PLATINUM ENTERTAINMENT INC, 10-K/A, 1998-08-14

PLATINUM ENTERTAINMENT INC
10-K/A, 1998-08-14
DURABLE GOODS, NEC

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<PAGE>

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K/A
AMENDMENT NO. 1 TO
TRANSITION REPORT ON
FORM 10-K

( ) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

(X) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from June 1 to December 31, 1997

Commission File Number 000-27852

PLATINUM ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)

Delaware 36-3802328
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

2001 Butterfield Road
Downers Grove, Illinois 60515
(Address of principal executive offices, including zip code)

(630) 769-0033
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share
(Title of Class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. ( )

The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant (based upon the per share closing sale price
of $7.438 on August 12, 1998, and for the purpose of this calculation only,
the assumption that all of the registrant's directors and executive officers
are affiliates) was approximately $35,615,000.

The number of shares outstanding of the registrant's Common Stock, par
value $.001, as of August 12, 1998 was 6,040,166.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents are incorporated by reference
into this report:
None.

<PAGE>

The Registrant hereby amends the Form 10-K filed May 20, 1998 in order
to revise items 7., 8. and 13. for the seven months ended December 31, 1997.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

The information in this section should be read together with the
consolidated financial statements and notes thereto that are included
elsewhere herein.

OVERVIEW

The Company is a full-service music company that produces, licenses,
acquires, markets and distributes high quality recorded music for a variety
of musical formats. The Company has produced recorded music products in the
Adult Contemporary, Gospel, Country and Blues music formats, primarily under
its River North Records, CGI Records and House of Blues Music Co. labels.
With its January 1997, acquisition of Intersound, the Company expanded its
artist base and music catalog within existing genres, and added new music
genres to its repertoire, including Urban/Dance and Classical/Themed
Productions.

Effective December 31, 1997, the Company changed its fiscal year from
May 31 to a calendar year. This change in fiscal year makes the Company's
year comparable with other public companies in the industry. This change in
fiscal year also conforms the Company's fiscal periods to the quarterly and
semi-annual periods for which the Company reports its royalties to its
recording artists and publishers as well as the annual term of the
distribution agreement with PolyGram.

As an integral part of the Company's growth strategy, the Company
completed several acquisitions during the twelve months ended May 31, 1997,
acquiring: (i) substantially all of the assets of REX during June 1996; (ii)
substantially all of the assets of Double J during September 1996; (iii) a
50% interest in the HOB Joint Venture during November 1996 and (iv)
substantially all of the assets of Intersound effective January 1997. See
"Significant Matters" below for more details of these transactions.

The Company determined the purchase price allocation for Intersound, as
disclosed in the balance sheet at May 31, 1997, based on available
information at that time. However, during the seven months ended December
31, 1997, the Company ascertained that the purchase value allocated certain
purchased assets exceeded their fair market values by approximately
$1,150,000. In addition, further liabilities of approximately $2,350,000,
which the Company believes relate to returned products that had been sold
prior to the Company's purchase of Intersound, were identified. Had these
matters been identified by the Company at the time of purchase or shortly
thereafter, such valuations would have been recorded through purchase
accounting, resulting in no subsequent income statement impact. As these
matters were not identified at the time of purchase or shortly thereafter,
the Company is required to reflect these amounts in its results of operations
for the seven months ended December 31, 1997, resulting in a nonrecurring
charge to current operations of $3,500,000. This amount is included in the
current period returns and allowances ($2,350,000) and cost of sales and
services ($1,150,000). The Company recorded a portion of these adjustments
through purchase accounting during the three month periods ended August 31
and November 30, 1997. The impact of subsequently recording these and
certain other adjustments through the Company's results of operations during
the month of December 1997 is currently being evaluated by management in
order to determine the effect on the previously reported quarterly results of
operations.

As a result of the acquisitions discussed above, the Company incurred
significant costs to merge and restructure its business with the acquired
companies. Such merger and restructuring costs include severance costs,
relocation costs, lease commitment write-offs, warehouse closing costs and
other related costs. Such costs approximated $251,000 and $1,700,000 during
the seven months ended December 31, 1997 and the twelve months ended May 31,
1997, respectively. The restructuring was substantially completed at
December 31, 1997. Such restructuring resulted in shifts in the selling and
promotion efforts of the Company's Country label and in-house sales
department and a shift in third-party fulfillment of Platinum Christian
Distribution. In addition, one-time costs for the twelve months ended May
31, 1997 include write-offs of artist advances of approximately $600,000 in
areas for which the Company has chosen to redirect its resources. These costs
are classified as merger, restructuring and one-time costs and are included
in the Company's operating losses.

2
<PAGE>

tel materially breached the K-tel Agreement. Both the Company and K-tel have
filed claim to the escrowed amounts. The outcome of such claims is
uncertain. See Item 3.-"Legal Proceedings." Accordingly, the Company
reserved the full escrowed amount during the seven months ended December 31,
1997. In addition, approximately $1,100,000 of legal, accounting, and other
incremental costs associated with the K-tel Acquisition were expensed by the
Company during the seven months ended December 31, 1997. These costs are
classified as merger, restructuring and one-time costs and are included in
the Company's operating loss.

The Company records revenues for music products, other than
telemarketing C.O.D. sales, when such products are shipped to retailers. In
accordance with industry practice, the Company's music products are sold on a
returnable basis. The Company's allowance for future returns is based upon
its historical returns, SOUNDSCAN data and the return rate of the Company's
third-party distributor, PolyGram. The Company terminated its relationship
with Riverside Book and Bible House, Inc. ("Riverside") for fulfillment of
Platinum Christian Distribution, effective August 1997. The acquisitions
enabled Platinum Christian Distribution fulfillment to be handled through the
recently acquired Intersound internal distribution system and the increased
volume allowed the Company to negotiate Christian Bookstore Market
distribution through its third-party secular market distributor, PolyGram.
As a result, the Company experienced unusually high returns of product
through the Riverside distribution channels as customers were allowed a
limited time to return products before returns were no longer accepted from
previous Riverside sales. In addition, the Company ceased relations with
certain customers who consistently failed to pay on a timely basis, prompting
an unusually high returns experience from these customers. Accordingly, the
Company's returns experience was 30% for the twelve months ended May 31,
1997, compared to 25% and 20% for the seven months ended December 31, 1997
and 1996, respectively, and 27% and 26% for the twelve months ended May 31,
1996 and 1995, respectively. As discussed above, the Company recorded
approximately $2,350,000 relating to returns of product that the Company
believes had been sold by Intersound prior to the Company's purchase.
Accordingly, the Company's returns experience was 35% for the seven months
ended December 31, 1997. It is the Company's policy to inventory all returned
product and resell such product at market value.

A significant recurring funding requirement of the Company is for artist
and repertoire ("A&R") expenses, which include recording costs and advances to
artists. The Company makes substantial payments each period for recording costs
and advances in order to maintain and enhance its artist roster. These costs
are recouped from the artists' royalties, to the extent possible, from future
album sales. Artist advances are capitalized as an asset when the current
popularity and past performance of the artist provides a sound basis for
estimating the probable future recoupment of such advances from earnings
otherwise payable to the artist.

The Company primarily distributes internationally by means of licensing
arrangements. The first of these arrangements began during the twelve months
ended May 31, 1996 with MCA. The Company subsequently terminated this
arrangement and has entered international licensing arrangements on a
country-by-country basis. Revenues derived from the licensing of recorded
masters are calculated as a percentage of retail sales by the licensee net of
returns and are recognized by the Company upon notification of retail sales net
of returns by the licensee.

3
<PAGE>

RESULTS OF OPERATIONS

The following table sets forth, as a percentage of gross revenues, certain
items that are included in the Company's statements of operations for the
periods reflected below. Operating results for any period are not necessarily
indicative of results for any future periods.

SEVEN MONTHS ENDED DECEMBER 31
----------------------------------------
1997 1996
----------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Total gross revenues . . . . $35,294 100.0% $12,878 100.0%

Less: Returns and allowances (11,351) -32.2% (2,326) -18.1%
Less: Discounts . . . . . . . (2,288) -6.5% (821) -6.4%
-------- --------
Total net revenues . . . . . 21,655 61.3% 9,731 75.5%
Cost of sales and services . 16,784 47.6% 6,225 48.3%
-------- --------
Gross profit . . . . . . . . 4,871 13.7% 3,506 27.2%

Other operating expense:
Selling, general and
administrative expenses . . 12,316 34.9% 5,695 44.2%
Merger, restructuring and
one-time costs . . . . . . 3,100 8.8% 6 --
Depreciation and amortization 1,062 3.0% 199 1.5%
-------- --------
Operating loss . . . . . . . (11,607) -33.0% (2,394) -18.5%
Interest income . . . . . . . 49 0.1% 136 1.1%
Interest expense . . . . . . (2,944) -8.3% (7) -0.1%
Other financing costs . . . . (1,258) -3.6% - -
Equity gain (loss) . . . . . (686) -1.9% - -
-------- --------
Loss from continuing
operations . . . . . . . . (16,446) -46.7% (2,265) -17.5%
Discontinued operations:
Loss from operations . . . - - - -
Loss on disposal . . . . . - - - -
-------- --------
Loss from discontinued
operations . . . . . . . . - - - -
-------- --------
Net loss . . . . . . . . . . ($16,446) -46.7% ($2,265) -17.5%
-------- --------
-------- --------

TWELVE MONTHS ENDED MAY 31
----------------------------------------------------------------
1997 1996 1995
----------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Total gross revenues . . . . $38,757 100.0% $20,121 100.0% $12,782 100.0%

Less: Returns and allowances (10,568) -27.3% (4,732) -23.5% (3,126) -24.5%
Less: Discounts . . . . . . . (2,463) -6.4% (712) -3.5% (507) -4.0%
-------- -------- --------
Total net revenues . . . . . 25,726 66.4% 14,677 73.0% 9,149 71.5%
Cost of sales and services . 14,019 36.2% 10,441 51.9% 4,945 38.7%
-------- -------- --------
Gross profit . . . . . . . . 11,707 29.9% 4,236 21.1% 4,204 32.8%

Other operating expense:
Selling, general and
administrative expenses . . 13,141 33.9% 8,017 39.8% 8,800 68.8%
Merger, restructuring and
one-time costs . . . . . . 2,231 5.8% - - - -
Depreciation and amortization 973 2.5% 156 0.8% 133 1.0%
-------- -------- --------
Operating loss . . . . . . . (4,638) -12.0% (3,937) -19.5% (4,729) -37.0%
Interest income . . . . . . . 154 0.4% 106 0.5% 46 0.4%
Interest expense . . . . . . (1,385) -3.6% (570) -2.8% (157) -1.2%
Other financing costs . . . . (3,533) -9.1% - - - -
Equity gain (loss) . . . . . 48 0.1% - - - -
-------- -------- --------
Loss from continuing
operations . . . . . . . . (9,354) -24.1% (4,401) -21.8% (4,840) -37.8%
Discontinued operations:
Loss from operations . . . - - - - (2,073) -16.2%
Loss on disposal . . . . . - - (226) -1.1% (2,611) -20.4%
-------- -------- --------
Loss from discontinued
operations . . . . . . . . - - (226) -1.1% (4,684) -36.6%
-------- -------- --------
Net loss . . . . . . . . . . ($9,354) -24.1% ($4,627) -22.9% ($9,524) -74.4%
-------- -------- --------
-------- -------- --------

</TABLE>

References made in the following discussion include: (i) Gospel
format - activity under the CGI Records, Light Records, Lexicon Music, R.E.X.
Music and Flying Tart labels, as well as Gospel activity under the House of
Blues label; (ii) Country format - activity under the River North Nashville
label; (iii) Adult Contemporary format - activity under the River North
Records label; (iv) Blues format - Blues activity under the House of Blues
label and (v) all activity from the Intersound Acquisition is referenced
"Intersound" so that the effects of the Intersound Acquisition can more
clearly be understood. Intersound activity includes music in the
Classical/Themed Productions, Urban/Dance and Country genres. See "Overview."

4
<PAGE>

SEVEN MONTHS ENDED DECEMBER 31, 1997 COMPARED TO SEVEN MONTHS ENDED DECEMBER 31,
1996

Gross revenues increased $22,416,000 or 174.1% to $35,294,000 for the
seven months ended December 31, 1997 compared to the seven months ended
December 31, 1996; the seven months ended December 31, 1996 did not include
the activities of Intersound, which represents $21,060,000 or 94.0% of this
increase. Gross revenues generated from various genres as a percentage of
total gross revenues is as follows:

<TABLE>
<CAPTION>
Seven Months Ended
December 31
-------------------
1997 1996
<S> <C> <C>
Gospel 17.8% 47.0%
Country 1.0% 36.1%
Adult Contemporary 13.3% 10.2%
Blues 8.2% 6.7%
Intersound 59.7% --

</TABLE>

Gross revenue generated from Gospel increased slightly, while gross
revenue generated from Adult Contemporary, Blues and Intersound increased
approximately $3,400,000, $2,000,000 and $21,100,000, respectively,
offsetting an approximate $4,300,000 decline in Country revenues. The
changes in percentages are due principally to the activities of Intersound as
noted above. Significant contributions to revenues for the current period
include William Becton's HEART OF A LOVE SONG (Gospel), John Denver's A
CELEBRATION OF LIFE and the continued success of Peter Cetera's YOU'RE THE
INSPIRATION (A COLLECTION) (Adult Contemporary), PAINT IT, BLUE - a tribute
to the Rolling Stones by various Blues artists (Blues) and BOOTLEG BOOTY, a
compilation of various Urban artists, George Clinton's LIVE . . . AND
KICKIN', Eddie Rabbitt's BEATIN' THE ODDS, and numerous Christmas releases
(Intersound). These increases were offset by decreased activity in Country
releases whose sales are largely determined by the success of obtaining
country radio airplay. Radio-driven country releases during the seven months
ended December 31, 1996 included The Beach Boys' STARS AND STRIPES, VOL. I
and Crystal Bernard's THE GIRL NEXT DOOR. The Company has shifted its
Country music strategy to principally sign artists with an established fan
base, thereby significantly reducing radio promotion expenses.

Returns and allowances increased $9,025,000 or 388.0% to $11,351,000 for
the seven months ended December 31, 1997 compared to the seven months ended
December 31, 1996; the seven months ended December 31, 1996 did not include
the activities of Intersound, which represents $7,844,000 or 86.9% of this
increase. Returns and allowances as a percentage of gross product sales, less
discounts, increased to 35.3% for the seven months ended December 31, 1997
from 20.1% for the seven months ended December 31, 1996. As discussed in the
"Overview," the Company ascertained additional product returns of $2,350,000
which the Company believes relate to Intersound prior to the Intersound
Acquisition. As these returns were not ascertained at the time of purchase
or shortly thereafter, the Company is required to reflect this amount in its
results of operations. Had these returns been identified by the Company at
the time of purchase or shortly thereafter, such amount would have been
recorded through purchase accounting, resulting in no subsequent income
statement impact. Excluding these returns, returns and allowances as a
percentage of gross product sales, less discounts, for the seven months ended
December 31, 1997 are 25.6%. Management attributes this current period
increase in returns to the effects of the acquisitions completed during the
twelve months ended May 31, 1997 and the termination of relationships with
certain slow-paying customers as discussed above in "Overview."

Discounts increased $1,467,000 or 178.7% to $2,288,000 for the seven
months ended December 31, 1997 compared to the seven months ended December
31, 1996; the seven months ended December 31, 1996 did not include the
activities of Intersound, which represents $1,181,000 or 80.5% of this
increase.

5
<PAGE>

Discounts as a percentage of gross product sales remained unchanged at 6.6% for
both the seven months ended December 31, 1997 and 1996.

Cost of sales and services increased $10,559,000 or 169.6% to
$16,784,000 for the seven months ended December 31, 1997 compared to the
seven months ended December 31, 1996; the seven months ended December 31,
1996 did not include the activities of Intersound, which represents
$7,124,000 or 67.5% of this increase. Cost of sales and services as a
percentage of gross revenues decreased to 47.6% for the seven months ended
December 31, 1997 from 48.3% for the seven months ended December 31, 1996. As
discussed in the "Overview," the Company ascertained that the purchase value
allocated certain assets purchased from Intersound exceeded their fair market
values, as disclosed in balance sheet at May 31, 1997. The Company
specifically ascertained certain unrecoupable artist advances ($750,000) and
obsolete inventory ($400,000), which, when recorded, affects cost of sales
and services. As these write-downs were not ascertained at the time of
purchase or shortly thereafter, the Company is required to reflect these
amounts in its results of operations. Had these write-downs been ascertained
by the Company at the time of purchase or shortly thereafter, such amounts
would have been recorded through purchase accounting, resulting in no
subsequent income statement impact. Excluding these write-downs, cost of
sales and services as a percentage of gross revenues for the seven months
ended December 31, 1997 is 44.3%. The decreased current period costs are
primarily a result of the lower cost of product sales associated with
direct-to-retail activity, which is generally subject to lower royalty costs
and does not incur a third-party distribution fee. In addition, the Company
is experiencing manufacturing cost savings due to volume discounts as a
result of the acquisitions completed during the twelve months ended May 31,
1997.

Gross profit increased $1,365,000 or 38.9% to $4,871,000 for the seven
months ended December 31, 1997 compared to the seven months ended December
31, 1996; the seven months ended December 31, 1996 did not include the
activities of Intersound, which represents the majority of this increase. As
discussed in the "Overview" above, gross profit includes $3,500,000 of costs
and expenses that related to Intersound prior to the Company's purchase. Had
these matters been ascertained by the Company at the time of purchase or
shortly thereafter, such adjustments would have been recorded through
purchase accounting, resulting in no subsequent income statement impact. As
these matters were not ascertained at the time of purchase or shortly
thereafter, the Company is required to reflect these amounts in its results
of operations. Excluding these adjustments, gross profit increased
$4,865,000 or 138.8%. The current period increase is attributable to the
Intersound activity due to lower associated royalty costs and the absence of
third-party distribution fees, offset by increased sales through distributed
labels such as House of Blues, which yields a lower gross margin, and the
increased returns and allowances as discussed above. As a percentage of gross
revenues, gross profit decreased to 23.7% for the seven months ended December
31, 1997 from 27.2% for the seven months ended December 31, 1996.

Selling, general and administrative expenses increased $6,352,000 or
111.5% to $12,047,000 for the seven months ended December 31, 1997 compared
to the seven months ended December 31, 1996; the seven months ended December
31, 1996 did not include the activities of Intersound, which represents
$5,211,000 or 82.0% of this increase. Selling, general and administrative
expenses as a percentage of gross revenues decreased to 34.1% for the seven
months ended December 31, 1997 from 44.2% for the seven months ended December
31, 1996 primarily due to an increased revenue base.

See "Overview" above for details of nonrecurring merger, restructuring
and one-time costs of $3,100,000.

Depreciation and amortization increased to $1,200,000 for the seven
months ended December 31, 1997 from $199,000 for the seven months ended
December 31, 1996. The increase relates primarily to amortization expense
resulting from music catalog, music publishing rights and goodwill recorded
from the acquisitions completed during the twelve months ended May 31, 1997.

As a result of the factors described above, an operating loss of
$11,607,000 was experienced in the seven months ended December 31, 1997
compared to an operating loss of $2,394,000 in the seven

6
<PAGE>

months ended December 31, 1996. As discussed in the "Overview" above,
operating loss includes $3,500,000 of costs and expenses that related to
Intersound prior to the Company's purchase. Had these matters been
ascertained by the Company at the time of purchase or shortly thereafter,
such adjustments would have been recorded through purchase accounting,
resulting in no subsequent income statement impact. As these matters were
not ascertained at the time of purchase or shortly thereafter, the Company is
required to reflect these amounts in its results of operations. Excluding
these adjustments, the Company experienced an operating loss of $8,107,000
during the current period. $3,100,000 of this current period increase is due
to nonrecurring merger, restructuring and one-time costs as discussed above.

No tax expense or benefit had been recorded through December 31, 1997
due to the Company's net operating loss carryforward and related valuation
allowance, as required under generally accepted accounting principles.
Pursuant to Section 382 of the Internal Revenue Code of 1986, as amended, the
Company's net operating loss carryforward of approximately $33,158,000 at May
31, 1997 (the Company has not yet obtained permission to change its fiscal
year to December 31 for tax purposes), expiring in years 2007 through 2012,
is subject to annual limitations due to a change in ownership as a result of
the IPO in March 1996. Accordingly, approximately $12,349,000 of the net
operating loss carryforward is subject to an annual limitation of
approximately $2,200,000.

Interest expense for the seven months ended December 31, 1997 totaled
$2,944,000 compared to $7,000 for the seven months ended December 31, 1996.
See "Capital Resources" below for details of the Company's current debt
structure.

Other financing costs of $1,258,000 were incurred during the seven
months ended December 31, 1997 due to the funding of the Intersound
Acquisition. See "Capital Resources" below for details of the Company's
current debt structure.

The net loss for the seven months ended December 31, 1997 totaled
$16,446,000 compared to $2,265,000 for the seven months ended December 31,
1996. As discussed in the "Overview" above, net loss includes $3,500,000 of
costs and expenses that related to Intersound prior to the Company's
purchase. Had these matters been ascertained by the Company at the time of
purchase or shortly thereafter, such adjustments would have been recorded
through purchase accounting, resulting in no subsequent income statement
impact. As these matters were not ascertained at the time of purchase or
shortly thereafter, the Company is required to reflect these amounts in its
results of operations. Excluding these adjustments, the Company experienced
a net loss of $12,946,000 during the current period. The current period
increase relates primarily to financing, merger, restructuring and one-time
costs of $4,359,000 and interest expense of $2,944,000 related to the
Intersound Acquisition, as well as a $1,001,000 increase in depreciation and
amortization related to the acquisitions completed during the twelve months
ended May 31, 1997.

7
<PAGE>

TWELVE MONTHS ENDED MAY 31, 1997 COMPARED TO TWELVE MONTHS ENDED MAY 31, 1996

Gross revenues increased $18,636,000 or 92.6% to $38,757,000 for the twelve
months ended May 31, 1997 compared to the twelve months ended May 31, 1996;
$12,671,000 or 68.0% of this increase related to the activities of Intersound
since January 1, 1997. Gross revenues generated from various genres as a
percentage of total gross revenues is as follows:

Twelve Months Ended
May 31
----------------------
1997 1996
<S> <C> <C>
Gospel 36.3% 66.0%
Country 13.7% 9.4%
Adult Contemporary 7.9% 19.3%
Blues 9.4% 5.3%
Intersound 32.7% --

</TABLE>

Gross revenues generated from Gospel, Country, Blues and Intersound
activity increased for the twelve months ended May 31, 1997 compared to the
twelve months ended May 31, 1996 by approximately $800,000, $3,400,000,
$2,600,000 and $12,700,000, respectively, offset by a decrease in Adult
Contemporary revenues of approximately $800,000. The changes in percentages are
due principally to the activities of Intersound since January 1, 1997.
Significant contributions to revenues for the twelve months ended May 31, 1997
include National Baptist Convention's LET'S GO TO CHURCH (Gospel), The Beach
Boys' STARS AND STRIPES, VOLUME I (Country), The Blues Brothers' LIVE FROM
CHICAGO'S HOUSE OF BLUES and the current year release of seven Blues
compilations compared to two during the prior twelve months, (Blues) and BOOTY
MIX 2: THE NEXT BOUNCE, Trapp's STOP THE GUNFIGHT, ROMANCE & ROSES and The
Taliesin Orchestra's ORINOCO FLOW: THE MUSIC OF ENYA (Intersound). These
increases were offset by decreased activity in Adult Contemporary due to the
first quarter release of Peter Cetera's ONE CLEAR VOICE in the twelve months
ended May 31, 1996 compared to the fourth quarter release of his A COLLECTION
during the twelve months ended May 31, 1997. In addition, revenues increased
despite the fact telemarketing activities were discontinued by the Company
during the twelve months ended May 31, 1996. Such revenues were approximately
$1,400,000 for that period.

Returns and allowances increased $5,836,000 or 123.3% to $10,568,000 for
the twelve months ended May 31, 1997 compared to the twelve months ended May 31,
1996; $3,173,000 of this increase related to the activities of Intersound since
January 1, 1997. Returns and allowances as a percentage of gross product sales,
less discounts, increased to 30.2% for the twelve months ended May 31, 1997 from
26.9% for the twelve months ended May 31, 1996. Management attributes the
increase in returns for the twelve months ended May 31, 1997 to the effects of
the acquisitions completed during that period as discussed above.

Discounts increased $1,751,000 or 245.9% to $2,463,000 for the twelve
months ended May 31, 1997 compared to the twelve months ended May 31, 1996;
$381,000 or 21.8% of this increase related to the activities of Intersound since
January 1, 1997. Discounts as a percentage of gross product sales increased to
6.6% for the twelve months ended May 31, 1997 from 3.9% for the twelve months
ended May 31, 1996. The increase relates to the Company's more aggressive
utilization of discount plans with retailers and the increase in new releases
volume for which it is industry practice to extend discounts for new release
orders, compared to reorders of previously released albums. Also, additional
discounts were extended to the member churches which purchased the National
Baptist Convention's LET'S GO TO CHURCH release directly from the Company. The
additional discounts allowed were more than offset by third-party distribution
fee savings.

8
<PAGE>

Cost of sales and services increased $3,578,000 or 34.3% to $14,019,000 for
the twelve months ended May 31, 1997 compared to the twelve months ended May 31,
1996; $2,733,000 or 76.4% of this increase related to the activities of
Intersound since January 1, 1997. Cost of sales and services as a percentage of
gross revenues decreased to 36.2% for the twelve months ended May 31, 1997 from
51.9% for the twelve months ended May 31, 1996. The Company has been
experiencing increased cost of product sales primarily attributable to increased
royalty costs associated with albums featuring established artists in non-Gospel
formats and the reduction in telemarketing sales has negatively impacted margins
due to the lower cost of product sales attributable to telemarketing sales
compared with other distribution channels. However, these increased costs have
been offset by the lower cost of product sales associated with Intersound
activity, which is generally subject to lower royalty costs and does not incur a
third-party distribution fee. In addition, significant costs of projects
released in the twelve months ended May 31, 1997, such as albums by The Beach
Boys and Crystal Bernard, were incurred in the twelve months ended May 31, 1996.
The projects in production during the twelve months ended May 31, 1997 are less
costly relative to the projects in production during the prior year.

Gross profit increased $7,471,000 or 176.4% to $11,707,000 for the twelve
months ended May 31, 1997 compared to the twelve months ended May 31, 1996;
$6,385,000 or 85.5% of this increase related to the activities of Intersound
since January 1, 1997. As a percentage of gross revenues, gross profit
increased to 29.9% for the twelve months ended May 31, 1997 from 21.1% for the
twelve months ended May 31, 1996. The increase is attributable both to the
Intersound activity since January 1, 1997 which experiences lower associated
royalty costs and the lack of a third-party distribution fee and that artist
projects during the twelve months ended May 31, 1997 required less allowances
for unrecoupability than during the twelve months ended May 31, 1996.

Selling, general and administrative expenses increased $5,124,000 or 63.9%
to $13,141,000 for the twelve months ended May 31, 1997 compared to the twelve
months ended May 31, 1996; $3,039,000 or 59.3% of this increase related to the
activities of Intersound since January 1, 1997. Selling general and
administrative expenses as a percentage of gross revenues decreased to 33.9% for
the twelve months ended May 31, 1997 from 39.8% for the twelve months ended May
31, 1996 primarily due to an increased revenue base.

See "Overview" above for details of nonrecurring merger, restructuring and
one-time costs of $2,231,000.

Depreciation and amortization increased to $973,000 for the twelve months
ended May 31, 1997 from $156,000 for the twelve months ended May 31, 1996. The
increase relates primarily to amortization expense resulting from music catalog,
music publishing rights and goodwill recorded from the acquisitions completed
during the twelve months ended May 31, 1997.

As a result of the factors described above, an operating loss of $4,638,000
was experienced in the twelve months ended May 31, 1997 compared to an operating
loss of $3,937,000 in the twelve months ended May 31, 1996.

No tax expense or benefit had been recorded through May 31, 1997 due to the
Company's net operating loss carryforward and related valuation allowance, as
required under generally accepted accounting principles. Pursuant to Section
382 of the Internal Revenue Code of 1986, as amended, the Company's net
operating loss carryforward of approximately $22,601,000 at May 31, 1997,
expiring in years 2007 through 2012, is subject to annual limitations due to a
change in ownership as a result of the IPO in March 1996. Accordingly,
approximately $12,349,000 of the net operating loss carryforward is subject to
an annual limitation of approximately $2,200,000.

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Interest expense for the twelve months ended May 31, 1997 totaled
$1,385,000 compared to $570,000 for the twelve months ended May 31, 1996. See
"Capital Resources" below for details of the Company's current debt structures.

Other financing costs of $3,533,000 were incurred during the twelve months
ended May 31, 1997 due to the funding of the Intersound Acquisition. These
costs include amortization of debt discount relating to the warrants issued Bank
of Montreal ("BMO") and BMO's financing fees charged the Company during the
twelve months ended May 31, 1997.

The net loss from continuing operations for the twelve months ended May 31,
1997 totaled $9,354,000 compared to $4,401,000 for the twelve months ended May
31, 1996. The increase relates primarily to financing, merger, restructuring
and one-time costs of $5,764,000 and interest expense of $1,385,000 related to
the Intersound Acquisition, as well as a $761,000 increase in depreciation and
amortization related to the acquisitions completed during the twelve months
ended May 31, 1997.

TWELVE MONTHS ENDED MAY 31, 1996 COMPARED TO TWELVE MONTHS ENDED MAY 31, 1995

Gross revenues increased $7,339,000 or 57.4% to $20,121,000 for the twelve
months ended May 31, 1996 compared to $12,782,000 for the prior twelve months,
while net revenues increased $5,528,000 or 60.4%. Gross revenues generated in
the Adult Contemporary, Gospel and Country markets increased by $3,583,000,
$2,128,000 and $885,000, respectively, for the twelve months ended May 31, 1996
compared to the prior twelve months. The increase in Adult Contemporary revenue
growth is due, in part, to the success of Peter Cetera's ONE CLEAR VOICE album.
The increase in Gospel revenue growth is attributable to the success of a number
of new releases, such as THE LIGHT YEARS series and Witness' A SONG IN THE
NIGHT, combined with the continued popularity of many of the Company's older
Gospel releases. The increase in Country revenues is principally due to the
release of Ronna Reeves' AFTER THE DANCE and Steve Azar's HEARTBREAK TOWN. In
addition, the Company released its initial three albums, ESSENTIAL BLUES, VOLUME
I AND II, and ESSENTIAL GOSPEL, under the House of Blues label during the twelve
months ended May 31, 1996. Licensing, publishing and other revenues increased
$1,592,000 to $1,799,000 for the twelve months ended May 31, 1996 compared to
$207,000 for the prior twelve months. The most significant component of this
increase was the result of the Company's first licensing revenue from
international sales through MCA of $553,000. During the twelve months ended May
31, 1996, management significantly reduced the Company's telemarketing efforts
due to the increased costs of television advertising. The increase in other
product revenues more than offsets decreased telemarketing sales, which declined
$527,000 or 27.0% to $1,422,000 for the twelve months ended May 31, 1996
compared to $1,949,000 for the prior twelve months.

Returns and allowances increased $1,606,000 or 51.4% to $4,732,000 for the
twelve months ended May 31, 1996 compared to $3,126,000 for the twelve months
ended May 31, 1995. Returns and allowances as a percentage of gross product
sales, less discounts, remained relatively unchanged at 26.9% for the twelve
months ended May 31, 1996 from 25.9% for the twelve months ended May 31, 1995.

Discounts increased $205,000 or 40.4% to $712,000 for the twelve months
ended May 31, 1996 compared to $507,000 for the twelve months ended May 31,
1995. Discounts as a percentage of gross product sales remained relatively
unchanged at 3.9% for the twelve months ended May 31, 1996 from 4.0% for the
twelve months ended May 31, 1995.

Cost of sales and services increased $5,496,000 or 111.1% to $10,441,000
for the twelve months ended May 31, 1996 compared to $4,945,000 for the twelve
months ended May 31, 1995, primarily as a consequence of increased product
sales. Cost of sales and services as a percentage of gross revenues increased
to 51.9% for the twelve months ended May 31, 1996 from 38.7% in the twelve
months ended May 31, 1995. This increase is primarily attributable to increased
royalty costs associated with albums released during the twelve months ended May
31, 1996 featuring established artists in non-Gospel formats. Further, the
reduction in telemarketing sales negatively impacted this percentage due to the
lower cost of

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product sales attributable to telemarketing sales compared with other
distribution channels. The increase also reflects the Company's increasing
volume of new products and the higher costs associated with developing projects
in the Adult Contemporary and Country formats, including projects involving
Peter Cetera, Ronna Reeves, Steve Azar and The Beach Boys, as compared to Gospel
projects.

In addition, these costs include the royalties paid by the Company to
artists in connection with its first international sales through MCA which
occurred during the twelve months ended May 31, 1996. The Company's liability
for such royalties is based on MCA's retail sales of the Company's products net
of returns, and equaled approximately 10% of such net retail sales. When
presented as a percentage of licensing revenues received by the Company,
however, royalties were equal to approximately 50% of such revenues.

Gross profit increased $32,000 or 0.8% to $4,236,000 for the twelve months
ended May 31, 1996 compared to $4,204,000 for the twelve months ended May 31,
1995. As a percentage of gross revenues, gross profit decreased to 21.1% for
the twelve months ended May 31, 1996 compared to 32.8% for the twelve months
ended May 31, 1995. This decrease relates to increased allowances on artist
advances and an increase in cost of product sales as described above. The
decrease is also attributable to increased royalty rates on non-Gospel record
sales, a decrease in telemarketing revenues which provide higher gross margins
due to the lack of a third-party distribution channel and an increase in product
returns. The timing of releases also affects gross profit. The costs of
developing several recently released, or soon to be released, projects at May
31, 1996 have the effect of decreasing the twelve months ended May 31, 1996
gross profit as product sales on these projects will occur in future periods.

Selling, general and administrative expenses decreased $783,000 or 8.9% to
$8,017,000 for the twelve months ended May 31, 1996 compared to $8,800,000 for
the twelve months ended May 31, 1995. Selling, general and administrative
expenses as a percentage of gross revenues decreased to 39.8% for the twelve
months ended May 31, 1996 compared to 68.8% for the twelve months ended May 31,
1995. These decreases are primarily attributable to an increased revenue base
as well as new budgeting and approval procedures to control and monitor
marketing, promotion, production and other costs implemented during the second
fiscal quarter of the twelve months ended May 31, 1996.

Depreciation and amortization increased $23,000 to $156,000 for the twelve
months ended May 31, 1996 from $133,000 for the twelve months ended May 31,
1995. The increase is primarily attributable to increased depreciation from the
addition of office equipment, computers, furniture and fixtures.

As a result of the factors described above, the operating loss decreased
$792,000 or 16.7% to $3,937,000 for the twelve months ended May 31, 1996 from
$4,729,000 for the twelve months ended May 31, 1995.

No tax benefit had been recorded to date through May 31, 1996 due to the
Company's valuation allowance at May 31, 1996, as required under generally
accepted accounting principles. Pursuant to Section 382 of the Internal Revenue
Code of 1986, as amended, the Company's net operating loss carryforward of
approximately $12,523,000, expiring in years 2007 through 2011, is subject to
annual limitations due to a change in ownership as a result of the IPO.
Consequently, approximately $3,700,000 of the loss carryforward at May 31, 1996
will be available to offset the twelve months ended May 31, 1997 taxable income.

Interest expense increased $413,000 to $570,000 for the twelve months ended
May 31, 1996 compared to $157,000 for the twelve months ended May 31, 1995.
This increase is due to increased bank and related party financing used by the
Company to fund operations in the twelve months ended May 31, 1996 compared to
the twelve months ended May 31, 1995. In the twelve months ended May 31, 1996,
all outstanding debt was retired with the net proceeds received from the IPO.
Accordingly, no interest expense was incurred following the closing of the IPO.

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<PAGE>

Net loss decreased $4,897,000 to $4,627,000 for the twelve months ended May
31, 1996 from $9,524,000 for the twelve months ended May 31, 1995. The net loss
for the twelve months ended May 31, 1995 included $4,684,000 related to the
discontinuance of the Company's River North recording studio ("the Studio").
During the twelve months ended May 31, 1995, the Company decided to discontinue
this business and disposed of the Studio operations in conjunction with the
Company's IPO during March 1996. During the twelve months ended May 31, 1996,
the Company experienced an additional $226,000 of costs related to the
discontinued operations in excess of estimated amounts at the measurement date.
Included in the aforementioned costs of the discontinued operations for the
twelve months ended May 31, 1996, are $302,000 for management, administrative
services and interest expense charged by the Company to the Studio. The reduced
net loss for the twelve months ended May 31, 1996 also reflects the success of
the Company's recent releases, the Company's first international sales through
MCA during the twelve months ended May 31, 1996 and the effect of management's
efforts to reduce expense, which included the implementation of cost controls as
discussed above.

RECENTLY ISSUED ACCOUNTING STANDARDS

Statement of Financial Accounting Standards ("SFAS") No. 130, REPORTING
COMPREHENSIVE INCOME, establishes standards for reporting and display of
comprehensive income (i.e., foreign currency translation gains/losses and
unrealized gains/losses on securities) and its components in a full set of
general-purpose financial statements. This Statement requires that an
enterprise (a) classify items of other comprehensive income by their nature
in a financial statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and additional paid-in
capital in the equity section of a statement of financial position. This
Statement is effective for the Company's fiscal year ending December 31,
1998. The impact of SFAS 130 will not be material to the Company's financial
disclosures.

SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION, establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. Operating
segments are components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in assessing
performance. This Statement is effective for the Company's fiscal year ending
December 31, 1998. The impact of SFAS 131 is not expected to be material to the
Company's financial disclosures.

SEASONALITY

The Company's results of operations are subject to seasonal variations.
In accordance with industry practice, the Company records revenues for music
product when such products are shipped to retailers. The Company has
historically experienced a decline in revenues and operating income during
December, January and February due to the fact that retailers purchase
products from the Company prior to December 1 in anticipation of holiday
sales. As a result, sales are traditionally lower during December and the
post holiday period. The acquisition of Intersound mitigates to some extent
the seasonality of this period due to its history of new releases during
January and February.

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PUBLIC OFFERING

During March 1996, the Company sold 2,740,000 shares of Common Stock to the
public at an initial offering price of $13.00 per share. These sales (after
payment of underwriting discounts and commissions and a financial advisory fee)
resulted in net proceeds of $32,127,000. The net proceeds were used to: (i)
retire outstanding related party debt; (ii) retire outstanding borrowings under
the Company's line of credit; (iii) retire an outstanding bank term loan; (iv)
redeem a portion of the Company's Series A-1 Non-Convertible Preferred Stock,
including settlement of unaccrued dividends, for cash (with the remaining
redemption settled with shares of Common Stock) and (v) pay costs related to
the IPO. The net proceeds of the IPO were also used in connection with the HOB
Joint Venture and the acquisitions of REX and Double J. See "Significant
Matters."

SIGNIFICANT MATTERS

During June 1996, the Company acquired substantially all of the assets of
REX. REX produces, licenses and markets recorded music, primarily in the Gospel
genre. The acquisition has been accounted for by the purchase method of
accounting and the purchase price of $580,000 approximates the fair value of the
assets acquired. The assets acquired include accounts receivable, artist
advances, inventory, music publishing rights and artist contracts. The value
allocated to music publishing rights and artist contracts totaled $440,000 and
is being amortized over 15 years using the straight-line method.

During September, 1996, the Company acquired substantially all of the
assets of Double J. Double J develops and acquires ownership of musical
compositions and exploits those compositions by means of recordings,
performances, audio-visual works, print publications and other licenses. The
acquisition has been accounted for by the purchase method of accounting and the
purchase price of $952,000 approximates the fair value of the assets acquired.
The purchase value was primarily allocated to music publishing rights and is
being amortized over 25 years using the straight-line method.

During November 1996, the Company and House of Blues Records, Inc. ("HOB"),
formed the HOB Joint Venture. The formation was executed upon the purchase by
the Company of the fifty percent (50%) interest of Private, Inc., a subsidiary
of Bertelsman Music Group, Inc. ("Seller"), in the joint venture between Seller
and HOB formed pursuant to a prior agreement. The payment for such 50% interest
was made in the cash amount of approximately $3,100,000, which is deemed a cash
capital contribution by the Company to the Venture. HOB contributed to the
Venture a license in HOB's trademarks, logo and other intellectual property in
consideration for their 50% interest in the Venture.

During January 1997, the Company purchased substantially all of the assets
of Intersound for consideration of $24,000,000 in cash, $5,000,000 in
convertible subordinated debentures and the assumption of certain liabilities.
Intersound produces, licenses, markets and distributes recorded music for
Urban/Dance, Gospel, Classical/Themed Productions and other genres. The
Acquisition has been accounted for by the purchase method of accounting and the
purchase price of approximately $41,000,000 including assumed liabilities,
exceeds the fair value of the assets acquired by $6,098,000, which represents
goodwill. The purchase value was allocated to the acquired assets based upon
their estimated respective fair market values. The amounts allocated to music
catalog, music publishing rights and goodwill are being amortized over 25 years
using the straight-line method.

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<PAGE>

purchase accounting, resulting in no subsequent income statement impact. As
these matters were not identified at the time of purchase or shortly
thereafter, the Company is required to reflect these amounts in its results
of operations for the seven months ended December 31, 1997, resulting in a
nonrecurring charge to current operations of $3,500,000. This amount is
included in the current period returns and allowances ($2,350,000) and cost
of sales and services ($1,150,000).

During March 1997, the Company and K-tel signed the K-tel Agreement
pursuant to which the K-tel Acquisition was to be completed. The Company
deposited $1,750,000 in escrow in accordance with the K-tel Agreement. During
September 1997, the Company terminated the K-tel Agreement alleging that K-tel
materially breached the K-tel Agreement. Both the Company and K-tel have filed
claim to the escrowed amounts. The outcome of such claims is uncertain. See
Item 3.-"Legal Proceedings." Accordingly, the Company reserved the full
escrowed amount during the seven months ended December 31, 1997. In addition,
approximately $1,100,000 of legal, accounting, and other incremental costs
associated with the K-tel Acquisition were expensed by the Company during the
seven months ended December 31, 1997. These costs are classified as merger,
restructuring and one-time costs and are included in the Company's operating
loss.

During December 1997, the Company issued preferred equity securities with
warrants for gross proceeds of $22,500,000 to an investor group consisting of
MAC Music LLC, SK-Palladin Partners, LP and Platinum Venture Partners II, LP.
MAC Music LLC is a joint venture between Alpine Equity Partners, L.P. and
Maroley Media Group LLC. Maroley is a private equity firm , led by Robert
Morgado, focusing on global media and entertainment investments. Morgado is the
former Chairman and Chief Executive Officer of the Warner Music Group.
SK-Palladin Partners, LP is a partnership controlled by Sidney Kimmel, Chairman
and CEO of Jones Apparel Group, and Mark J. Schwartz, President and CEO of
Palladin Capital, Inc. Platinum Venture Partners II, L.P. is a partnership
including several of Platinum Entertainment's directors and officers. See
"Capital Resources."

LIQUIDITY

The Company's cash balances were $11,000 and $53,000 at December 31 and May
31, 1997, respectively. Net cash used in operating activities was $6,335,000
for the seven months ended December 31, 1997. The uses reflect net cash used to
fund trade receivables, inventories and artist advances, attributable to
releases by such artists as John Denver, Peter Cetera and William Becton, and
numerous scheduled future releases by such artists as Ronna, Jim Belushi and
Roger Daltrey. The net cash provided by royalties payable arose primarily from
the current period sales of albums in the non-Gospel format, which typically
command a higher royalty rate. Royalties are not paid to the artist until all
advances made to the artist have been recouped by the Company. Also, the
Company establishes and maintains reserves relative to royalty payments for a
period of approximately 18 to 24 months to allow for product returns activity as
royalties are not owed on returned product. In addition, the Company fully
reserved the escrowed monies per the K-tel Agreement. See "Significant
Matters."

Net cash provided by financing activities for the seven months ended
December 31, 1997 was $6,409,000. Such activities include the refinancing of
the Company's line of credit and short-term loan with BMO with the net
proceeds from the sale of preferred stock with warrants and a new line of
credit and three year term loan with BMO. See "Capital Resources." In
addition, the Company sold shares of its Common Stock to a director of the
Company for proceeds of $500,000. In addition, during the seven months ended
December 31, 1997, the Company borrowed $1,500,000 from Steven Devick, an
officer and director of the Company, and $1,150,000 from a party unrelated to
the Company, which such unrelated loan was guaranteed by Mr. Devick and
Douglas C. Laux, an officer and director of the Company. Such loans bore
interest of 10.0% per annum and were repaid in full prior to December 31,
1997. Interest accrued and paid on these loans during the seven months ended
December 31, 1997 approximated $34,000.

Investing activities for the seven months ended December 31, 1997 totaled
$116,000 relating primarily to additions of office equipment and computers and
leasehold improvements

Net cash used in operating activities was $10,573,000 for the twelve months
ended May 31, 1997. The uses reflect net cash used to fund trade receivables of
$2,753,000, inventories of $1,447,000, artist advances of $2,149,000, trade
payables of $431,000 and accrued liabilities and other of $591,000, attributable
to releases by such artists as The Beach Boys, Crystal Bernard, Peter Cetera and
National Baptist Convention and scheduled future releases including numerous
Gospel albums, including William Becton and Vickie Winans. Net cash provided by
notes receivable of $1,148,000 results from an

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<PAGE>

agreement dated May 1996, whereby the Company sold certain video rights for
$401,000 and its right to free future studio usage for $850,000 to a minority
stockholder and former officer of the Company. The net cash provided by
royalties payable arose primarily from the twelve months ended May 31, 1997
sales of albums in the non-Gospel format, which typically command a higher
royalty rate. Royalties are not paid to the artist until all advances made to
the artist have been recouped by the Company. Also, the Company establishes and
maintains reserves relative to royalty payments for a period of approximately 18
to 24 months to allow for product returns activity as royalties are not owed on
returned product.

Net cash used in investing activities for the twelve months ended May 31,
1997 was $29,146,000. Such activities include $3,063,000 relating to the
Company's investment in the HOB Joint Venture. The Company paid approximately
$24,000,000 for the Intersound Acquisition, funded with outside financing which
is further described below. Approximately $100,000 was paid in connection with
the Company's purchase of Double J, with the remainder of the purchase price
paid in shares of the Company's common stock. In addition, the Company acquired
substantially all of the assets of REX for $480,000 during June 1996. The
purchase price approximated the indebtedness of REX to the Company and cash
payments relating to this purchase during the current period were not
significant. During the fourth fiscal quarter, the Company paid $1,750,000 to
an escrow account related to the purchase of K-tel. See "Significant Matters"
above. Purchases of equipment and leasehold improvements of $307,000 relate
primarily to office equipment, computers and software.

Net cash provided by financing activities for the twelve months ended May
31, 1997 was $31,550,000. Such activities include $25,000,000 in short-term
borrowings from BMO for the Intersound Acquisition; such Acquisition was also
financed with $5,000,000 in convertible debentures and approximately $1,500,000
in borrowings under the revolving line of credit with BMO. The Company also
borrowed approximately $1,400,000 and $7,000,000 under the revolving line of
credit to fund financing costs to BMO in connection with the Acquisition and
Company operations, respectively.

Net cash used in operating activities was $8,755,000 for continuing
operations and $1,011,000 for discontinued operations for the twelve months
ended May 31, 1996. The uses reflect the significant increases in volume for
continuing operations during the period, including net cash used to fund trade
receivables of $1,927,000 and artist advances of $4,466,000, attributable to new
releases by various artists, including Peter Cetera, Steve Azar, Ronna Reeves
and numerous Gospel artists and increased investment in new and future releases
including albums by The Beach Boys, Crystal Bernard and a number of Gospel
artists. Net cash used in operating activities was $6,590,000 in the twelve
months ended May 31, 1995. The uses reflect the significant increases in sales
volume during the period, including an increase in inventory to support greater
product sales volume and increased investment in releases for and subsequent to
the period including albums by Peter Cetera, Holly Dunn and a number of Gospel
artists.

Financing activities to fund the Company's operations for the twelve months
ended May 31, 1996 were funded with the net proceeds from the IPO of $32,127,000
(before $1,170,000 in costs related to the IPO), $4,330,000 of additional
related party financing and $1,980,000 of bank debt. Such related party
indebtedness and bank debt were paid in full at the time of the IPO. Of the net
proceeds, $9,480,000 was used to retire all outstanding bank debt, $4,867,000
was used to retire all outstanding related party debt and $4,500,000 was used to
redeem the Company's Series A-1 Non-Convertible Preferred Stock (see "Public
Offering" above).

Investing activities for the twelve months ended May 31, 1996 totaled
$574,000 relating primarily to additions of office equipment and computers and
leasehold improvements.

A significant recurring funding requirement of the Company is for A&R
expenses, which include recording costs and advances to artists. The Company
makes substantial payments each year for recording costs and advances in order
to maintain and enhance its artist roster. These costs are recouped from the
artists' royalties, to the extent possible, from future album sales. Artist
advances are capitalized when the

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<PAGE>

current popularity and past performance of the artist provides a sound basis for
estimating the probable future recoupment of such advances from earnings
otherwise payable to the artist.

As a result of the seasonal nature of the business, an advance made in
connection with the recently announced distribution agreement with Ichiban
Records, scheduled term payments on the Company's bank debt, the funding of
future releases and the acquisition of additional catalogs, the Company
expects to fully utilize its available line of credit by the end of the second
quarter of 1998. While management believes that available cash will be
sufficient to meet the Company's capital requirements, there can be no
assurances. Historically, the Company has funded its operations and other
activities from a variety of capital sources. Failure to obtain capital on
terms favorable to the Company, or at all, could have a material adverse
effect on the Company's business, results of operations and financial
condition. See "Capital Resources."

CAPITAL RESOURCES

Pursuant to an Investment Agreement dated October 12, 1997, as amended,
on December 12, 1997 the Company issued and sold to certain parties (the
"Purchasers"), for aggregate gross consideration of $20,000,000, 20,000
shares of Series B Convertible Preferred Stock ("Series B Preferred Stock")
and warrants to purchase 3,600,000 shares of Common Stock ("Purchaser
Warrants"). The Company also issued and sold to Platinum Venture Partners II
LP, for aggregate gross consideration of $2,500,000, 2,500 shares of Series
C Convertible Preferred Stock ("Series C Preferred Stock") and warrants to
purchase 450,000 shares of Common Stock (the "Affiliate Warrants"). The
Series B Preferred Stock and the Series C Preferred Stock are collectively
referred to as the "Preferred Stock." The values of the Series B and Series C
Preferred Stocks are approximately $17,938,000 and $2,242,000, respectively.
The values of the Purchaser and Affiliate Warrants are $2,062,000 and
$258,000, respectively. These amounts, net of associated costs of
approximately $2,045,000, are reflected in additional paid-in capital on the
balance sheet.

The Preferred Stock accrues dividends compounded at an annual rate of 12.0%
for the first year, 14.0% for the second year, 16.0% for the third year, 18.0%
for the fourth and fifth years and 20% at all times thereafter, of the purchase
price of the Preferred Stock, in preference to any dividends on any other class
of capital stock. The Preferred Stock will be redeemable by the Company at any
time at a price equal to the purchase price paid by the Purchasers thereof plus
accrued and unpaid dividends. The Preferred Stock will be convertible,
commencing two years from the date of issue, into shares of Common Stock at the
lesser of $5.9375 or the average of the daily closing price per share of Common
Stock for 30 consecutive trading days following the public release by the
Company of its consolidated earnings statement for the 1998 fiscal year;
provided that if shares of Common Stock are not then traded on any national
securities exchange or quoted on the Nasdaq Stock Market or a similar service,
the closing price for the foregoing purpose shall be deemed to be the fair value
of a share of Common Stock as determined in good faith by the Board of
Directors. If the Board of Directors is unable to determine fair market value
or if the holders of a majority of the outstanding shares of the Preferred Stock
disagree with the Board's determination, then fair market value will be
determined by an independent financial expert.

The number of shares of Common Stock which may be received upon exercise of
the Purchaser Warrants will be increased by an amount equal to 12.0% of the
shares initially underlying the Purchaser Warrants on each anniversary of the
original date of issuance of the Series B Preferred Stock, so long as any Series
B Preferred Stock remains outstanding. The Common Stock underlying the
Purchaser and Affiliate Warrants may be purchased at an exercise price per share
of the lesser of $6.25 and 82.5% of the average of the daily closing price per
share of Common Stock for the 30 consecutive trading days following the public
release by the Company of its consolidated earnings statement for the 1998
fiscal year; provided that if shares of Common Stock are not then traded on any
national securities exchange or quoted on the Nasdaq Stock Market or a similar
service, the closing price for the foregoing purpose shall be deemed to be the
fair value of a share of Common Stock as determined in good faith by the Board
of Directors. If the Board of Directors is unable to determine fair market
value or if the holders of a majority of the outstanding shares of the Preferred
Stock disagree with the Board's determination, then fair market value will be
determined by an independent financial expert.

On December 12, 1998, the Company issued a warrant to purchase 50,000
shares of Common Stock in connection with the consummation of Preferred Stock
with Warrants Issuance (the "Harnick Warrants"). The exercise price of the
Harnick Warrants is $6.25. The Harnick Warrant expires December 12, 2007.

Convertible debentures in the aggregate principal amount of $5,000,000 that
were issued to Intersound in connection with the Intersound Acquisition on
January 31, 1997, mature on January 31, 2004 and bear interest at the seven-year
Treasury rate plus one percent per annum (6.75% at December 31, 1997) and are
convertible, in whole or in part, at any time prior to maturity into the
Company's Common Stock at a conversion price of $9.80 per share, subject to
adjustment as provided in the debentures.

16
<PAGE>

On January 31, 1997, the Company entered a Credit Agreement with BMO,
individually and as agent, to provide a 90-day term loan in the amount of
$25,000,000 and a 90-day revolving credit facility in the amount of $10,000,000
(the "Original Credit Facility"). The Original Credit Facility was extended
through December 31, 1997 and was refinanced on December 12, 1997 as discussed
below. Financing costs associated with the Original Credit Facility from
January 31, 1997 through December 31, 1997 approximated 9% of the total
facility. The interest incurred on the Original Credit Facility was initially
LIBOR plus 6% and was increased to LIBOR plus 9% effective August 1, 1997.

On December 12, 1997, the Company refinanced the Original Credit Facility
with the net proceeds from the Preferred Stock with Warrants Issuance and an
amended credit agreement with BMO (the "Amended Credit Facility"). Under the
terms of the Amended Credit Facility, the Company has $20,000,000 in bank debt
with a three year term, due in quarterly installments beginning June 1, 1998,
bearing interest at the bank's base rate plus 1.0% per annum, and a $10,000,000
available revolving line of credit, due in three years and bearing interest at
the bank's base rate plus 1/2 of 1.0% per annum. The Company had drawn $800,000
against the available line of credit as of December 31, 1997. Borrowings under
the revolving line of credit are limited to the Borrowing Base, as defined,
which is based upon eligible accounts receivable and inventory. The Amended
Credit Facility contains certain financial covenants and is secured by
substantially all of the Company's assets. Effective March 31, 1998, the
Amended Credit Facility was amended to appoint Harris Trust and Savings Bank as
the lender. All other terms remained substantially unchanged.

The Company issued to BMO a warrant to purchase approximately 259,000
shares of Common Stock at an exercise price of $.01 per share in connection
with the BMO Credit Facility. The value of the warrants amounted to
$1,240,000, which is included in additional paid-in capital. The warrants
expire on January 31, 2002.

Subsequent to the IPO in the twelve months ended May 31, 1996, the Company
retired all of its then-outstanding bank debt, consisting of borrowings against
a line of credit totaling $4,980,000 and a term loan of $4,000,000, with net
proceeds from the IPO.

The Company's near and long-term capital requirements depend on numerous
factors, including the rate at which the Company grows and acquires new artists
and products. The Company has various on-going needs for capital, including
working capital for operations, artist advances and project development costs
and capital expenditures to maintain and expand its operations. In addition, as
part of its strategy, the Company evaluates potential acquisitions of music
catalogs, publishing rights and labels. The Company may in the future
consummate acquisitions which may require the Company to make additional capital
expenditures, and such expenditures may be significant. Future acquisitions, as
well as other on-going capital needs, may be funded with institutional
financing, seller financing and/or additional equity or debt offerings. The
Company currently does not have any material commitments for capital
expenditures for the next twelve months. However, the Company is currently
engaged in a review of accounting and operating software packages to achieve
further economies of scale. The selection, acquisition and implementation of
this software, along with the related consulting services, is expected to cost
between $600,000 and $800,000.

Stockholders' equity at December 31, 1997 totaled $12,875,000 compared
to $7,866,000 at May 31, 1997. This net increase of $4,989,000 is primarily
due to the sale of preferred stock with warrants as discussed above, offset
by net losses experienced by the Company during the seven months ended
December 31, 1997. As discussed in the "Overview" above, stockholders' equity
includes $3,500,000 of costs and expenses that related to Intersound prior to
the Company's purchase. Had these matters been identified by the Company at
the time of purchase or shortly thereafter, such adjustments would have been
recorded through purchase accounting, resulting in no stockholders' equity
impact. As these matters were not identified at the time of purchase or
shortly thereafter, the Company is required to reflect these amounts in its
results of operations, thus impacting

17
<PAGE>

stockholders' equity. Excluding these adjustments, the Company's stockholders'
equity would have been $16,375,000 at December 31, 1997.

INFLATION

The impact of inflation on the Company's operating results has been
moderate in recent years, reflecting generally lower rates of inflation in the
economy. While inflation has not had a material impact on operating results,
there is no assurance that the Company's business will not be affected by
inflation in the future.

SAFE HARBOR PROVISION

This Report contains certain forward-looking statements (within the
meaning of the Private Securities Litigation Reform Act of 1995) that involve
substantial risks and uncertainties. When used in this Report, the words
"anticipate," "believe," "estimate" and "expect" and similar expressions as
they relate to the Company or its management are intended to identify such
forward-looking statements. A number of important factors could cause the
Company's actual results, performance or achievements for the twelve months
ended December 31, 1998 and beyond to differ materially from those expressed
in such forward-looking statements. Reference is made to the Company's prior
filings with the Securities and Exchange Commission, in particular the "Risk
Factors" section of the Company's Prospectus dated March 12, 1996, for a
discussion of such factors. These factors include, without limitation,
commercial success of the Company's repertoire, charges and costs related to
acquisitions, relationships with artists and producers, attraction and
retention of key personnel, general economic and business conditions and
enhanced competition and new competitors in the recorded music industry.

YEAR 2000 TECHNOLOGY PREPAREDNESS

The Company is currently working to resolve the potential impact of the
year 2000 on the processing of time-sensitive information by its computerized
information systems. Year 2000 issues may arise if computer programs have been
written using two digits (rather than four) to define the applicable year. In
such cases, programs that have time-sensitive logic may recognize a date using
"00" as the year 1900 rather than the year 2000, which could result in
miscalculations or system failures. Management is in the process of completing
a review of significant software and equipment used in the Company's operations
and, to the extent practicable, in the operations of its key business partners,
in order to determine if any year 2000 risks exist that may be material to the
Company as a whole. This process includes an assessment of year 2000 risks and
the identification of practical remediation measures that could be taken on a
timely basis to alter, validate or replace time-sensitive software and
equipment. Management has already begun implementing certain of these measures
and intends to complete its remediation efforts prior to any anticipated
material impact on its computerized information systems. Costs of addressing
potential problems have not been material to date and, based on preliminary
information, are not currently expected to have a material adverse impact of the
Company's financial position, results of operations or cash flows in future
periods. However, if the Company or its significant customers or vendors are
unable to resolve such processing issues in a timely manner, it could result in
a material adverse effect. Accordingly, management plans to devote the
resources it concludes are appropriate to resolve all significant year 2000
issues in a timely manner.

18
<PAGE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Board of Directors and Stockholders
Platinum Entertainment, Inc.

We have audited the consolidated balance sheets of Platinum Entertainment,
Inc. as of December 31, 1997 and May 31, 1997 and 1996, and the related
consolidated statements of operations, stockholders' equity (net capital
deficiency) and cash flows for the seven month period ended December 31, 1997
and each of the three years in the period ended May 31, 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 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 consolidated financial position of Platinum
Entertainment, Inc. at December 31, 1997 and at May 31, 1997 and 1996, and
the consolidated results of its operations and its cash flows for the seven
month period ended December 31, 1997 and for each of the three years in the
period ended May 31, 1997 in conformity with generally accepted accounting
principles.

/s/ ERNST & YOUNG LLP

Chicago, Illinois
May 20, 1998,
except for Note 9, as to which
the date is July 31, 1998

19
<PAGE>

PLATINUM ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)

MAY 31
DECEMBER 31 -------------------------
1997 1997 1996
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 11 $ 53 $ 8,222
Cash in escrow, less reserves of
$1,750 and $-, respectively - 1,750 -
Accounts receivable, less allowances of
$3,912, $3,291 and $233, respectively 15,147 15,034 4,103
Artist advances 2,510 2,444 1,581
Inventories, less allowances of $590, $350
and $100, respectively 4,997 5,416 1,538
Notes receivable 50 50 1,467
Other 898 1,018 473
--------------------------------------------
Total current assets 23,613 25,765 17,384
Artist advances, net of current amounts, less
allowances of $12,936, $9,745 and $4,942, respectively - 2,297 2,093
Equipment and leasehold improvements, net 1,079 1,185 698
Music catalog, less accumulated amortization of $784
and $327, respectively 18,820 19,277 -
Music publishing rights, less accumulated amortization
of $308, $203 and $90, respectively 3,519 3,624 350
Goodwill, less accumulated amortization of $244
and $97, respectively 5,854 6,001 -
Deferred financing costs, net 631 - -
Equity investment in joint venture 2,468 3,154 -
Other 1,473 1,001 19
--------------------------------------------
Total assets $ 57,457 $ 62,304 $ 20,544
-------------------------------------------
--------------------------------------------

</TABLE>

See accompanying notes to financial statements.

20
<PAGE>

PLATINUM ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)

MAY 31
DECEMBER 31 ------------------------------
1997 1997 1996
<S> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Revolving line of credit $ 20,800 $ 9,706 $ -
Term loan - 25,000
Accounts payable 4,256 4,038 997
Accrued liabilities and other 3,423 2,521 2,104
Reserve for future returns 6,301 2,660 800
Royalties payable 5,302 5,513 1,428
----------------------------------------------
Total current liabilities 40,082 49,438 5,329

Convertible subordinated debentures 5,000 5,000 -
----------------------------------------------
Total liabilities 45,082 54,438 5,329

Stockholders' equity:
Preferred Stock:
Preferred Stock ($.001 par value); 10,000,000 shares authorized,
no shares issued and outstanding - - -
Series B Convertible Preferred Stock ($.001 par value);
20,000 shares authorized, issued and outstanding December 31,
1997, no shares authorized, issued and outstanding May 31,
1997 and May 31, 1996, respectively - - -
Series C Convertible Preferred Stock ($.001 par value);
2,500 shares authorized, issued and outstanding December 31,
1997, no shares authorized, issued and outstanding May 31,
1997 and May 31, 1996, respectively - - -
Common Stock:
Common Stock ($.001 par value); 40,000,000 shares authorized,
5,275,040, 5,171,439 and 5,063,207 shares issued and outstanding
December 31, 1997, May 31, 1997 and May 31, 1996, respectively 5 5 5
Additional paid-in capital 58,216 37,261 35,254
Accumulated deficit (45,846) (29,400) (20,044)
----------------------------------------------
Stockholders' equity 12,375 7,866 15,215
----------------------------------------------
Total liabilities and stockholders' equity $ 57,457 $ 62,304 $ 20,544
----------------------------------------------
----------------------------------------------

</TABLE>

See accompanying notes to financial statements.

21
<PAGE>

PLATINUM ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

SEVEN MONTHS ENDED
DECEMBER 31 TWELVE MONTHS ENDED MAY 31
----------------------- ------------------------------------
1997 1996 1997 1996 1995
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Gross product sales $ 34,485 $12,393 $37,502 $18,322 $12,575
Less: Returns and allowances (11,351) (2,326) (10,568) (4,732) (3,126)
Less: Discounts (2,288) (821) (2,463) (712) (507)
----------------------- --------------------------------------
Not product sales 20,846 9,246 24,471 12,878 8,942
Licensing, publishing and other revenues 809 485 1,255 1,799 207
----------------------- --------------------------------------
Net sales 21,655 9,731 25,726 14,677 9,149

Cost of sales and services 16,784 6,225 14,019 10,441 4,945
----------------------- --------------------------------------

Gross profit 4,871 3,506 11,707 4,236 4,204

Other operating expenses:
Selling, general and administrative 12,316 5,695 13,141 8,017 8,800
Merger, restructuring and one-time costs 3,100 6 2,231 - -
Depreciation and amortization 1,062 199 973 156 133
----------------------- --------------------------------------
16,478 5,900 16,345 8,173 8,933
----------------------- --------------------------------------
Operating income (loss) (11,607) (2,394) (4,638) (3,937) (4,729)
Interest income 49 136 154 106 46
Interest expense (2,944) (7) (1,385) (570) (157)
Other financing costs (1,258) - (3,533) - -
Equity gain (loss) (686) - 48 - -
----------------------- --------------------------------------
Loss from continuing operations (16,446) (2,265) (9,354) (4,401) (4,840)
Discontinued operations:
Loss from operations - - - - (2,073)
Loss on disposal - - - (226) (2,611)
----------------------- --------------------------------------
Loss from discontinued operations - - - (226) (4,694)
----------------------- --------------------------------------
Net loss (16,446) (2,265) (9,354) (4,627) (9,524)
Less: Cumulative preferred dividends - - - (602) -
----------------------- --------------------------------------

Loss applicable to common shares $(16,446) $(2,265) $(9,354) $(5,229) $(9,524)
----------------------- --------------------------------------
----------------------- --------------------------------------

Basic and diluted loss per common share:
Loss from continuing operations $(3.14) $(0.44) $(1.82) $(1.71) $(2.12)
Loss from discontinued operations - - - (0.08) (2.05)
----------------------- --------------------------------------
Net loss $(3.14) $(0.44) $(1.82) $(1.79) $(4.17)
----------------------- --------------------------------------
----------------------- --------------------------------------

Weighted average number of common shares outstanding 5,232,030 5,112,066 5,136,830 2,925,987 2,284,090

</TABLE>

See accompanying notes to financial statements.

22
<PAGE>

PLATINUM ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

PREFERRED STOCK
-------------------------------------------------
SERIES A-2 NO SERIES SERIES B SERIES C
<S> <C> <C> <C> <C>
Balance at May 31, 1994 $ - $ - $ - $ -
Proceeds from issuance of Preferred Stock, net ($.69 per share) 18 - - -
Net loss for the year ended May 31, 1995 - - - -
Other - - - -
-------------------------------------------------
Balance at May 31, 1995 18 - - -
Conversion into Common Stock (18) - - -
Initial public offering, net ($11.30 per share) - - - -
Exercise of stock options - - - -
Conversion of Series A-1 Redeemable Preferred Stock - - - -
Dividends on Series A-1 Redeemable Preferred Stock - - - -
Founders' bonus - - - -
Shares issued in lieu of compensation - - - -
Net loss for the year ended May 31, 1996 - - - -
-------------------------------------------------
Balance at May 31, 1996 - - - -
Issuance of Common Stock for business acquisition - - - -
Issuance of stock warrants for financing costs - - - -
Net loss for the year ended May 31, 1997 - - - -
Other - - - -
-------------------------------------------------
Balance at May 31, 1997 - - - -
Proceeds from issuance of Common Stock, ($4.88 per share) - - - -
Proceeds from issuance of Preferred Stock with warrants, net - - - -
Net loss for the seven months ended December 31, 1997 - - - -
-------------------------------------------------
Balance at December 31, 1997 $ - $ - $ - $ -
-------------------------------------------------
-------------------------------------------------

COMMON STOCK
----------------------------------------------
CLASS A CLASS B NO CLASS
-------------------
SHARES AMOUNT
<S> <C> <C> <C> <C>
Balance at May 31, 1994 $ - $ 1 40 $ -
Proceeds from issuance of Preferred Stock, net ($.69 per share) - - - -
Net loss for the year ended May 31, 1995 - - - -
Other - - 10 -
----------------------------------------------
Balance at May 31, 1995 - 1 50 -
Conversion into Common Stock - (1) 2,050 2
Initial public offering, net ($11.30 per share) - - 2,740 3
Exercise of stock options - - 22 -
Conversion of Series A-1 Redeemable Preferred Stock - - 117 -
Dividends on Series A-1 Redeemable Preferred Stock - - - -
Founders' bonus - - 65 -
Shares issued in lieu of compensation - - 19 -
Net loss for the year ended May 31, 1996 - - - -
----------------------------------------------
Balance at May 31, 1996 - - 5,063 5
Issuance of Common Stock for business acquisition - - 88 -
Issuance of stock warrants for financing costs - - - -
Net loss for the year ended May 31, 1997 - - - -
Other - - 20 -
----------------------------------------------
Balance at May 31, 1997 - - 5,171 5
Proceeds from issuance of Common Stock, ($4.88 per share) - - 103 -
Proceeds from issuance of Preferred Stock with warrants, net - - - -
Net loss for the seven months ended December 31, 1997 - - - -
----------------------------------------------
Balance at December 31, 1997 $ - $ - 5,274 $ 5
----------------------------------------------
----------------------------------------------

STOCKHOLDERS'
ADDITIONAL EQUITY
PAID-IN (NET CAPITAL
CAPITAL DEFICIT DEFICIENCY)
<S> <C> <C> <C>
Balance at May 31, 1994 $ 1,989 $ (5,292) $ (3,302)
Proceeds from issuance of Preferred Stock, net ($.69 per share) 487 - 505
Net loss for the year ended May 31, 1995 - (9,523) (9,523)
Other - - -
------------------------------------
Balance at May 31, 1995 2,476 (14,815) (12,320)
Conversion into Common Stock 17 - -
Initial public offering, net ($11.30 per share) 30,953 - 30,956
Exercise of stock options 56 - 56
Conversion of Series A-1 Redeemable Preferred Stock 1,525 - 1,525
Dividends on Series A-1 Redeemable Preferred Stock - (602) (602)
Founders' bonus - - -
Shares issued in lieu of compensation 227 - 227
Net loss for the year ended May 31, 1996 - (4,627) (4,627)
------------------------------------
Balance at May 31, 1996 35,254 (20,044) 15,215
Issuance of Common Stock for business acquisition 777 - 777
Issuance of stock warrants for financing costs 1,240 - 1,240
Net loss for the year ended May 31, 1997 - (9,354) (9,354)
Other (10) (2) (12)
------------------------------------
Balance at May 31, 1997 37,261 (29,400) 7,866
Proceeds from issuance of Common Stock, ($4.88 per share) 500 - 500
Proceeds from issuance of Preferred Stock with warrants, net 20,455 - 20,455
Net loss for the seven months ended December 31, 1997 - (16,446) (16,446)
------------------------------------
Balance at December 31, 1997 $ 58,216 $ (45,846) $ 12,375
------------------------------------
------------------------------------
</TABLE>

See accompanying notes to financial statements.

23
<PAGE>

PLATINUM ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)

SEVEN MONTHS ENDED
DECEMBER 31 TWELVE MONTHS ENDED MAY 31
---------------------- ---------------------------------
1997 1996 1997 1996 1995
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss $ (16,446) $ (2,265) $ (9,354) $ (4,627) $ (9,523)
Adjustments to reconcile net loss to net cash used in
continuing operating activities:
Provision for doubtful accounts 688 - 300 43 -
Charge to provision for future returns 4,246 - 277 572 513
Charge to provision for co-op advertising 362 - 79 83 92
Charge to provision for slow-moving inventory 500 - - 100 -
Charge to provision for unrecoupable artist balances 3,136 308 2,039 3,067 1,128
Depreciation and amortization 1,062 199 973 156 133
Common Stock issued in lieu of compensation - - - 227 -
Amortization of loan discount - - 1,240 - -
Deferred financing costs 9 - - - -
Equity (gain) loss from joint venture 686 - (48) - -
Write-off of one-time costs 2,525 - - - -
Changes in operating assets and liabilities:
Accounts receivable (1,152) (1,115) (2,753) (1,927) (189)
Inventories (81) (737) (1,447) (186) (892)
Notes receivable - 1,025 1,148 (1,402) (23)
Artist advances (906) (2,301) (2,149) (4,466) (3,197)
Accounts payable 218 (5) (431) (822) 1,122
Accrued liabilities and other 902 (1,145) (591) 1,234 668
Reserve for future returns (605) (43) (1,044) (425) -
Royalties payable (211) 2,228 1,405 141 557
Other (1,268) (895) (217) (523) (129)
---------------------- ---------------------------------
Net cash used in continuing operating activities (6,335) (4,746) (10,573) (8,755) (9,740)
Discontinued operations:
Depreciation and amortization - - - - 539
Loss on disposal - - - 226 2,611
Change in net liabilities - - - (1,237) -
---------------------- ---------------------------------
Net cash used in discontinued operating activities - - - (1,011) 3,150
---------------------- ---------------------------------
Net cash used in operating activities (6,335) (4,746) (10,573) (9,766) (6,590)

INVESTING ACTIVITIES
Acquisitions of businesses, net of cash acquired - (100) (24,026) - -
Prepaid acquisition costs - (124) - - -
Investment in joint venture - (3,063) (3,063) - -
Cash in escrow - - (1,750) - -
Purchases of equipment and leasehold improvements (116) (171) (307) (574) (238)
---------------------- ---------------------------------
Net cash used in investing activities (116) (3,458) (29,146) (574) (238)

FINANCING ACTIVITIES
Net proceeds from (payment of) related parties - - - (537) 537
Payment of note payable to related party - - - - (944)
Related party borrowings 2,650 - - - -
Related party payments (2,650) - - - -
Net proceeds from (payment of) revolving lines of credit (8,906) - 7,106 (3,000) 3,000
Net proceeds from bank term loans 20,000 - 25,000 - 4,500
Payment of bank term loans (25,000) - - (4,500) (4,000)
Payment of long-term debt - - - - (1,140)
Net proceeds from initial public offering - - - 30,956 -
Net proceeds from exercise of stock options - - - 56 -
Net proceeds from issuance of Redeemable Preferred Stock - - - - 4,953
Redemption of Redeemable Preferred Stock - - - (4,500) -
Proceeds from sale of Common Stock to a related party 500 - - - -
Net proceeds from sale of preferred stock with warrants 20,455 - - - -
Deferred financing costs (640) - (556) - -
---------------------- ---------------------------------
Net cash provided by financing activities 6,409 - 31,550 18,475 6,906
---------------------- ---------------------------------

Net Increase (decrease) in cash (42) (8,204) (8,169) 8,135 78
Cash and cash equivalents, beginning of period 53 8,222 8,222 87 9
---------------------- ---------------------------------
Cash and cash equivalents, end of period $ 11 $ 18 $ 53 $ 8,222 $ 87
---------------------- ---------------------------------
---------------------- ---------------------------------

</TABLE>

See accompanying notes to financial statements.

24
<PAGE>

PLATINUM ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

1. DESCRIPTION OF BUSINESS

The Company is a full-service music company that produces, licenses, acquires,
markets and distributes high quality recorded music for a variety of musical
formats. The Company has produced recorded music products in the Adult
Contemporary, Gospel, Country and Blues music formats, primarily under its River
North Records, CGI Records and House of Blues Music Co. labels. With its
January 1, 1997, acquisition of Intersound, Inc. ("Intersound"), the Company
expanded its artist base and music catalog within existing genres, and added new
music genres to its repertoire, including Urban/Dance and Classical/Themed
Productions. The Company's products are distributed through PolyGram Group
Distribution, Inc. ("PolyGram") and two operating divisions of the Company,
Platinum Christian Distribution and Intersound Distribution.

The Company's total gross product sales by distribution channel as a
percentage of total gross products sales are as follows:

SEVEN MONTHS ENDED
DECEMBER 31 TWELVE MONTHS ENDED MAY 31
------------------ --------------------------
1997 1996 1997 1996 1995
<S> <C> <C> <C> <C> <C>
PolyGram 36.9% 75.2% 46.9% 58.2% 57.6%
Intersound 60.4% - 32.8% - -
Platinum Christian Distribution
(to Christian bookstores) 2.5% 18.1% 9.1% 23.2% 23.2%
Record Clubs/Direct Sales 0.2% 6.7% 11.2% 10.8% 3.0%
Telemarketing - - - 7.8% 16.2%

</TABLE>

Accounts receivable resulting from product sales through PolyGram are secured
by a distribution agreement (see Note 6). Gross accounts receivable resulting
from product sales outside of this distribution agreement are unsecured and
approximate $14,960, $14,298 and $3,010 at December 31, 1997, May 31, 1997
and May 31, 1996, respectively, exclusive of reserves and allowances for
future returns, co-op advertising and doubtful accounts (see Note 7).

2. CHANGE IN FISCAL YEAR

On February 26, 1998, the Board of Directors of the Company resolved by
unanimous consent to change the Company's fiscal year, formerly May 31, to a
calendar year, effective December 31, 1997. This change in fiscal year makes
the Company's year comparable with other public companies in the industry.
This change in fiscal year also conforms the Company's fiscal periods to the
quarterly and semi-annual periods for which the Company reports its royalties
to its recording artists and publishers as well as the annual term of the
distribution agreement with PolyGram.

25
<PAGE>

Pro forma results of operations for the change in fiscal year, as if the change
in fiscal year had occurred at January 1, 1996, are as follows:

TWELVE MONTHS ENDED
DECEMBER 31
------------------------
1997 1996
(UNAUDITED)
<S> <C> <C>
Gross revenues $ 60,560 $ 21,157
Net revenues 37,650 15,048
Gross profit 13,074 2,733
Operating loss (13,848) (6,430)
Net loss from continuing operations (23,533) (6,417)

Basic and diluted loss per common share from
continuing operations $ (4.52) $ (1.41)

</TABLE>

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts and transactions of
the Company and its wholly owned subsidiaries: Intersound, Inc. (formerly River
North Studios, Inc.); River North Records, Inc.; CGI Records, Inc.; Lexicon
Music, Inc.; Light Records, Inc.; The Recording Experience, Inc.; Just Mike
Music, Inc.; Peg Publishing, Inc. and Royce Publishing, Inc. Significant
intercompany accounts and transactions have been eliminated in consolidation.

CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.

EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements are carried at cost, less accumulated
depreciation. Depreciation is computed using accelerated methods over the
estimated useful lives of the assets (5 to 7 years).

ARTIST ADVANCES
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
50, FINANCIAL REPORTING IN THE RECORD AND MUSIC INDUSTRY, advances to artists
and producers are capitalized as an asset when the current popularity and
past performance of the artist or producer provides a sound basis for
estimating the probable future recoupment of such advances from earnings
otherwise payable to the artist or producer. Any portion of such advances
not deemed to be recoupable from future royalties is reserved at the time the
advance is made. All other advances which do not meet the above criteria are
reserved when incurred.

INVENTORIES
Inventories are valued at the lower of cost, determined on the first-in,
first-out method of accounting, or market. Inventories consist primarily of
finished compact discs and cassette tapes.

ADVERTISING
Promotional costs are capitalized for unreleased projects and expensed when the
related product is released. All other advertising and promotional costs are
fully expensed when incurred. Advertising and

26
<PAGE>

promotional expenses were $2,776, $1,031, $3,270, $1,968 and $3,664 for the
seven months ended December 31, 1997 and 1996 and the twelve months ended May
31, 1997, 1996 and 1995, respectively.

MUSIC CATALOG AND MUSIC PUBLISHING RIGHTS
Music catalog and music publishing rights represent the value allocated to
master recordings and copyrights recorded through the purchase method of
accounting as a result of the Company's historical acquisitions. Such costs
are amortized using the straight-line method over the estimated period to be
benefited which ranges from 15-25 years. The Company assesses the
recoverability of such assets by determining whether the carrying value of
the net assets over their remaining lives can be recovered through projected
undiscounted future cash flows.

GOODWILL
Goodwill, which represents the excess cost of purchase price over the fair value
of identifiable net assets acquired from Intersound, Inc. ("Intersound"), is
amortized over the expected period to be benefited of 25 years.

REVENUE RECOGNITION
Net product sales represent revenues derived from sales of records, net of
actual returns, discounts and reserves for estimated future returns. Revenues
derived from the licensing of recorded masters are calculated as a percentage of
retail sales by the licensee net of returns and are recognized by the Company
upon notification of retail sales net of returns by the licensee. Publishing
revenues are recognized by the Company on a cash basis.

SEGMENT REPORTING
Statement of Financial Accounting Standards ("SFAS") No. 131, DISCLOSURES
ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, establishes
standards for the way that public business enterprises report information
about operating segments in annual financial statements and requires that
those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. Operating segments are
components of an enterprise about which separate financial information is
available that is evaluated regularly by the chief operating decision maker
in deciding how to allocate resources and in assessing performance. This
Statement is effective for the Company's fiscal year ending December 31,
1998. The impact of SFAS 131 is not expected to be material to the Company's
financial disclosures.

COMPREHENSIVE INCOME
SFAS No. 130, REPORTING COMPREHENSIVE INCOME, establishes standards for
reporting and display of comprehensive income (i.e., foreign currency
translation gains/losses and unrealized gains/losses on securities) and its
components in a full set of general-purpose financial statements. This
Statement requires that an enterprise (a) classify items of other comprehensive
income by their nature in a financial statement and (b) display the accumulated
balance of other comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of a statement of financial
position. This Statement is effective for the Company's fiscal year ending
December 31, 1998. The impact of SFAS 130 will not be material to the Company's
financial disclosures.

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 amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.

FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist of cash equivalents, trade accounts
receivable, notes receivable, trade accounts payable, revolving line of credit,
term loan and convertible subordinated debentures. The fair value of the
Company's financial instruments approximates the carrying value of the
instruments.

27
<PAGE>

INCOME TAXES
Deferred income taxes are calculated based on the differences between the bases
of assets and liabilities for financial statement and income tax return
purposes, primarily related to the reserves for doubtful accounts receivable,
unrecoupable artist advances and future returns, at the enacted tax rates at
which the resulting taxes are expected to be paid. See Note 9 for further
details.

STOCK-BASED COMPENSATION
SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, encourages, but does not
require, companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has chosen to continue to account
for stock-based compensation using the intrinsic value method as prescribed in
Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR STOCK ISSUED
TO EMPLOYEES, and related Interpretations, under which no compensation cost
related to stock options has been recognized as the exercise price of each
option at the date of grant was equal to the fair value of the underlying Common
Stock.

BASIC AND DILUTED LOSS PER COMMON SHARE
Effective December 31, 1997, the Company adopted SFAS No. 128, EARNINGS PER
SHARE, which established simplified standards for computing and presenting
earnings per share information. The adoption of SFAS No. 128 did not have
any effect on the Company's financial statements.

Basic loss per common share is based upon the net loss applicable to common
shares after preferred dividend requirements and upon the weighted average of
common shares outstanding during the period. Diluted loss per common share
adjusts for the effect of convertible securities, stock options and warrants
only in the periods presented in which such effect would have been dilutive.
The total of such securities at December 31, 1997 is 14,790,000. Such effect
was not dilutive in any of the periods presented herein.

RECLASSIFICATIONS
Certain amounts in the twelve months ended May 31, 1997, 1996 and 1995
consolidated financial statements have been reclassified to conform with the
seven months ended December 31, 1997 presentation.

4. ACQUISITIONS

During June 1996, the Company acquired substantially all of the assets of R.E.X.
Music, Inc. ("REX") for $480, which approximated the indebtedness of REX to the
Company (which primarily arose during fiscal 1996) and $100 in accrued
liabilities. REX produces, licenses and markets recorded music, primarily in
the Gospel genre. The acquisition has been accounted for by the purchase method
of accounting and the purchase price of $580 approximates the fair value of the
assets acquired. The assets acquired include accounts receivable, artist
advances, inventory, music publishing rights and artist contracts. The value

28
<PAGE>

allocated to music publishing rights and artist contracts totaled $440 and is
being amortized over 15 years using the straight-line method.

During September 1996, the Company acquired substantially all of the assets of
Double J Music Group ("Double J") for 88,000 shares of Common Stock of the
Company and the assumption of approximately $100 of debt and $75 of accrued
liabilities. Double J develops and acquires ownership of musical compositions
and exploits those compositions by means of recordings, performances,
audio-visual works, print publications and other licenses. The acquisition has
been accounted for by the purchase method of accounting and the purchase price
of $952 approximates the fair value of the assets acquired. The purchase value
was primarily allocated to music publishing rights and is being amortized over
25 years using the straight-line method.

During January 1997, the Company purchased substantially all of the assets of
Intersound for consideration of $24,000 in cash, $5,000 in convertible
subordinated debentures and the assumption of certain liabilities. Intersound
produces, licenses, markets and distributes recorded music for Urban/Dance,
Gospel, Classical/Themed Productions and other genres. The acquisition has been
accounted for by the purchase method of accounting and the purchase price of
approximately $41,000, including assumed liabilities, exceeds the fair value of
the assets acquired by $6,098, which represents goodwill. The purchase value was
allocated to the acquired assets based upon their estimated respective fair
market values. The amounts allocated to music catalog, music publishing rights
and goodwill are being amortized over 25 years using the straight-line method.

The Company determined the purchase price allocation, as disclosed in the
balance sheet at May 31, 1997, based on available information at that time.
However, during the seven months ended December 31, 1997, the Company
ascertained that the purchase value allocated certain purchased assets
exceeded their fair market values by approximately $1,150. In addition,
further liabilities of approximately $2,350, which the Company believes
relate to returned products that had been sold prior to the Company's
purchase of Intersound, were identified. Had these matters been identified
by the Company at the time of purchase or shortly thereafter, such valuations
would have been recorded through purchase accounting, resulting in no
subsequent income statement impact. As these matters were not identified at
the time of purchase or shortly thereafter, the Company is required to
reflect these amounts in results of operations for the seven months ended
December 31, 1997, resulting in a nonrecurring charge to current operations
of $3,500. This amount is included in the current period returns and
allowances ($2,350) and cost of sales and services ($1,150).

Pro forma results of operations for the acquisitions, as if the acquisitions had
occurred at June 1, 1995, for the twelve months ended May 31 are as follows:

TWELVE MONTHS ENDED
MAY 31
-----------------------
1997 1996
(UNAUDITED)
<S> <C> <C>
Gross revenues $ 61,332 $ 57,163
Net revenues 43,859 40,327
Gross profit 20,898 17,606
Operating loss (2,959) (2,503)
Net loss from continuing operations (9,858) (10,022)

Basic and diluted loss per common share from
continuing operations $ (1.92) $ (3.63)

</TABLE>

29
<PAGE>

5. JOINT VENTURE

The Company and House of Blues Records, Inc. ("HOB") formed the House of Blues
Music Company, a joint venture between HOB and the Company ("Venture"),
effective November 1, 1996. The Company invested approximately $3,100 for a 50%
interest in the Venture. HOB contributed to the Venture a license in HOB's
trademarks, logo and other intellectual property in consideration for its 50%
interest in the Venture.

The Venture develops and produces recordings and related film and video
properties featuring primarily Blues and Gospel music. The Venture, exclusively
through the Company, manufactures, distributes, performs, exhibits and sells
sound recordings and related audiovisual works under the "House of Blues" label.
The Company distributes the Venture's products through its normal distribution
channels for a fee to the Venture. The Company recorded gross revenues and
gross profit from the distribution of Venture products of $3,038, $3,404 and
$82, $368 for the seven months ended December 31, 1997 and the twelve months
ended May 31, 1997, respectively

The Company records the activity of the Venture under the equity method of
accounting for investments in joint ventures. Earnings and distributions of the
Venture are allocated to the Company and HOB in accordance with the Venture
agreement. The Company recorded a loss of $686 and a gain of $48 representing
its share of the loss and profits in the Venture for the seven months ended
December 31, 1997 and the twelve months ended May 31, 1997, respectively.

6. DISTRIBUTION AGREEMENT

The Company has an exclusive domestic distribution agreement with PolyGram
("PolyGram Agreement"). The term of the PolyGram Agreement is through
December 31, 2002, unless extended or terminated under certain provisions of
the PolyGram Agreement. The PolyGram Agreement appoints PolyGram exclusive
distributor of certain of the Company's products through normal retail channels,
which excludes certain methods of distribution as defined. The distribution
services rendered by PolyGram include billing and collecting from customers,
bearing bad debts, distributing promotional items, advertising, inventory
control activities and processing returns. Distribution fees paid by the
Company for such services provided by PolyGram to secular accounts include
15-18% of net sales generated by PolyGram. For sales to stores in the
Christian bookstore market, the distribution fee is 12% of net sales. The
payment of all such fees owed to PolyGram by the Company is secured by all of
the Company's inventories in PolyGram's possession awaiting distribution.
Inventories held by PolyGram are $681, $843 and $901 at December 31, 1997 and
May 31, 1997 and 1996, respectively. Accounts receivable due from PolyGram
are $4,099, $4,027 and $1,326 at December 31, 1997 and May 31, 1997 and 1996,
respectively. Gross product sales distributed through PolyGram were $13,580,
$9,322, $17,605, $9,969 and $6,944 for the seven months ended December 31,
1997 and 1996 and the twelve months ended May 31, 1997, 1996 and 1995,
respectively.

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<PAGE>

7. VALUATION AND QUALIFYING ACCOUNTS

Activity of the Company's valuation and qualifying accounts are as
follows:

ADDITIONS
---------
BALANCE AT CHARGED TO CHARGED TO BALANCE
BEGINNING OF COSTS AND OTHER AT END
PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD
------ -------- -------- ---------- ---------
<S> <C> <C> <C> <C> <C>
SEVEN MONTHS ENDED DECEMBER 31, 1997

Reserve for future returns $ 2,660 $ - $ 4,246 (1) $ 605 (3) $ 6,301
Allowance for doubtful accounts 2,725 688 20 673 (4) 2,760
Reserve for unrecoupable artist advances 9,745 3,136 55 - 12,936
Allowance for slow-moving inventory 350 500 - 260 (5) 590

TWELVE MONTHS ENDED MAY 31, 1997

Reserve for future returns $ 800 $ - $ 2,904 (1) $1,044 (3) $ 2,660
Allowance for doubtful accounts 58 300 2,414 (2) 47 (4) 2,725
Reserve for unrecoupable artist advances 4,942 2,039 3,089 (2) 325 (6) 9,745
Allowance for slow-moving inventory 100 - 250 (2) - 350

TWELVE MONTHS ENDED MAY 31, 1996

Reserve for future returns $ 653 $ - $ 572 (1) $ 425 (3) $ 800
Allowance for doubtful accounts 30 43 - 15 (4) 58
Reserve for unrecoupable artist advances 3,010 3,067 - 1,135 (6) 4,942
Allowance for slow-moving inventory - 100 - - 100

TWELVE MONTHS ENDED MAY 31, 1995

Reserve for future returns $ 140 $ - $ 513 (1) $ - $ 653
Allowance for doubtful accounts 40 - - 10 (4) 30
Reserve for unrecoupable artist advances 1,882 1,128 - - 3,010

</TABLE>

(1) Gross margin impact of estimated future sales returns, charged against
gross product sales. Seven months ended December 31, 1997 amount
includes $2,350 related to returns of product sold by Intersound prior
to the Company's purchase. See Note 4. Twelve months ended May 31, 1997
amount includes $2,627 related to acquisitions accounted for under the
purchase method of accounting.
(2) Relates to acquisitions accounted for under the purchase method of
accounting.
(3) Gross margin impact of actual sales returns, charged against reserve for
future returns.
(4) Write-offs, net of recoveries.
(5) Recoveries of reserved product.
(6) Recoupment of reserved advances and write-offs.

31
<PAGE>

8. EQUIPMENT AND LEASEHOLD IMPROVEMENTS

Equipment and leasehold improvements consist of the following:

MAY 31
DECEMBER 31 -------------------
1997 1997 1996
<S> <C> <C> <C>
Office equipment and computers $1,126 $1,041 $ 499
Furniture and fixtures 308 306 267
Leasehold improvements 222 217 150
Audio equipment 158 157 11
Warehouse equipment 67 44 -
Autos 5 5 5
-------- ------------------
1,886 1,770 932
Less: Accumulated depreciation 807 585 234
-------- ------------------
Equipment and leasehold improvements, net $1,079 $1,185 $ 698
-------- ------------------
-------- ------------------

</TABLE>

During the twelve months ended May 31, 1996, the Company purchased $421 of
office equipment, furniture and fixtures, and leasehold improvements from a
company that is wholly owned by a director, officer and stockholder of the
Company.

9. DEBT

Convertible debentures in the aggregate principal amount of $5,000 that were
issued to Intersound in connection with the Intersound Acquisition on January
31, 1997, mature on January 31, 2004 and bear interest at the seven-year
Treasury rate plus one percent per annum (6.75% at December 31, 1997) and are
convertible, in whole or in part, at any time prior to maturity into the
Company's Common Stock at a conversion price of $9.80 per share, subject to
adjustment as provided in the debentures.

On January 31, 1997, the Company entered into a Credit Agreement with Bank of
Montreal ("BMO"), individually and as agent, to provide a 90-day term loan in
the amount of $25,000 and a 90-day revolving credit facility in the amount of
$10,000 (the "Original Credit Facility"). The Original Credit Facility was
extended through December 31, 1997 and was refinanced on December 12, 1997 as
discussed below. Financing costs associated with the Original Credit Facility
from January 31, 1997 through December 31, 1997 approximated 10% of the total
facility. The interest incurred on the Original Credit Facility was
initially LIBOR plus 6% and was increased to LIBOR plus 9% effective August
1, 1997.

On December 12, 1997, the Company refinanced the Original Credit Facility with
the net proceeds from the Preferred Stock with Warrants Issuance and an amended
credit agreement with BMO (the "Amended Credit Facility"). Under the terms of
the Amended Credit Facility, the Company has $20,000 in bank debt with a three
year term, due in quarterly installments beginning June 1, 1998, bearing
interest at the bank's base rate plus 1.0% per annum (9.5% at December 31,
1997), and a $10,000 available revolving line of credit, due in three years and
bearing interest at the bank's base rate plus 1/2 of 1.0% per annum (9.0% at
December 31, 1997). The Company had drawn $800 against the available line of
credit as of December 31, 1997. Borrowings under the revolving line of credit
are limited to the Borrowing Base, as defined, which is based upon eligible
accounts receivable and inventory. The Amended Credit Facility contains certain
financial covenants and is secured by substantially all of the Company's assets.
Effective March 31, 1998, the Amended Credit Facility was amended to appoint
Harris Trust and Savings Bank as the lender. All other terms remained
substantially unchanged.

On July 31, 1998, the Company replaced the Amended Credit Facility with a
$35,000 revolving line of credit from First Source Financial, Inc. ("New
Credit Facility"). The New Credit Facility has a five year term, bears
interest at the bank's base rate plus 0.75% per annum and includes a LIBOR
option of LIBOR + 2.75%. Borrowings under the New Credit Facility are limited
to the Borrowing Base, as defined, which is based upon eligible accounts
receivable, inventory and music catalog. The New Credit Facility contains
certain financial covenants, requires a lockbox arrangement and is secured by
substantially all of the Company's assets. The effects of this refinancing
have been reflected in the balance sheet at December 31, 1997.

32
<PAGE>

Subsequent to the IPO during the twelve months ended May 31, 1996, the
Company retired all of its then-outstanding bank debt, consisting of
borrowings against a line of credit totaling $4,980 and a term loan of
$4,000, with net proceeds from the IPO.

Interest expense and cash paid for interest are as follows:

SEVEN MONTHS ENDED TWELVE MONTHS ENDED
DECEMBER 31 MAY 31
------------------ ---------------------------
1997 1996 1997 1996 1995
<S> <C> <C> <C> <C> <C>
Interest expense, total $2,944 $7 $ 1,385 $ 891 $597
Interest expense relating to discontinued operations - - - 333 447
Cash paid for interest 3,233 7 985 1,022 516

</TABLE>

Other financing costs totaled $1,258 for the seven months ended December 31,
1997 and include extension fees for the BMO Credit Facility. Other financing
costs totaled $3,533 for the twelve months ended May 31, 1997 and include
amortization of $1,240 for the loan discount related to the warrants issued to
BMO and $2,293 for initial closing and a subsequent extension of the BMO Credit
Facility.

10. INCOME TAXES

Significant components of deferred income taxes consist of the following:

MAY 31
DECEMBER 31 ---------------------
1997 1997 1996
<S> <C> <C> <C>
Net operating loss carryforwards $12,600 $ 9,840 $ 4,741
Reserve for unrecoupable artist advances 3,723 2,510 1,878
Allowance for doubtful accounts 353 202 22
Reserve for future returns 1,396 12 304
Other (1,133) (1,853) 368
-------- ---------------------
16,939 10,711 7,313
Less: Valuation allowance 16,939 10,711 7,313
-------- ---------------------
Net deferred income tax asset $ - $ - $ -
-------- ---------------------
-------- ---------------------

</TABLE>

The valuation allowance increased $6,228, $3,398 and $1,735 during the seven
months ended December 31, 1997 and the twelve months ended May 31, 1997 and
1996, respectively, due principally to net operating loss carryforwards and
differences between the book and tax accounting treatment of the reserve for
unrecoupable artist advances. No taxes have been paid for the periods
indicated.

Pursuant to Section 382 of the Internal Revenue Code of 1986, as amended, the
Company's net operating loss carryforward of approximately $33,158, expiring in
years 2007 through 2012, is subject to annual limitations due to a change in
ownership as a result of the IPO. Accordingly, approximately $12,349 of the net
operating loss carryforward is subject to an annual limitation of approximately
$2,200.

11. MERGER, RESTRUCTURING AND ONE-TIME COSTS

As a result of the acquisitions discussed in Note 4, the Company incurred
significant costs to merge and restructure its business with the acquired
companies. Such merger and restructuring costs include severance costs,
relocation costs, lease commitment write-offs, warehouse closing costs and other
related costs. Such costs approximated $251 and $1,700 during the seven months
ended December 31, 1997 and

33
<PAGE>

the twelve months ended May 31, 1997,respectively, relating primarily to
severance costs and a distribution termination fee. The restructuring was
substantially completed at December 31, 1997. Such restructuring resulted in
shifts in the selling and promotion efforts of the Company's Country label and
in-house sales department and a shift in third-party fulfillment of Platinum
Christian Distribution. In addition, one-time costs for the twelve months ended
May 31, 1997 include write-offs of artist advances of approximately $600 in
areas for which the Company has chosen to redirect its resources. These costs
are classified as merger, restructuring and one-time costs and are included in
the Company's operating losses. See Note 18 for further discussion of
one-time costs.

12. RELATED PARTY TRANSACTIONS

During the twelve months ended May 31, 1996, the Company retired all of its
outstanding related party debt with net proceeds from the IPO. Principal and
interest payments to related parties during this period totaled $4,867 and $202,
respectively. Interest expense incurred due to related parties approximated
interest paid to related parties.

Under an agreement dated May 1996, the Company sold certain audio-visual rights
for $401 and its right to free future studio usage for $850 to a minority
stockholder and former officer of the Company (see Note 13). The $401 is
reflected in licensing, publishing and other revenues in the accompanying twelve
months ended May 31, 1996 statement of operations. The $850 was credited to
deferred revenues and is being amortized to offset cost of artist projects over
a 27-month period. As a result, the notes receivable balance at May 31, 1996
includes $1,058 relating to these transactions.

The Company entered into Consulting Agreements, each dated as of
December 12, 1997, between the Company and each of MAC Music LLC and Palladin
Capital Group, Inc. The Company has paid each consulting group a one-time
fee of $200 for its services. Each consulting group has agreed to render
consulting services to the Company in connection with (i) management and
strategic planning, (ii) the identification of financing, acquisition,
divestiture, joint venture and licensing opportunities for the Company and
(iii) other matters relating to the day-to-day business and operations of the
Company, or any of its subsidiaries or affiliated companies, as the Chief
Executive Officer or the Board of Directors of the Company may from time to
time reasonably request. The term of each agreement is for five years.

The Company borrowed and repaid in full $1,500 from an officer and director
of the Company during the seven months ended December 31, 1997. In addition,
the Company borrowed and repaid in full $1,150 from a party unrelated to the
Company during the seven months ended December 31, 1997, of which repayment
was guaranteed by certain officers and directors of the Company. Both amounts
bore interest of 10.0% per annum. Interest accrued and paid on these loans
during the seven months ended December 31, 1997 approximated $34.