
COMMITMENTS (Notes 5, 8 and 9) 

STOCKHOLDERS' EQUITY:
  Preferred stock, no par value--
    Authorized -- 2,000,000 shares.................................................             --             --
  Common stock, no par value--
    Authorized -- 10,000,000 shares 
    Issued and outstanding 2,889,399 shares and 3,803,027 shares at 
    June 30, 1996 and June 29, 1997, respectively..................................     10,346,710     14,984,557
  Retained earnings................................................................      1,013,976        399,278
-------------------------------------------------------------------------------------------------------------------
    Total Stockholders' Equity.....................................................     11,360,686     15,383,835
-------------------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity.........................................  $  18,130,412  $  21,098,204
-------------------------------------------------------------------------------------------------------------------

</TABLE>
 
The accompanying notes are an integral part of these financial statements.
 
                                       6
<PAGE>
                           CAMBRIDGE SOUNDWORKS, INC.

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                        YEAR ENDED     SIX MONTHS     YEAR ENDED     YEAR ENDED     YEAR ENDED
                                       DECEMBER 31,   ENDED JULY 2,     JULY 2,       JUNE 30,       JUNE 29,
                                           1994           1995           1995           1996           1997
-------------------------------------------------------------------------------------------------------------------
<S>                                    <C>            <C>            <C>            <C>            <C>
                                                                      (UNAUDITED)
NET SALES............................  $  19,431,892  $  15,014,837  $  26,927,699  $  43,585,017  $  51,285,380
COST OF GOODS SOLD...................     10,133,001      8,696,852     15,043,196     25,871,582     30,965,293
-------------------------------------------------------------------------------------------------------------------
  Gross profit.......................      9,298,891      6,317,985     11,884,503     17,713,435     20,320,087
-------------------------------------------------------------------------------------------------------------------
SALES AND MARKETING EXPENSES.........      6,890,254      5,829,589     10,406,100     14,253,742     18,320,541
GENERAL AND ADMINISTRATIVE
  EXPENSES...........................      1,616,323      1,182,245      2,196,623      2,061,351      2,217,765
ENGINEERING AND DEVELOPMENT
  EXPENSES...........................        669,179        403,773        760,590        679,637        586,901
-------------------------------------------------------------------------------------------------------------------
  Total expenses.....................      9,175,756      7,415,607     13,363,313     16,994,730     21,125,207
-------------------------------------------------------------------------------------------------------------------
  Income (loss) from operations......        123,135     (1,097,622)    (1,478,810)       718,705       (805,120)

INTEREST INCOME......................        187,241         23,078        164,735             --             --
INTEREST EXPENSE.....................         (5,225)       (13,325)       (15,343)      (300,870)      (219,578)
-------------------------------------------------------------------------------------------------------------------
  Income (loss) before provision
   (benefit) for income taxes........        305,151     (1,087,869)    (1,329,418)       417,835     (1,024,698)
PROVISION (BENEFIT) FOR INCOME
  TAXES..............................         98,000       (435,000)      (558,000)       167,000  $    (410,000)
-------------------------------------------------------------------------------------------------------------------
  Net income (loss)..................  $     207,151  $    (652,869) $    (771,418) $     250,835  $    (614,698)
-------------------------------------------------------------------------------------------------------------------
Net Income (Loss) per Common and
  Common Equivalent Share............  $         .08  $        (.23) $        (.27) $         .09  $        (.19)
-------------------------------------------------------------------------------------------------------------------
Weighted Average Number of Common and
  Common Equivallent Shares
  outstanding........................      2,461,169      2,872,617      2,869,626      2,922,323      3,193,692
-------------------------------------------------------------------------------------------------------------------

</TABLE>
 
STATEMENTS OF STOCKHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                                                   COMMON STOCK                            TOTAL
                                            ---------------------------    RETAINED    STOCKHOLDERS'
                                               SHARES        AMOUNT        EARNINGS       EQUITY
-----------------------------------------------------------------------------------------------------
<S>                                         <C>           <C>            <C>           <C>
Balance, December 31, 1993................     1,456,580        334,750     1,208,859      1,543,609
  Initial public offering of common stock,
    net of issuance costs of $1,344,793...     1,410,000      9,935,207            --      9,935,207
  Exercise of stock options...............         5,000         16,800            --         16,800
  Net income..............................            --             --       207,151        207,151
-----------------------------------------------------------------------------------------------------
Balance, December 31, 1994................     2,871,580     10,286,757     1,416,010     11,702,767
  Exercise of stock options...............        17,244         57,940            --         57,940
  Net loss................................            --             --      (652,869)      (652,869)
-----------------------------------------------------------------------------------------------------
Balance, July 2, 1995.....................     2,888,824     10,344,697       763,141     11,107,838
  Exercise of stock options...............           575          2,013            --          2,013
  Net income..............................            --             --       250,835        250,835
-----------------------------------------------------------------------------------------------------
Balance, June 30, 1996....................     2,889,399  $  10,346,710  $  1,013,976  $  11,360,686
  Issuance of common stock, net of issuance
   costs of $156,649......................       912,294      4,632,895            --      4,632,895
  Exercise of stock options...............         1,334          4,952            --          4,952
  Net loss................................            --             --      (614,698)      (614,698)
-----------------------------------------------------------------------------------------------------
Balance, June 29, 1997....................  $  3,803,027  $  14,984,557  $    399,278  $  15,383,835
</TABLE>
 
 
The accompanying notes are an integral part of these financial statements.
 
                                       7
<PAGE>
                           CAMBRIDGE SOUNDWORKS, INC.
 
STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                              YEAR ENDED    SIX MONTHS    YEAR ENDED   YEAR ENDED   YEAR ENDED
                                             DECEMBER 31,  ENDED JULY 2,    JULY 2,     JUNE 30,     JUNE 29,
                                                 1994          1995          1995         1996         1997
---------------------------------------------------------------------------------------------------------------
<S>                                          <C>           <C>            <C>          <C>          <C>
                                                                        (UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss)........................   $  207,151    $  (652,869)  $  (771,418) $   250,835  $  (614,698)
  Adjustments to reconcile net income (loss)
    to net cash used in operating
    activities--
    Depreciation and amortization..........      276,915        286,482       499,888      744,009    1,096,147
    Deferred (prepaid) income taxes........      233,000       (308,000)      100,000     (284,000)     (43,653)
    Changes in current assets and
     liabilities--
     Accounts receivable, net..............     (312,583)      (427,164)     (692,644)  (1,628,623)   1,711,815
     Income tax refund receivable..........     (667,000)       286,072      (380,928)     380,928     (404,434)
     Inventories...........................   (5,761,353)    (2,189,452)   (7,165,942)    (881,725)  (3,411,266)
     Prepaid expenses......................     (148,824)       164,622       207,569      (70,038)       6,097
     Preopening costs......................     (717,719)       560,114      (157,605)     157,605           --
     Accounts payable......................    2,192,488         (6,161)    2,304,890   (1,205,555)      24,626
     Accrued expenses......................      145,121       (131,269)      172,171      496,513      (64,711)
     Customer prepayments and other current
      liabilities..........................       59,575       (185,085)      (13,943)     161,589      464,572
---------------------------------------------------------------------------------------------------------------
        Net cash used in operating 
         activities........................   (4,493,229)    (2,602,710)   (5,897,962)  (1,878,462)  (1,235,505)
----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property and equipment......   (2,136,742)      (850,943)   (2,698,048)  (1,224,649)  (2,090,766)
  Increase in other assets.................      (46,800)       (15,830)      (54,156)    (223,923)     138,890
----------------------------------------------------------------------------------------------------------------
        Net cash used in investing 
         activities........................   (2,183,542)      (866,773)   (2,752,204)  (1,448,572)  (1,951,876)
----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Borrowings under line of credit, net.....           --             --            --    3,395,557   (1,479,844)
  Repayment of capital lease obligation....      (47,812)            --       (42,345)          --           --
  Sale of common stock, net of issuance
   costs...................................    9,935,207             --            --           --    4,632,895
  Exercise of stock options................       16,800         57,940        74,740        2,013        4,952
    Net cash provided by financing
     activities............................    9,904,195         57,940        32,395    3,397,570    3,158,003
NET (DECREASE) INCREASE IN CASH............    3,227,424     (3,411,543)   (8,617,771)      70,536      (29,378)
CASH, BEGINNING OF PERIOD..................      201,004      3,428,428     8,634,656       16,885       87,421
CASH, END OF PERIOD........................   $3,428,428    $    16,885   $    16,885  $    87,421  $    58,043
----------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
  INFORMATION:
  Cash paid during the period for-- 
   Income taxes............................   $  561,563    $    77,500   $   157,500  $   145,500  $    66,100
----------------------------------------------------------------------------------------------------------------
   Interest................................   $    5,225    $    13,325   $    14,490  $   276,454  $   233,257
----------------------------------------------------------------------------------------------------------------
</TABLE>
 

The accompanying notes are an integral part of these financial statements.
 
                                       8
<PAGE>
                           CAMBRIDGE SOUNDWORKS, INC.
 
Notes to Financial Statements 
(Including Data Applicable to Unaudited Periods)
 
Note 1 Operations and Significant Accounting Policies
 
Cambridge SoundWorks, Inc. (the Company) was organized in 1988. The Company
designs and manufactures speakers for stereo, home theater and multimedia
computers. The Company markets its products and sells other audio and video
components through its mail-order catalog, Company-owned retail stores and other
methods of distribution, including large retail chains throughout the United
States.
 
The accompanying financial statements reflect the application of certain
accounting policies described in this note and elsewhere in the accompanying
notes to financial statements. The preparation of these 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 and disclosures 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.
 
(a) Change in Fiscal Year
 
On March 14, 1995, the Company's Board of Directors approved a change in the 
Company's fiscal year. The Company's fiscal year ends on the Sunday nearest 
the end of June. Included in the accompanying financial statements are 
unaudited statements of income and cash flows for the year ended July 2, 
1995. These financial statements have been prepared on a basis consistent 
with those of audited periods.
 
(b) Credit Card Policy
 
The Company generally does not extend credit to catalog and Company-owned 
retail store customers, except through third-party credit cards, including 
its branded Cambridge SoundWorks credit card. Credit under these accounts is 
extended by third parties, and accordingly, the Company bears no financial 
risk under these agreements except in the case of fraud. The Company's 
agreements with third-party credit companies provide for the electronic 
processing of credit approvals and the electronic submission of transactions. 
Upon the submission of these transactions to the credit card companies, 
payment is transmitted to the Company's bank account. Accordingly, the 
Company records these amounts as cash upon the electronic submission of the 
transaction to the appropriate processing agency.
 
The Company pays fees to third-party credit card companies. These fees range 
from .75% to 3.75% of the amount financed. These fees were approximately 
$371,000, $198,000, $423,000, $597,000 and $963,000 for the years ended 
December 31, 1994, for the six-month period ended July 2, 1995, and for the 
years ended July 2, 1995, June 30, 1996 and June 29, 1997 respectively, and 
are included in selling and marketing expenses in the accompanying statements 
of operations.
 
(c) Inventories
 
Inventories are stated at the lower of cost (first-in, first-out) or market 
and consist of the following:
 
<TABLE>
<CAPTION>
                                                                                       JUNE 30,       JUNE 29,
                                                                                         1996           1997
------------------------------------------------------------------------------------------------------------------
<S>                                                                                  <C>            <C>
Raw materials and work-in-process..................................................  $   3,823,302  $   3,010,897
Finished goods.....................................................................      7,582,050     11,805,721
------------------------------------------------------------------------------------------------------------------
                                                                                     $  11,405,352  $  14,816,618
------------------------------------------------------------------------------------------------------------------
                                                                                     -------------  -------------
</TABLE>
 
Inventories consist of materials, labor and overhead.
 
(d) Prepaid Expenses
 
The Company offers its products and those of others directly to consumers 
through its mail-order catalog. Direct mail costs related to catalog 
mailings, including printing and postage, which constitute direct-response 
advertising, are classified as prepaid expenses and are expensed over the 
estimated useful life of each catalog, typically two to six months, 
commencing on the date of the mailing.
 
(e) Preopening Costs
 
Throughout fiscal 1995 and during the first half of fiscal 1996, the Company 
opened numerous retail stores. The Company incurred direct costs prior to the 
opening of these new stores and amortized the preopening costs over periods 
of up to nine months.
 
(f) Depreciation and Amortization
 
The Company provides for depreciation and amortization using the 
straight-line method by charges to operations in amounts estimated to 
allocate the cost of the assets over their estimated useful lives as follows:
 
<TABLE>
<CAPTION>
                                                                                                ESTIMATED USEFUL
ASSET CLASSIFICATION                                                                                  LIFE
------------------------------------------------------------------------------------------------------------------
<S>                                                                                           <C>
Production equipment and tooling............................................................       3--5 Years
Office equipment and furniture..............................................................       5 Years
Leasehold improvements......................................................................       Life of lease
Motor vehicles..............................................................................       3 Years
</TABLE>
 
(g) Customer Prepayments
 
Advance payments received from customers are classified as customer
prepayments and recognized as revenue when the products are shipped.
 
(h) Revenue Recognition and Warranty Costs
 
The Company recognizes revenue from product sales, net of estimated future 
sales returns, at the time of shipment. The Company has not provided for any 
warranty reserves, as warranty costs incurred by the Company have not been 
significant.
 
(i) Net Income (Loss) per Common and Common Equivalent Share
 
Net income (loss) per share data are computed using the weighted average 
number of shares of common stock outstanding during each period. Common 
equivalent shares from stock options have been included in the computation 
using the treasury stock method only when their effect would be dilutive. 
Fully diluted net income (loss) per share data have not been separately 
presented, as the difference from primary net income (loss) per share data is 
insignificant.
 
On March 3, 1997, the Financial Accounting Standards Board issued SFAS No. 
128, Earnings Per Share. SFAS No. 128 establishes standards for computing and 
presenting earnings per share and applies to entities with publicly held 
common stock or potential common stock. This statement is effective for 
fiscal years ending after December 15, 1997 and early adoption is not 
permitted. When adopted, the statement will require restatement of prior 
years' earnings per share. The Company will adopt this statement for its 
fiscal year ended June 28, 1998. The Company believes that the adoption of 
SFAS No. 128 will not have a material effect on its financial statements.
 
(j) Engineering and Development Expenses
 
Engineering and development expenses are charged to operations as incurred.
 
(k) Concentration of Credit Risk
 
Financial instruments that potentially subject the Company to concentrations 
of credit risk are principally accounts receivable. This credit risk with 
respect to accounts receivable relates primarily to the following customers 
to whom the Company has substantial sales.
 
<TABLE>
<CAPTION>
                                                                                                        PERCENTAGE OF ACCOUNTS
                                                                                                         RECEIVEABLE CUSTOMERS
                                                                                                        A          B          C
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                                 <C>        <C>        <C>
Year Ended June 30, 1996..........................................................................         85%        --         --
Year Ended June 29, 1997..........................................................................          3%        13%       36%
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
 
To reduce the credit risk, the Company routinely assesses the financial 
strength of this and other customers and, as a consequence, believes that its 
accounts receivable credit risk exposure is limited. The Company maintains an 
allowance for potential credit losses but historically has not experienced 
any significant credit losses related to an individual customer or groups of 
customers in any particular industry or geographic area.
 
The estimated fair value of the Company's financial instruments, which 
include cash, accounts receivable and borrowings under the line of credit, 
approximates their carrying value.
 
Note 2 Significant Customers
 
During the six-month period and years ended July 2, 1995 and June 30, 1996, 
one customer accounted for approximately 23%, 13% and 22% of net sales, 
respectively. This customer accounted for substantially all of the Company's 
accounts receivable at June 30, 1996. During the years ended December 31, 
1994 and June 29,1997, there were no customers that accounted for greater 
than 10% of net sales.

                                      9

<PAGE>

                           CAMBRIDGE SOUNDWORKS, INC.
 
NOTE 3 LINE OF CREDIT
 
In April 1995, the Company entered into a $5 million demand discretionary 
line of credit (line of credit) with The First National Bank of Boston. As of 
June 29, 1997, subsequent amendments to the agreement increased the maximum 
borrowings under the line of credit to $8 million based upon certain 
percentages of eligible accounts receivable and inventory, as defined. The 
line of credit is secured by all assets of the Company. Borrowings under the 
line of credit accrue interest at the bank's prime rate (8.5% at June 29, 
1997) plus .25%. Based on the line of credit lending formula, as defined, the 
Company had available for borrowing, approximately $3.7 million at June 29, 
1997.
 
NOTE 4 INCOME TAXES
 
The Company follows Statement of Financial Accounting Standards (SFAS) No. 
109, Accounting for Income Taxes. Under SFAS No. 109, the Company recognizes 
a current tax liability or asset for current taxes payable or refundable and 
a deferred tax liability or asset for the estimated future tax effects of 
temporary differences to the extent they are realizable.


The provision (benefit) for income taxes consists of the following:
 
<TABLE>
<CAPTION>
                                                                               SIX-MONTH
                                                                    YEAR        PERIOD       YEAR        YEAR         YEAR
                                                                    ENDED        ENDED       ENDED       ENDED        ENDED
                                                                  DEC. 31,      JULY 2,     JULY 2,    JUNE 30,     JUNE 29,
IN THOUSANDS                                                        1994         1995        1995        1996         1997
--------------------------------------------------------------------------------------------------------------------------------
                                                                                          (UNAUDITED)
<S>                                                              <C>          <C>          <C>        <C>          <C>
Current--
  Federal......................................................   $    (104)   $    (107)  $    (508)  $     345    $    (281)
  State........................................................         (31)         (20)       (150)        106          (85)
--------------------------------------------------------------------------------------------------------------------------------
                                                                       (135)        (127)       (658)        451         (366)
--------------------------------------------------------------------------------------------------------------------------------
Deferred--
  Federal......................................................         196         (266)         61        (216)         (33)
  State........................................................          37          (42)         39         (68)         (11)
--------------------------------------------------------------------------------------------------------------------------------
                                                                        233         (308)        100        (284)         (44)
--------------------------------------------------------------------------------------------------------------------------------
Total 
provision (benefit)............................................   $      98    $    (435)  $    (558)  $     167    $    (410)
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>
 
Pursuant to the provisions of SFAS No. 109, as of June 30, 1996 and June 29, 
1997, the Company recorded deferred tax assets of approximately $570,000 and 
$614,000, respectively. These deferred tax assets primarily result from 
timing differences in the recognition of revenues and expenses for tax and 
financial reporting purposes. The sources of these differences and the 
approximate amount of each are as follows:
 
<TABLE>
<CAPTION>
                                                                                             JUNE 30,    JUNE 29,
                                                                                               1996        1997
--------------------------------------------------------------------------------------------------------------------
<S>                                                                                         <C>         <C>
Inventory reserve.........................................................................  $  244,000  $  216,000
Net operating loss carryforward and other credit carryforwards............................      66,000      45,000
Other reserves............................................................................      97,000     103,000
Depreciation..............................................................................     175,000     350,000
Valuation allowance.......................................................................     (12,000)   (100,000)
--------------------------------------------------------------------------------------------------------------------
                                                                                            $  570,000  $  614,000
--------------------------------------------------------------------------------------------------------------------
                                                                                            ----------  ----------
</TABLE>
 
At June 29, 1997, the Company had available net operating loss carry forwards 
of approximately $96,000. These Net operating loss carry forwards may be used 
to reduce future taxable income, if any. These carry forwards expire through 
2012 and are subject to review and possible adjustment by the appropriate 
taxing authorities.
 
Due to the uncertainty of the realization of certain of these potential tax 
benefits, the Company has recorded a valuation allowance against a portion of 
its deffered tax assets.
 
    A reconciliation of the federal statutory rate to the Company's effective
tax rate is as follows:
 
<TABLE>
<CAPTION>
                                                                              SIX-MONTH
                                                                 YEAR          PERIOD        YEAR         YEAR         YEAR
                                                                 ENDED          ENDED        ENDED        ENDED        ENDED
                                                             DECEMBER 31,      JULY 2,      JULY 2,     JUNE 30,     JUNE 29,
                                                                 1994           1995         1995         1996         1997
----------------------------------------------------------------------------------------------------------------------------------
<S>                                                         <C>              <C>          <C>          <C>          <C>
                                                                             (UNAUDITED)
Statutory tax rate........................................          34.0%         (34.0)%      (34.0)%       34.0%       (34.0)%
State taxes, net of federal benefit.......................           6.3           (6.3)        (6.3)         6.3         (6.3)
Research and development credits..........................          (8.2)            --         (1.7)          --           --
Other.....................................................            --            0.3           --         (0.3)         0.3
----------------------------------------------------------------------------------------------------------------------------------
Effective tax rate........................................          32.1%         (40.0)%      (42.0)%       40.0%       (40.0)%
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
 
NOTE 5 COMMITMENTS
 
The Company conducts its operations in leased facilities and leases certain 
equipment under operating lease agreements. These operating leases expire 
through December 2011. Future minimum lease payments under these operating 
leases are approximately as follows:
 
<TABLE>
<CAPTION>
FISCAL YEAR                                                                               AMOUNT
-----------------------------------------------------------------------------------------------------
<S>                                                                                    <C>
1998.................................................................................   $  3,083,000
1999.................................................................................      3,063,000
2000.................................................................................      2,554,000
2001.................................................................................      2,435,000
2002.................................................................................      2,466,000
Thereafter...........................................................................      8,919,000
------------------------------------------------------------------------------------------------------           
                                                                                       $  22,520,000
</TABLE>
 
The Company is also obligated to pay for certain operating and other expenses 
in accordance with the terms of its various leases.
 
Total rent expense under these leases for the years ended December 31, 1994, 
the six-month period ended July 2, 1995 and the years ended July 2, 1995, 
June 30, 1996 and June 29, 1997 was approximately $320,000, $576,000, 
$799,000, $1,929,000 and $2,886,000 respectively.
 
Note 6 Stockholders' Equity
 
(a) Issuance of Common Stock
 
The Company entered into a Common Stock and Warrant Purchase Agreement dated 
as of February 20, 1997 (the Purchase Agreement), with Creative Technology, 
Ltd., a Singapore corporation. Pursuant of the terms of the Purchase 
Agreement, the Company sold and issued to Creative Technology, Ltd. (i) 
912,294 shares of common stock of the Company at a purchase price of $5.25 
per share, and (ii) a warrant to purchase 257,314 shares of common stock of 
the Compnay at an exercise price of $6.00 per share at a purchase price of 
$1,000 in the aggregate.
 
(b) Preferred Stock
 
The Company has authorized 2,000,000 shares of no par preferred stock. The 
Board of Directors has full authority to issue this stock and to fix the 
voting powers, preferences, rights, qualifications, limitations or 
restrictions thereof, including dividend rights, conversion rights, 
redemption privileges and liquidation preferences, and the number of shares 
constituting any series or designation of such series. With regard to 
dividends, redemption privileges and liquidation preferences, any particular 
series of preferred stock may rank junior to, on parity with, or senior to 
any other series of preferred stock or the common stock.
 
(c) Stock Option Plans
 
The Company's 1993 Stock Option Plan as amended (the 1993 Plan) is 
administered by the Board of Directors and authorizes the Company to issue 
options to purchase up to 620,000 shares that have been reserved by the 
Company. Under the terms of the 1993 Plan, the Company may grant employees 
either incentive stock options or nonqualified stock options to purchase 
shares of the Company's common stock, at a price not less than the fair 
market value at the date of grant, which vest over periods determined by the 
Board of Directors. In addition, the Company may grant nonqualified options 
to nonemployees.

                                   10

<PAGE>

                           CAMBRIDGE SOUNDWORKS, INC.
 
Note 6 Stockholders' Equity (Continued)
 
Under a separate plan, on February 1, 1993, the Board of Directors and 
stockholders granted a former officer an option to purchase 22,244 shares of 
common stock at an exercise price of $3.36 per share, the fair market value 
of the common stock at the date of grant as determined by the Board of 
Directors, pursuant to an Incentive Stock Option Plan and Agreement. As of 
July 2, 1995, the former officer had exercised all options under this plan.
 
The following table summarizes stock option activity under the stock option 
plans for the years ended December 31, 1994 the six-month period ended July 
2, 1995 and the years ended June 30, 1996 and June 29, 1997:
 
<TABLE>
<CAPTION>
                                                                                        NUMBER    WEIGHTED AVERAGE
                                                                                      OF SHARES     OPTION PRICE
--------------------------------------------------------------------------------------------------------------------
<S>                                                                                   <C>         <C>
Outstanding, December 31, 1993......................................................      22,244      $    3.36
  Granted...........................................................................     101,120           8.01
  Terminated........................................................................     (21,440)          8.00
  Exercised.........................................................................      (5,000)          3.36
--------------------------------------------------------------------------------------------------------------------
Outstanding, December 31,1994.......................................................      96,924           7.19
  Granted...........................................................................     169,200           4.12
  Terminated........................................................................     (18,320)          6.14
  Exercised.........................................................................     (17,244)          3.36
--------------------------------------------------------------------------------------------------------------------
Outstanding, July 2, 1995...........................................................     230,560           5.42
  Granted...........................................................................     356,780           4.86
  Terminated........................................................................    (142,190)          5.40
  Exercised.........................................................................        (575)          3.50
--------------------------------------------------------------------------------------------------------------------
Outstanding June 30, 1996...........................................................     444,575           5.01
  Granted...........................................................................     187,820           4.01
  Terminated........................................................................     (50,795)          5.82
  Exercised.........................................................................      (1,334)          3.71
--------------------------------------------------------------------------------------------------------------------
Outstanding June 29, 1997...........................................................     580,266      $    3.92
--------------------------------------------------------------------------------------------------------------------
Exercisable, June 29, 1997..........................................................     230,235      $    4.81
--------------------------------------------------------------------------------------------------------------------
</TABLE>
 
The range of actual exercise prices for options outstanding and options 
excercisable as of June 29, 1997 was $3.50 to $8.02.
 
In October 1995, the Financial Accounting Standards Board (FASB) issued SFAS 
No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 requires the 
measurement of the fair value of stock options or warrants to be included in 
the statement of operations or disclosed in the notes to financial 
statements. The Company has determined that it will continue to account for 
stock-based compensation for its employees under the Accounting Principles 
Board Option No. 25 and elect the disclosure-only alternative under SFAS No. 
123 for stock-based compensation awarded in 1996 and 1997 using the 
Black-Scholes option pricing model prescribed by SFAS No. 123. The underlying 
assumptions used are as follows:
 
<TABLE>
<CAPTION>
                                                                                                      YEARS ENDED
                                                                                                ------------------------
                                                                                                 JUNE 30,     JUNE 29,
                                                                                                   1996         1997
------------------------------------------------------------------------------------------------------------------------
<S>                                                                                             <C>          <C>
Risk-free interest rate.......................................................................        6.13%        6.51%
Expected dividend yield.......................................................................          --           --
Expected lives................................................................................           7            7
Expected volatility...........................................................................        60.1%        60.1%
Weighted average remaining contractual life of options outstanding (years)....................         8.5          8.6
</TABLE>
 
The weighted average grant date fair value of options granted during the 
years ended June 29, 1997 and June 30, 1996 under these plans is $3.15 and 
$2.68, respectively. Had compensation cost for the Company's stock option 
plans been determined consistent with SFAS No. 123, pro forma net loss and 
net loss per share would have been:
 
<TABLE>
<CAPTION>
                                                      JUNE 30,                 JUNE 29,
                                                       1996                     1997
------------------------------------------------------------------------------------------
<S>                                                <C>                   <C>
Net income (loss)--
  As reported......................................  $250,835             $  (614,698)
  Pro forma........................................  (21,011)              (1,137,701)
Net income (loss) per share-- 
  As reported......................................      .09                     (.19)
  Pro forma........................................     (.01)                    (.36)

</TABLE>

Because the method prescribed by SFAS No. 123 has not been applied to options 
granted prior to January 1, 1995, the resulting pro forma compensation cost 
may not be representative of that to be expected in future years.

Simultaneous with the Common Stock and Warrant Purchase Agreement, the 
Company entered into an exclusive distribution agreement with Creative 
Technologies Ltd. which has a life of three years.

The Warrant has been valued at approximately $385,000 using the fair value 
method approach as prescribed in SFAS 123. The Warrant value will be 
amortized over the life of the relevant distribution agreement.

Note 7 Accrued expenses

Accrued expenses consist of the following:


<TABLE>
<CAPTION>
                                                                                             JUNE 30,    JUNE 29,
                                                                                               1996        1997
-------------------------------------------------------------------------------------------------------------------
<S>                                                                                         <C>         <C>
Marketing Expenses........................................................................  $  192,294  $  400,296
Other.....................................................................................     787,395     514,682
-------------------------------------------------------------------------------------------------------------------
                                                                                            $  979,689  $  914,978
-------------------------------------------------------------------------------------------------------------------
</TABLE>
 
Note 8 Related Parties
 
In February 1994, the Company entered into a License Agreement with Henry 
Kloss, a stockholder of the Company, whereby the Company and Mr. Kloss's name 
on its products. The License Agreement between the Company and Mr. Kloss 
provided that the Company has the perpetual right to use his name on products 
that Mr. Kloss designed or had a substantial role in designing, subject to 
termination, as to any product whose appearance or performance specifications 
are materially changed by the Company without Mr. Kloss's consent. Upon 
termination of Mr. Kloss's employment, as described above, the Company could 
not thereafter use his name generically or in connection with a product 
unless the Company had previously done so, unless Mr. Kloss consents to such 
use. Under this agreement, the Company was not required to make any payments 
to Mr. Kloss for the right to use his name. 

In April 1996, the Company entered into a Consulting Agreement with Henry 
Kloss, with respect to the selection and design by the Company for current 
and future products, expiring in September 1999. Pursuant to the Consulting 
Agreement, the Employment Agreement between the Company and Mr. Kloss was 
effectively terminated, with no additional payments due. The Consulting 
Agreement called for annual payments to Mr. Kloss of $330,000 plus certain 
fringe benefits, such as described therein through September 1996 with annual 
payments thereafter of $110,000, plus certain fringe benefits, as described 
therein from September 1996 through September 1999.
 
Effective September 30, 1996, Henry Kloss terminated the Consulting Agreement 
dated April 24, 1996 which he had entered into with the Company to provide 
general and specific advice, counsel and assistance to the Company with 
respect to the selection and design by the Company of its current and future 
products. At the same time, Mr. Kloss notified the Company of his intention 
not to stand for reelection as a Director. Mr. Kloss continues on an informal 
basais to act as a consultant to the Company for which he is paid $10,565 per 
month but for which there is no formanl written agreement. This arrangement 
can be terminated by either party at will. Mr. Kloss, former Chairman of the 
Board of Directors of the Company and former Director of Product Development 
provided consulting services to the Company during year ended June 29, 1997 
for which he has received $179,000 from the company.

                                   11

<PAGE>

                           CAMBRIDGE SOUNDWORKS, INC.
 
Note 9 Employment Agreements
 
On February 14, 1997 the Company entered into a three year agreement with 
Thomas J. DeVesto (the Employment Agreement) employing him in the capacity as 
President and Chief Executive Officer. Pursuant to the Employment Agreement, 
which provides for an initial salary of no less than $385,000, with such 
adjustments thereto after the first year which the Board of Directors may 
approve. Mr. DeVesto is also entitled to certain fringe benefits, including 
the right to participate in all bonus and benefit programs that the Company 
makes available to its employees and an annual $8,000 car allowance. The 
Employment Agreement may be terminated by any party on six month's prior 
notice for any reason in which event Mr. DeVesto is entitled to a payment 
equal to his then annual salary in consideration for an agreement not to 
compete for one year following the termination of employment.
 
Note 10 Benefit Plan
 
During fiscal 1996, the Company adopted the Cambridge SoundWorks 401(k) Plan 
(the Plan), a voluntary savings plan for all eligible employees, as defined. 
The Plan is a qualified benefit plan in accordance with Section 401(k) of the 
Internal Revenue Code. Under the terms of the Plan, participants may 
contribute a certain percentage of their annual compensation, up to a defined 
maximum. The Company may, but is not obligated to, make a matching 
contribution up to a certain percentage of each participant's contribution. 
For the year ended June 30, 1996 and June 29, 1997, the Company did not make 
a matching contribution to the Plan.
 
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To Cambridge SoundWorks, Inc.:
 
We have audited the accompanying balance sheets of Cambridge SoundWorks, Inc. 
(a Massachusetts corporation) as of June 30, 1996 and June 29, 1997, and the 
related statements of operations, stockholders' equity and cash flows for the 
years ended December 31, 1994, the six-month period ended July 2, 1995 and 
the years ended June 30, 1996 and June 29, 1997. 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 Cambridge SoundWorks, Inc. 
as of June 30, 1996 and June 29, 1997, and the results of its operations and 
its cash flows for the year ended December 31, 1994, for the six-month period 
ended July 2, 1995 and for the years ended June 30, 1996 and June 29, 1997, 
in conformity with generally accepted accounting principles.
 
ARTHUR ANDERSEN LLP
 
Boston, Massachusetts 
July 28, 1997

                                   12

<PAGE>

BOARD OF DIRECTORS
 
<TABLE>
<S>                            <C>                            <C>
Thomas J. DeVesto              President, Chief Executive     Cambridge SoundWorks, Inc.
                               Officer
 
Thomas E. Brew, Jr.            President, Chief Executive     Kurzweil Applied
                               Officer                        Intelligence, Inc.
 
Franklin S. Browing, Jr.       Business Consultant
 
Leo Kahn                       Partner                        United Properties
 
Craig L. McHugh                Vice President, General        Creative Labs, Inc.
                               Manager
 
Peter B. Seamans               Partner                        Peabody & Arnold
</TABLE>
 

EXECUTIVE OFFICERS
 
<TABLE>
<S>                                            <C>
Thomas J. DeVesto                              President, Chief Executive Officer
Wayne P. Garrett                               Vice President--Finance, Chief Financial Officer
Thomas J. Hannaher                             Vice President--Marketing
Robert S. Mainiero                             Vice President--Business Development
Sandy Ruby                                     Vice President--Retail

</TABLE>
<TABLE>
<C>                                           <S>
                                                Stock Data
CORPORATE INFORMATION
 
Corporate Offices 
                                                Cambridge SoundWorks, Inc., is traded on the NASDAQ
Cambridge SoundWorks, Inc.                      National Market System under the symbol HIFI.
311 Needham Street 
Newton, MA 02164                                Annual Meeting
(617) 332-5936
(617) 332-9229 Fax                              The annual meeting of shareholders will be held on November 4, 1997
                                                at 11:00 a.m. at the Company's headquarters, 311 Needham Street, 
Legal Counsel                                   Newton, MA 02164

Peabody & Arnold                                Press Releases and Quarterly Results
Boston, Massachusetts
                                                Press releases including quarterly financial results are available by fax to
Independent Accountants                         all shareholders immediately upon their release, free of charge, by calling 
                                                PR Newswire's Company News On Call at 1-800-758-5804 (ext. 114553) 
Arthur Andersen LLP                             or through access on the Internet at http://www.prnewswire.com.
Boston, Massachusetts

Transfer Agent                                  Form 10-Q and 10-K 

State Street Bank and Trust Company             The Company's quarterly and annual reports to the Security and
c/o Boston EquiServe                            Exchange Commission are filed electronically on Form 10-Q and 10-K,
P. O. Box 8200                                  respectively. These reports can be accessed on the Internet at
Canton, MA 02021                                http://www.sec.gov or can be obtained, free of charge, by phoning or
(617) 575-2000                                  writing to the Company or its Investor Relations counsel.
                                                
Investor Relations                              Internet Site 

John H. Swanson                                 The Company's Internet site may be accessed at the following address:
Swanson Communications, Inc.                    http:// www.hifi.com.
234 5th Avenue
New York, NY 10001 
(212) 683-4890
(212) 679-1184 Fax

</TABLE>

<PAGE>




                                        CAMBRIDGE
                                       SoundWorks
                                CAMBRIDGE SOUNDWORKS, INC. 
                                    311 NEEDHAM STREET
                                     NEWTON, MA 02164