MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
         The Company is a  full-service,  turnkey  provider  of CDs,  cassettes,
diskettes and related  services.  The Company services the multimedia needs of a
wide  variety  of   customers,   including   software   distributors,   computer
manufacturers,  recording studios and other producers of multimedia products for
retail distribution,  publishers,  marketing groups and data base suppliers.  In
addition to actually replicating  information on CDs, cassettes,  and diskettes,
the Company offers its customers a "one-stop  shop" with a full range of related
services  such  as  package  design,  graphics  design,   printing,   packaging,
warehousing and drop shipping.  The Company began  manufacturing CDs in 1993. To
further its reputation as a  full-service  provider of multimedia  products,  in
1995 the Company acquired  cassette  manufacturing  equipment and added diskette
manufacturing to its operations.

         Zomax Optical Media,  Inc. (the Company) was  incorporated  on February
22, 1996 and completed its initial  public stock offering of its common stock on
May 10, 1996. Upon completion of the initial public stock offering,  the Company
received all of the  operating  assets,  liabilities,  and debt of Zomax Optical
Media Limited  Partnership  (Partnership)  in a tax-free  exchange for 2,800,000
shares of its common stock.  This transfer was accounted for at historical  cost
with no  change  in the  book  and  tax  bases  of the  assets  contributed  and
liabilities and debts assumed,  except for tax effects resulting from converting
from a partnership to a corporation.  Since the exchange created a new reporting
entity,  the financial  statements of the Partnership prior to the offering have
been captioned Predecessor Partnership.


Results of Operations
         The following  table sets forth certain  operating data as a percentage
of sales for the periods indicated.
<TABLE>
<CAPTION>
                                                               (Predecessor
                                                               Partnership)
                                                              For the Period         (Predecessor
                                      Period From May 11       from Jan. 1           Partnership)
                                     Through Dec. 27, 1996   Through May 10,      For the Year Ended
                                                                   1996              Dec. 31, 1995
<S>                                       <C>                 <C>                      <C>   
Sales                                     100.0%              100.0%                   100.0%
Cost of goods sold                         71.2%               72.2%                    75.9%
                                           -----               -----                    -----
Gross profit                               28.8%               27.8%                    24.1%
SG&A                                       16.3%               16.9%                    15.5%
                                           -----               -----                    -----
Operating income                           12.5%               10.9%                     8.5%
Interest expense                          (1.7)%              (2.4)%                   (2.4)%
Interest income                             2.0%                 .4%                      .5%
                                            ----                 ---                      ---
Income before income taxes                 12.8%                8.9%                     6.7%
                                                                ----                     ----
Income taxes                                5.2%
                                           -----
Net income                                  7.6%
                                           -----

</TABLE>




<PAGE>

Year Ended December 27, 1996 Compared to Year Ended December 31, 1995
Sales
         Sales increased 40.3% to $18,547,796 in 1996 for the combination of the
Predecessor  Partnership  and the Company from  $13,217,539  in 1995. The higher
sales in 1996  resulted  principally  from a 46%  increase  in CD sales  and the
addition of diskette duplicating  services,  offset by a 16% decline in cassette
sales.  Substantially  all of the  increase  in CD  sales  in 1996 was due to an
increase in the number of units  sold.  The  Company  believes  the growth in CD
sales resulted from increased  production  capacity which allowed the Company to
manufacture more CDs and thereby compete more effectively in the rapidly growing
CD-ROM  market,  increased  marketing  efforts and the  strategy of being a full
service  provider of  multimedia  products and related  services.  Cassette unit
sales declined  approximately  16% in 1996 principally due to lower sales to one
customer.

Cost of goods sold
         Cost of goods  sold as a  percentage  of sales  was 71.6% and 75.9% for
1996 and 1995, respectively.  The Company was able to decrease the cost of goods
sold percentage through increased production and improved plant efficiency.  The
Company outsourced 3% of its CD manufacturing during the year ended December 27,
1996 as  compared to 35% in 1995.  The cost for such  outsourced  production  is
significantly  higher than the cost of CDs produced by the Company.  The Company
was able to reduce its outsourcing by increasing its CD  manufacturing  capacity
by  approximately  10.0  million  units  in 1996  through  the  purchase  of new
machinery.

Selling, general and administrative
         Selling,  general and administrative  expense increased as a percentage
of sales to 16.4% in 1996 from  15.5% in 1995.  The  increase  in 1996  resulted
principally from an increase in salary expense, resulting from hiring additional
corporate staff in sales, customer service,  accounting and other administrative
functions. In 1996, the Company also increased its reserve for doubtful accounts
principally  due to the  uncertainty  regarding  the  collection  of a  $209,000
receivable balance and an overall increase in accounts receivable  balances.  In
1996, the Company also incurred additional costs of being a public company.

Interest income (expense)
         Interest income increased to $284,624 in 1996 from $70,956 in 1995. The
increase in interest  income resulted from the investment of the proceeds of the
Company's  initial public offering in May, 1996.  Interest expense  increased to
$357,166 in 1996 from $318,087 in 1995 as the result of increased  borrowings to
finance purchases of additional CD manufacturing equipment in 1996.

Income tax expense
         The  Company's  effective  income tax rate for the period  from May 11,
1996  through  December 27, 1996 was 40.4%.  Prior to May 11, 1996,  the Company
operated as a partnership for income tax purposes.

Liquidity and Capital Resources
         As of December 27, 1996,  the Company had cash totaling  $6,914,899 and
working  capital of  $7,110,373.  The increase in cash and working  capital from
1995  levels  of  $936,662  and  $1,019,496,  respectively,  resulted  from  the
completion  of the  Company's  initial  public  offering on May 10, 1996.  Total
proceeds to the Company from the sale of  1,585,000  shares of common stock were
$9,251,850,  net of offering costs. The Company has committed to the purchase of
mastering equipment with an estimated cost of $4.0 million and plans to purchase
additional CD manufacturing and related equipment totaling $3.0 million in 1997.
The Company plans to finance these  purchases with long term financing and cash.
The Company has a revolving  line of credit  facility  for up to $1.5 million of
borrowings  limited  to an amount  based on a formula  using  eligible  accounts
receivable  and  inventories.  There were no  borrowings  outstanding  under the
revolving  line of credit  facility at December 27, 1996.  The Company  believes
that it has  sufficient  liquidity  and capital  resources to meet its operating
needs and capital expenditure requirements for the foreseeable future.


<PAGE>

         In 1996,  the Company  generated  $2.1 million of cash from  operations
while in 1995, the Company used cash in operations totaling $182,000. The use of
cash for operating  activities in 1995 principally  resulted from a $2.5 million
increase in accounts receivable.  In 1996, the Company purchased $4.0 million of
equipment as compared to $2.4 million in 1995. During 1996, the Company financed
equipment  purchases  totaling  $791,000  with long term debt  compared  to $2.1
million  financed  with long  term  debt in 1995.  During  the  period  when the
Partnership existed, $1.5 million of capital contributions were received in 1995
and  partners  distributions  were $1.1  million and  $230,000 in 1996 and 1995,
respectively.

         In February 1997, the Company signed a letter of intent to purchase all
outstanding stock of Benchmark Media Services, Inc., a manufacturer,  replicator
and  marketer  of compact  discs and  diskettes.  The  Company  intends to use a
combination of cash and bank debt to finance this acquisition.

Seasonality
         The demand for CDs and other multimedia  consumer products is seasonal,
with  increases  in the fall  reflecting  increased  demand  relative to the new
school year and holiday  season  purchases.  This  seasonality  could  result in
significant quarterly variations in financial results, with the third and fourth
quarters generally being the strongest.

Inflation
         Historically,  inflation has not had a material  impact on the Company.
The cost of the  Company's  products is  influenced by the cost of raw materials
and labor.  There can be no  assurance  that the Company will be able to pass on
increased costs to its customers in the future.

Outlook
         The statements  contained in this Outlook  section are based on current
expectations.  These statements are forward looking and are made pursuant to the
safe harbor  provisions of the Private  Securities Reform Act of 1995. There are
certain  important  factors that could cause results to differ  materially  from
those anticipated by some of the statements made herein. Investors are cautioned
that all forward-looking statements involve risk and uncertainty.

          The  Company  believes  the total  number of CDs sold  worldwide  will
continue to grow in 1997. Further,  1997 unit prices are expected to decrease as
a result of an increase in the number of CD manufacturers  and higher production
capacity for existing manufacturers. The Company believes it has an organization
in place that will support the expected  increase in sales growth with a minimum
increase in salaried personnel.

         The  Company  plans to expand its  manufacturing  capacity  through new
equipment  purchases in 1997 including the  installation  of CD glass  mastering
equipment during the second quarter of 1997 and additional  molding equipment in
the second half of 1997. The Company believes that these advancements will allow
it to pursue a broader  customer  base and improve the quality of its  products.
The Company  intends to finance  these  purchases  with long term  financing and
existing  cash.  Additionally,  the  Company  intends to expand  its  operations
nationally by increasing its presence on the East and West coasts as well as the
South through plant  start-ups or  acquisitions.  There can be no guarantee that
the Company  will be able to secure the  necessary  financing  or find  suitable
expansion  opportunities.  Its  inability  to do so will  result in the delay or
cancellation of planned equipment  purchases and the need to forego other growth
plans, which may adversely impact the Company's ability to meet market demand or
expand operations.

         If the CD market demand does not continue to grow as expected,  revenue
growth would be adversely impacted and the manufacturing  capacity installed may
be  underutilized.  Pricing  strategies  of  competitors  and  general  economic
factors, such as consumer confidence and inflation, all impact the Company.


<PAGE>

                                  COMMON STOCK
         The Company's common stock began trading on May 10, 1996, on the Nasdaq
National  Market under the symbol "ZOMX," in connection  with its initial public
offering.  Prior to May 10, 1996,  there was no public  market for the Company's
Common  Stock.  A summary  of the range of high and low bid  quotations  for the
Company's common stock for the period from May 10, 1996 to December 27, 1996, is
presented  below.  These prices  reflect  interdealer  prices and do not include
retail markups, markdowns or commissions.

                                                High                 Low
                 1996
                 Second Quarter (May 10,        $7.75                $6.75
                      1996 - June 30, 1996)
                 Third Quarter                  $8.63                $6.75
                 Fourth Quarter                 $7.88                $5.00


         The Company has never paid cash dividends on its capital stock and does
not anticipate declaring or paying any cash dividends in the foreseeable future.
The  Company  intends  to retain  future  earnings  for the  development  of its
business.

         As of March  3,  1997,  the  Company  had 85  stockholders  of  record,
excluding  stockholders whose stock is held either in nominee name and/or street
name brokerage  accounts.  Based on  information  which the Company has obtained
from its transfer agent, there are approximately  1,500 stockholders whose stock
is held either in nominee name and/or street name brokerage accounts.

<PAGE>



                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To Zomax Optical Media, Inc.:

We have audited the accompanying  balance sheets of Zomax Optical Media, Inc. (a
Minnesota  corporation which operated as Zomax Optical Media Limited Partnership
through May 10, 1996) as of December  27, 1996 and  December  31, 1995,  and the
related statements of operations, changes in partners' capital and shareholders'
equity and cash flows for the periods  from May 11, 1996  through  December  27,
1996 and January 1, 1996  through  May 10, 1996 and for the year ended  December
31, 1995.  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 Zomax Optical Media, Inc. as of
December 27, 1996 and December 31, 1995,  and the results of its  operations and
its cash flows for the periods from May 11, 1996  through  December 27, 1996 and
January 1, 1996  through May 10, 1996 and for the year ended  December 31, 1995,
in conformity with generally accepted accounting principles.


                                                   /s/ Arthur Andersen LLP
                                                   ARTHUR ANDERSEN LLP



Minneapolis, Minnesota,
   January 24, 1997



<PAGE>



                            ZOMAX OPTICAL MEDIA, INC.

             (Successor to Zomax Optical Media Limited Partnership)

                                 Balance Sheets
<TABLE>
<CAPTION>

                                                                                   (Predecessor
                                                                                   Partnership)
                                                             December 27, 1996  December 31, 1995
                                                             -----------------  ----------------- 
                                    ASSETS

<S>                                                             <C>               <C>
CURRENT ASSETS:
   Cash and cash equivalents                                    $ 6,914,899       $  936,662
   Accounts receivable, net of 
      allowance for doubtful accounts
      of $531,000 and $110,000                                    3,944,929        3,019,333
   Inventories                                                    1,262,665          787,198
   Prepaid expenses                                                 110,443          102,234
                                                                -----------       ---------- 
               Total current assets                              12,232,936        4,845,427

PROPERTY AND EQUIPMENT, net of accumulated
   depreciation of $1,983,875 and $938,904                        7,574,501        4,662,406

RESTRICTED CASH (Note 2)                                            135,249          391,406

OTHER ASSETS, net                                                    12,167            5,167
                                                                -----------       ---------- 
                                                                $19,954,853       $9,904,406
                                                                ===========       ========== 

            LIABILITIES AND PARTNERS' CAPITAL/ SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
   Current portion of notes payable                             $ 1,508,607       $1,216,375
   Accounts payable                                               1,590,088        1,767,262
   Accrued expenses                                               1,510,049          719,065
   Income taxes payable                                             513,819                -
   Preferential distribution to partners                                  -          123,229
                                                                -----------       ---------- 
               Total current liabilities                          5,122,563        3,825,931

NOTES PAYABLE, net of current portion                             1,714,374        2,589,218

COMMITMENTS AND CONTINGENCIES (Notes 2, 9 and 10)

PARTNERS' CAPITAL                                                         -        3,489,257
                                                                -----------       ---------- 
SHAREHOLDERS' EQUITY:
   Common stock, no par value, 15,000,000 authorized
      shares, 4,385,000 shares issued and outstanding            12,133,585                -
   Retained earnings                                                984,331                -
                                                                -----------       ---------- 
               Total shareholders' equity                        13,117,916                -
                                                                -----------       ---------- 
                                                                $19,954,853       $9,904,406
                                                                ===========       ========== 
</TABLE>



      The accompanying notes are an integral part of these balance sheets.

<PAGE>


                            ZOMAX OPTICAL MEDIA, INC.

             (Successor to Zomax Optical Media Limited Partnership)

                            Statements of Operations
<TABLE>
<CAPTION>


                                                                                       (Predecessor Partnership)
                                                                  Period From        Period From
                                                                  May 11 Through     January 1           Year Ended
                                                                  December 27,       Through May 10,     December 31,
                                                                      1996               1996                1995
                                                                   -----------       ----------          -----------
<S>                                                                <C>               <C>                 <C>        
SALES                                                              $12,887,050       $5,660,746          $13,217,539

COST OF SALES                                                        9,180,325        4,089,721           10,036,991
                                                                    ----------       ----------           ----------
              Gross profit                                           3,706,725        1,571,025            3,180,548
  
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES                         2,094,741          956,239            2,053,443
                                                                    ----------       ----------           ----------
               Operating income                                      1,611,984          614,786            1,127,105

INTEREST EXPENSE                                                      (221,266)        (135,900)            (318,087)

INTEREST INCOME                                                        261,613           23,011               70,956
                                                                    ----------       ----------           ----------
               Income before income taxes                            1,652,331          501,897              879,974

PROVISION FOR INCOME TAXES                                             668,000
                                                                    ----------
NET INCOME                                                         $   984,331
                                                                    ==========
EARNINGS PER SHARE                                                 $      0.23
                                                                    ==========
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING                        4,355,434
                                                                    ==========
PRO FORMA:
   Provision for income taxes                                                           195,000              340,000
                                                                                      ---------            ---------
   Net income                                                                        $  306,897          $   539,974
                                                                                      =========            ========= 
   Earnings per share                                                                $     0.11          $      0.19
                                                                                      =========            ========= 
   Weighted average number of shares outstanding                                      2,800,000            2,800,000
                                                                                      =========            ========= 

</TABLE>


         The accompanying notes are an integral part of these tatements.


<PAGE>



                            ZOMAX OPTICAL MEDIA, INC.

             (Successor to Zomax Optical Media Limited Partnership)

       Statements of Changes in Partners' Capital and Shareholders' Equity
<TABLE>
<CAPTION>


                                                                             Shareholders' Equity
                                                                       ---------------------------------------------------------
                                                        Partners'                  Common           Retained
                                                         Capital       Shares       Stock           Earnings           Total
                                                        ----------    ---------    -----------      ---------        -----------
<S>                                                     <C>           <C>          <C>              <C>              <C>        
BALANCE, December 31, 1994                              $1,634,632            -    $         -      $      -         $ 1,634,632
   Partner capital contributions,
      net of issuance costs                              1,527,735            -              -             -           1,527,735
   Repurchase of limited interests                        (300,000)           -              -             -            (300,000)
   Net income for the Predecessor Partnership              879,974            -              -             -             879,974
   Distribution to partners                               (253,084)           -              -             -            (253,084)
                                                        ----------    ---------    -----------      ---------        -----------

BALANCE, December 31, 1995                               3,489,257            -              -             -           3,489,257
   Net income for the Predecessor Partnership              501,897            -              -             -             501,897
   Distribution to partners                             (1,109,419)           -              -             -          (1,109,419)
                                                        ----------    ---------    -----------      ---------        -----------

BALANCE, May 10, 1996                                    2,881,735            -              -             -           2,881,735
   Issuance of common stock at initial public 
      offering at $6.75 per share, net of 
      offering costs of $1,446,900                               -    1,585,000      9,251,850             -           9,251,850
   Transfer of partnership interests in exchange
      for common stock in the Company                   (2,881,735)   2,800,000      2,881,735             -                   -
   Net income for the Company for the period from 
      May 11, 1996 to December 27, 1996                          -            -              -       984,331             984,331
                                                        ----------    ---------    -----------      ---------        -----------
BALANCE, December 27, 1996                              $        -    4,385,000    $12,133,585      $984,331         $13,117,916
                                                        ==========    =========    ===========      =========        ===========

</TABLE>



        The accompanying notes are an integral part of these statements.


<PAGE>
                            ZOMAX OPTICAL MEDIA, INC.

             (Successor to Zomax Optical Media Limited Partnership)

                            Statements of Cash Flows
<TABLE>
<CAPTION>
                                                                                               (Predecessor Partnership)
                                                                                            --------------------------------
                                                                           Period From        Period From
                                                                          May 11 Through       January 1         Year Ended
                                                                           December 27,      Through May 10,    December 31, 
                                                                               1996              1996                1995
                                                                          ------------       ------------       ------------
<S>                                                                        <C>                <C>                <C>
OPERATING ACTIVITIES:
   Net income                                                              $  984,331         $  501,897         $  879,974
   Adjustments to reconcile net income
      to net cash provided by (used in)
      operating activities-
         Depreciation and amortization                                        720,076            326,876            542,122
         Deferred income taxes                                                 (9,000)                 -                  -
         Changes in operating assets and liabilities:
            Accounts receivable                                            (1,153,064)           227,468         (2,527,001)
            Inventories                                                      (534,208)            58,741           (375,488)
            Prepaid expenses                                                    6,833            (15,042)           (99,397)
            Accounts payable                                                  152,894           (330,068)         1,062,782
            Accrued expenses                                                  734,493            (66,738)           335,354
            Income taxes payable                                              513,819                  -                  -
                                                                          ------------       ------------       ------------
               Net cash provided by (used in) operating activities          1,416,174            703,134           (181,654)
                                                                          ------------       ------------       ------------
INVESTING ACTIVITIES:
   Purchase of property and equipment, net                                 (2,867,837)        (1,089,210)        (2,361,683)
   Sale of financial instruments                                              249,408            265,749            519,275
   Purchase of financial instruments                                                -           (259,000)          (391,406)
                                                                          ------------       ------------       ------------
               Net cash used in investing activities                       (2,618,429)        (1,082,461)        (2,233,814)
                                                                          ------------       ------------       ------------

FINANCING ACTIVITIES:
   Capital contributions, net of issuance costs                                     -                  -          1,527,735
   Proceeds from notes payable-
      Affiliate                                                                     -                  -            207,341
      Other                                                                         -            790,500          1,845,171
   Repayment of notes payable-
      Affiliate                                                               (52,848)           (25,327)          (129,167)
      Other                                                                  (906,687)          (388,250)          (685,782)
   Short-term borrowings                                                     (300,000)           300,000                  -
   Repurchase of limited interests                                                  -                  -           (300,000)
   Distribution to partners                                                         -         (1,109,419)          (229,855)
   Proceeds from sale of common stock, net of offering costs                9,251,850                  -                  -
                                                                          ------------       ------------       ------------
               Net cash provided by (used in) financing activities          7,992,315           (432,496)         2,235,443
                                                                          ------------       ------------       ------------
               Net increase (decrease) in cash                              6,790,060           (811,823)          (180,025)

CASH AND CASH EQUIVALENTS:
   Beginning of period                                                        124,839            936,662          1,116,687
                                                                          ------------       ------------       ------------
   End of period                                                           $6,914,899         $  124,839         $  936,662
                                                                          ============       ============       ============

SUPPLEMENTAL CASH FLOW DISCLOSURE:
   Cash paid for interest                                                  $  221,155         $  135,900         $  296,524
                                                                          ============       ============       ============
   Cash paid for income taxes                                              $  162,000         $        -         $        -
                                                                          ============       ============       ============

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

                            ZOMAX OPTICAL MEDIA, INC.

             (Successor to Zomax Optical Media Limited Partnership)

                          Notes to Financial Statements

                     December 27, 1996 and December 31, 1995


1.   Business Description:

Zomax Optical Media,  Inc. (the Company) was  incorporated  on February 22, 1996
and completed its initial  public  common stock  offering on May 10, 1996.  Upon
completion of the initial public stock offering, the Company received all of the
operating  assets and liabilities of Zomax Optical Media Limited  Partnership in
exchange for 2,800,000 shares of its common stock.  Since the exchange created a
new reporting  entity,  the financial  statements of Zomax Optical Media Limited
Partnership prior to the offering have been captioned Predecessor Partnership.

The  Company is a  full-service  provider  of compact  discs  (CDs),  cassettes,
diskettes and related services to a variety of customers  operating primarily in
North America.

2.   Summary of Significant Accounting Policies:

Revenue Recognition

The Company  records sales to its customers at the time  merchandise is shipped.
For certain  customers,  merchandise is invoiced upon  completion of orders with
shipment occurring based on written customer instructions.

Use of Estimates

The preparation of financial  statements in conformity  with generally  accepted
accounting principles requires management to make estimates and assumptions that
affect  the  reported  amounts  of  assets  and  liabilities  at the date of the
financial  statements and the reported  amounts of revenues and expenses  during
the reporting period.
Ultimate results could differ from those estimates.

Concentrations of Credit Risk

The Company markets and sells its multimedia  products and services  through its
own sales force to a wide variety of customers,  including recording studios and
other  producers for retail  distribution,  distributors,  software  developers,
publishers, marketing groups and database suppliers.

At December 27, 1996,  Metacom,  Inc. (Metacom) (see Note 8) accounted for 17.9%
of the Company's accounts receivable, and three unaffiliated customers accounted
for 15.9%, 13.0% and 12.1% of accounts receivable.

For the year ended  December 27, 1996,  two  customers  accounted  for 26.1% and
11.8% of the  Company's  sales.  For the  year  ended  December  31,  1995,  two
customers accounted for 19.1% and 15.9% of the Company's sales.
<PAGE>

Cash and Cash Equivalents

Cash equivalents  consist of highly liquid short-term  investments with original
maturities  of 90 days or less  and are  recorded  at cost,  which  approximates
market value.

Inventories

Inventories, consisting of material, labor and overhead, are stated at the lower
of first-in, first-out cost or market.

Inventories were as follows:

                                          December 27,        December 31, 
                                             1996                1995
                                          ------------        ------------
              Raw materials                $1,132,083          $663,707
              Finished goods                  126,316           109,272
              Work in process                   4,266            14,219
                                          ------------        ------------
                                           $1,262,665          $787,198
                                          ============        ============
              
              
Property and Equipment

Property and equipment are stated at cost.  Repairs and  maintenance are charged
to  expense  as  incurred,   while  significant   betterments  are  capitalized.
Depreciation  is  calculated  using  the  straight-line   method  for  financial
reporting purposes over the following estimated useful lives:

Property and equipment consisted of the following:

                                      December 27,    December 31, 
                                         1996             1995          Lives
                                      ------------    ------------    ---------

Manufacturing equipment                $8,782,310      $5,360,874      7 years
Office equipment                          630,742         129,174     5-7 years
Building improvements                     116,406         111,262    Lease term
Vehicles                                   28,918               -      5 years
                                      ------------    ------------  
                                        9,558,376       5,601,310
Less- Accumulated depreciation         (1,983,875)       (938,904)
                                      ------------    ------------  
Property and equipment, net            $7,574,501      $4,662,406
                                      ============    ============  


Restricted Cash

Restricted cash represents  amounts  invested in certificates of deposit held as
collateral  for notes  payable (see Note 3). The rights to the  certificates  of
deposit had been assigned to the lender and were released in January 1997.


<PAGE>

Other Assets

Other assets consist of organization costs, which are amortized over five years,
and deferred  taxes.  At December  27, 1996 and  December 31, 1995,  accumulated
amortization was $6,833 and $4,833, respectively.

Accrued Expenses

Accrued expenses consisted of the following:

                                               December 27,      December 31, 
                                                   1996              1995
                                               ------------      ------------  
              Accrued royalties                 $  793,468          $283,000
              Accrued compensation                 466,896           300,731
              Other                                249,685           135,334
                                               ------------      ------------  
                                                $1,510,049          $719,065
                                               ============      ============  


The Company  accrues for all known  royalties using estimated rates on all units
manufactured.  Currently,  the Company has license agreements with two companies
for the use of certain CD  manufacturing  technology.  In 1995, a third  company
approached  the Company  and claimed it also owns rights to certain  patented CD
manufacturing  technology.  The Company  believes  that the  resolution  of this
matter will not have a material  effect on the Company's  financial  position or
results of operations.

Income Taxes

Deferred  income  taxes are provided  for  differences  between the tax basis of
assets and  liabilities  and their  carrying  amounts  for  financial  reporting
purposes, based on income tax rates in effect at the balance sheet date.

Fair Value of Financial Instruments

The financial  instruments with which the Company is involved are primarily of a
traditional nature. For most instruments,  including cash, receivables, accounts
payable,  accrued expenses and short-term debt, the Company has assumed that the
carrying amounts approximate fair value because of their short-term nature.

Earnings Per Share

Primary and fully  diluted  earnings  per common share are based on the weighted
average number of common and common  equivalent  shares  outstanding  during the
period.  Common  equivalent shares include the dilutive effects of stock options
and  warrants  which are assumed to be exercised or converted to common stock at
the  beginning  of  the  applicable  period.   Common  stock  and  common  stock
equivalents issued during the 12-month period prior to the initial filing of the
initial  public  offering have been included in the  calculation as if they were
outstanding  for all periods  presented  using the treasury stock method.  Fully
diluted  earnings per share did not differ  significantly  from primary earnings
per share for any of the periods presented.


<PAGE>

Stock Option Plan

The Company  accounts for its stock option  grants under  Accounting  Principles
Board Opinion No. 25,  "Accounting  for Stock Issued to Employees"  (APB 25) and
provides the pro forma footnote  disclosures  required by Statement of Financial
Accounting  Standards No. 123,  "Accounting for Stock-Based  Compensation" (SFAS
123).

3.   Notes Payable:

Notes payable consist of several  installment  notes, with monthly  installments
payable through November 1999, at interest rates ranging from 8.4% to 10.5%. The
notes  are  collateralized  by  certain  equipment.  In  addition,  one note was
collateralized by certificates of deposits totaling $135,249 which were released
subsequent  to December  27,  1996.  A note  payable to Metacom (see Note 8) was
repaid in full during 1996.

Future  scheduled  maturities of notes payable are as follows as of December 27,
1996:

              1997                                             $1,508,607
              1998                                              1,270,147
              1999                                                444,227
                                                               ---------- 
                                                               $3,222,981
                                                               ==========

4.   Bank Credit Facilities:

As of December 27,  1996,  the Company had a revolving  line-of-credit  facility
with a lender  for up to  $1,500,000,  which  expires  on April  30,  1997.  The
interest rate is at prime (8.25% at December 27, 1996).  Maximum  borrowings are
limited to an amount based on a formula using eligible  accounts  receivable and
inventories ($1,500,000 as of December 27, 1996). During 1996 maximum borrowings
outstanding were $300,000.

In addition,  the Company has a capital  expenditure term loan facility with the
lender for up to $3,000,000.  Borrowings under the capital expenditure term loan
may be for up to 60 months,  and interest rates will vary based on the length of
the term loan and the  interest  rate  structure  selected.  The  interest  rate
structure  that can be selected by the  Company  varies from a variable  rate of
prime plus 1/4% or a fixed rate equal to the three-year U.S.  Treasury rate plus
3%.

At  December  27,  1996,   there  were  no   borrowings   under  the   revolving
line-of-credit  facility, and $633,670 outstanding under the capital expenditure
term loan facility.

The line-of-credit  agreement and certain of the notes contain covenants related
to levels of net income and net worth.  The Company was in compliance with these
covenants as of December 27, 1996.

5.   Shareholder's Equity:

On May 10, 1996,  the Company  completed the sale of 1,400,000  shares of common
stock in an initial public stock offering.  Subsequently,  on June 17, 1996, the
underwriter  exercised  an  overallotment  option and  purchased  an  additional
185,000 shares. The Company received proceeds from the offering, net of issuance
costs, of $9,251,850.  The underwriter  also purchased,  for a nominal  purchase
price,  warrants to purchase  140,000 shares of common stock at a price of $8.10
per share.  The warrants are exercisable for a period of four years,  commencing
one year from the offering date.


<PAGE>

6.   Stock Plans:

Employee Stock Purchase Plan

In March 1996,  the board of directors of the Company  adopted an Employee Stock
Purchase  Plan (the Employee  Plan)  effective  July 1, 1996.  The Employee Plan
enables  employees  to  contribute  up to 10% of their  compensation  toward the
purchase of the Company's  common stock at 85% of fair market value.  A total of
250,000  shares have been reserved for issuance  under this plan. No shares were
issued in 1996 under this plan.

Stock Option Plan

In March 1996,  the board of  directors  of the  Company  adopted the 1996 Stock
Option Plan (the Plan) in order to provide for the granting of stock  options to
employees,  officers,  directors and  independent  consultants of the Company at
exercise  prices not less than 100% of the fair  market  value of the  Company's
common stock on the date of grant.  The Company has reserved  600,000  shares of
its common stock for issuance upon  exercise of options  granted under the Plan.
These  options,  which can be either  incentive  stock  options or  nonqualified
options, vest over a three- to five-year schedule and expire ten years after the
grant date.

Information regarding the Company's stock option plan is summarized below:

                                                               1996
                                                       ------------------------
                                                                     Weighted
                                                                      Average  
                                                       Shares     Exercise Price
                                                       --------   --------------
        Options outstanding, beginning of period              -          $ -
           Granted                                      395,000            6.79
           Canceled                                     (35,000)           6.75
           Exercised                                          -            -
                                                        -------          ------
        Options outstanding, end of period              360,000          $ 6.79
                                                        =======          ======
        Options exercisable, end of period               62,500          $ 6.75
                                                        =======          ======
        Weighted average fair value of
           options granted                                               $ 5.95
                                                                         ======

Options  outstanding at December 27, 1996 have an exercise price ranging between
$6.75 and $8.00 and a weighted average remaining contractual life of 9.39 years.
<PAGE>

The Company  accounts  for its stock option  grants under APB 25. Since  options
have been  granted  at not less than the market  value on the date of grant,  no
compensation  expense has been  recognized  for the stock options  granted.  Had
compensation cost of option grants been determined consistent with SFAS 123, the
Company's  income and earnings per share, on a pro forma basis,  would have been
reported as follows:

                                                               1996
                                                               ----
         Net income:
            As reported                                      $984,331
            Pro forma                                         614,331
         Primary and fully diluted earnings per share:
             As reported                                         0.23
             Pro forma                                           0.14

In  determining  the  compensation  cost of the options  granted during 1996, as
specified by SFAS 123, the fair value of each option grant has been estimated on
the date of grant using the Black-Scholes option pricing model, and the weighted
average assumptions used in these calculations are summarized below:


              Risk-free interest rate                           6.97%
              Expected life of options granted               10 years
              Expected volatility of options granted           76.45%

7.   Income Taxes:

The  provision for income taxes for the Company for the period from May 11, 1996
to December 27, 1996 was as follows:

              Current                                        $677,000
              Deferred                                         (9,000)
                                                             --------
              Total provision                                $668,000
                                                             ========

The components of the deferred tax asset,  which is classified as a component of
other assets, at December 27, 1996 was as follows:

              Accounts receivable reserves                   $202,000
              Accrued liabilities                             292,000
              Long-lived assets                              (485,000)
                                                             --------
              Net deferred tax asset                         $  9,000
                                                             ========
<PAGE>

A  reconciliation  of the  statutory  federal  income tax rate to the  Company's
effective income tax rate is as follows:
<TABLE>
<CAPTION>

                                                                  Predecessor Partnership
                                                                          (Pro Forma)
                                                 Period From       Period From
                                                   May 11           January 1
                                                   Through           Through          Year Ended
                                                December 27,         May 10,         December 31,
                                                    1996               1996              1995
                                                ------------        -----------      ------------
<S>                                                 <C>              <C>                 <C>  
Statutory federal income tax rate                   34.0%            34.0%               34.0%
State income taxes, net of federal
    income tax benefit                               4.1              4.0                 4.0
Other                                                2.3              0.9                 0.6
                                                ------------        -----------      ------------
Effective income tax rate                           40.4%            38.9%               38.6%
                                                ============        ===========      ============
</TABLE>


8.   Related-Party Transactions:

A  significant   shareholder   of  the  Company,   Metacom,   provides   certain
administrative  functions,  including  costs of occupancy,  to the Company for a
monthly fee. Charges for these services were as follows:

                                                        1996          1995
                                                      --------      --------
              Administrative support                  $ 88,194      $139,670
              Occupancy                                460,218       380,780
                                                      --------      --------
                                                      $548,412      $520,450
                                                      ========      ========


In addition,  the Company  reimbursed  Metacom  $117,407 and $56,622 in 1996 and
1995, respectively, for certain expenditures for the Company.

Metacom Manufacturing Assets--Manufacturing Agreement

In January  1995,  the Company  acquired the entire  manufacturing  operation of
Metacom  in  exchange  for  $318,000  in cash,  two  promissory  notes  totaling
$207,341,  the  assumption  of  $42,085 of  Metacom's  liabilities  and  limited
interests in the Predecessor  Partnership  which, upon completion of the initial
public  offering,  were  exchanged for common stock of the Company (see Note 1).
Both promissory notes were paid in full and canceled during 1995 and 1996.

As a result of the common control of the  Predecessor  Partnership  and Metacom,
the  acquisition  was accounted for essentially as a pooling of interests and no
value was assigned to the limited  partnership  units issued in the transaction.
The difference of $62,810 between the cash and note payable  consideration,  the
assumed  liability and Metacom's  historical net book value of the net assets of
the manufacturing  operation received was treated as a distribution of partners'
capital in the accompanying financial statements.
<PAGE>

In  connection  with this  transaction,  Metacom and the Company  entered into a
manufacturing  agreement (the Agreement) whereby Metacom must purchase a minimum
of two million audio cassettes and one million CDs from the Company under normal
trade terms.  The Agreement  was to expire in December  1997.  However,  in 1996
Metacom did not fulfill its purchase  commitment.  As a result,  the Company and
Metacom have agreed to allow Metacom to make up the 1996  shortfall  during 1997
in  exchange  for a  contract  extension  until  the year  2000.  This  contract
extension  specifies  that  Metacom is to purchase  all of its supply of CDs and
audio  cassettes  exclusively  from the Company  under normal  trade  terms.  No
minimum quantities have been established.

Metacom  purchases   totaled   $1,587,000  and  $2,524,000  in  1996  and  1995,
respectively.

9.   Commitments and Contingencies:

Litigation

The Company is involved in claims  arising in the normal course of business.  In
management's  opinion,  the final  resolution  of these claims should not have a
material  adverse  effect on the  Company's  financial  position or results from
operations.

Operating Leases

The Company is committed under an operating lease with Metacom for the rental of
manufacturing,  warehouse and office  facilities.  The initial lease term is for
three years ending  December 31, 1997, and provides for renewal options of three
3-year  periods.  In addition,  the Company is obligated to pay a  proportionate
share of real estate taxes, insurance,  utilities,  repairs and maintenance, and
common area costs.  Based on current  space  rented,  annual  rental  expense is
$575,000.

Purchase Commitments

In  February  1997,  the Company  committed  to the  purchase  of  approximately
$4,000,000  of  manufacturing  equipment to provide  in-house  mastering for its
customers. The Company plans to finance the equipment on a long-term basis.

Employment Agreement

The  Company  has in place an  employment  agreement  with its  chief  executive
officer  which  provides  for base  compensation,  bonus  payments  of 5% of the
Company's  earnings  before taxes,  as defined,  and a severance  payout in case
employment  is  terminated  under  conditions  specified in the  agreement.  The
agreement expires on December 31, 1998.

10.  Events Subsequent to December 27, 1996:

In  February  1997,  the  Company  signed a letter  of intent  to  purchase  all
outstanding shares of Benchmark Media Services, Inc., a manufacturer, replicator
and marketer of CDs and diskettes.