UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                    FORM 10-K

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

                     For the fiscal year ended June 30, 1999

                                       OR

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

           For the transition period from ___________ to _____________

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

                        Commission File Number: 333-60991

          Delaware                                               74-288316
(State or other jurisdiction of                              (I.R.S. Employer
incorporation or organization)                               Identification No.)


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

                               Commission File Number: 333-60989

          Delaware                                               13-3785856
(State or other jurisdiction of                              (I.R.S. Employer
 incorporation or organization)                             Identification No.)


                              1815 East Main Street
                              Chattanooga, TN 37404
                                 (423) 624-3301

     (Address, including zip code and telephone number, including area code,
                        of principal executive offices)


           Securities Registered Pursuant to Section 12(b) of the Act:
                                      None.


           Securities Registered Pursuant to Section 12(b) of the Act:
                                      None.


<PAGE>



Indicate  by check mark  whether  the  registrants  (1) have  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) have been subject to such
filing requirements for the past 90 days. (X) Yes ( ) No

As of  September  27, 1999,  1,000 shares of common stock of AKI Holding  Corp.,
$0.01 par value, were outstanding and 1,000 shares of common stock of AKI, Inc.,
$0.01 par value, were outstanding.

Indicate  by check mark if  disclosure  of  delinquent  filers is not  contained
herein,  and will not be contained,  to the best of registrants'  knowledge,  in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K. ( X)

AKI, Inc. meets the requirements set forth in General Instruction I 1(a) and (b)
of Form 10-K and is therefore filing this form with reduced disclosure format.

                      DOCUMENTS INCORPORATED BY REFERENCE:

                                      None.




<PAGE>



         As used within this report,  the term  "company"  refers to AKI Holding
Corp.,  a Delaware  corporation,  and its  subsidiaries  including  AKI, Inc., a
Delaware  corporation  ("AKI"),  and the term  "Holding"  refers  solely  to AKI
Holding Corp.

                                     PART I

ITEM 1.  BUSINESS

         Part I is presented with respect to both  registrants  submitting  this
filing, Holding and AKI.

General

         Our  company  is  a  leading  global   marketer  and   manufacturer  of
multi-sensory,  interactive  sampling  systems  that engage the senses of touch,
sight,  sound and olfactory.  Our sampling systems are widely  recognized in the
fragrance,  cosmetics  and personal  care  industries,  as well as the household
products and food and beverage  industries.  We offer an extensive  portfolio of
proprietary,   patented  and   patent-pending   sampling  systems  that  can  be
incorporated into various media which is designed to reach the consumer at home,
such as magazine  inserts,  catalog  inserts,  remittance  envelopes,  statement
enclosures and blow-ins.

         Our company is a fully integrated sampling company and is positioned to
provide complete,  interactive advertising programs to our customers,  including
creative content and sample product and distribution.

         Product sampling is one of the most effective,  widely used and fastest
growing forms of promotional activity.  Product sampling is particularly crucial
to the fragrance and cosmetics  industries  where consumers  traditionally  "try
before  they  buy"  due to the  highly  personal  nature  of the  products.  Our
company's   introduction  in  1979  of  the  ScentStrip(R)  Sampler,  the  first
pull-apart,  microencapsulated scent sampling system,  transformed the fragrance
sampling industry.  By combining  advertising with a sampling system,  marketers
were afforded the first  cost-effective  means to reach consumers in their homes
on a mass scale. Though the microencapsulated  fragrance sampling system remains
the most widely used product throughout the fragrance industry,  our company has
developed and/or acquired a portfolio of alternative scent sampling systems, all
designed for cost-effective  mass distribution,  and continues to be the leading
innovator in the sampling industry.

         In recent  years,  our company has expanded  our  sampling  business by
developing new technologies  specifically for the skincare,  makeup and consumer
products markets.  Although product sampling is critical to the success of these
markets,  sampling programs for these products historically have been too costly
for mass  production  and  incapable  of  efficiently  being  incorporated  into
magazines,  catalogs,  direct mail and other printed  vehicles.  Our  innovative
sampling  systems are designed to fill the needs of these marketers by providing
a cost-effective means of reaching consumers in their homes on a mass scale with
quality  renditions  of skincare  products,  foundation,  lipstick  and cosmetic




                                       1
<PAGE>

powders.  Management  believes  that our new  sampling  systems have altered the
economics and efficiencies of product sampling in the cosmetics market.

         In December  1997, DLJ Merchant  Banking  Partners II, L.P. and certain
related investors (collectively, "DLJMBII") and certain members of our company's
prior  management  organized AHC I  Acquisition  Corp.,  a Delaware  corporation
("Acquisition  Corp."),  to acquire all of the outstanding  equity  interests of
AKI.  Holding was formed as a holding  company in 1998 and its only  significant
asset is the capital stock of AKI.  Holding conducts all of its business through
AKI.  As of  September  27,  1999,  DLJMBII  owned  approximately  98.8%  of the
outstanding  common stock of Acquisition Corp. See "Management's  Discussion and
Analysis of Financial Condition and Results of Operations--The Acquisition."

         On September  15, 1999,  we acquired all of the issued and  outstanding
shares of capital stock of RetCom  Holdings Ltd. and refinanced  working capital
indebtedness of RetCom and its subsidiaries.  See  "Management's  Discussion and
Analysis of Financial Condition and Results of Operations--RetCom  Acquisition."
The acquired  businesses of RetCom and its  subsidiaries  include a portfolio of
sampling  systems  catering  to  the  fragrance,  cosmetics  and  personal  care
industries,  as well as microencapsulation  products and processes. The acquired
businesses  also include a creative  service  division that engages in marketing
communications  and catalogs,  and a multi-media  division for  merchandising at
point-of-sale.   The  acquired   businesses  offer  proprietary,   patented  and
patent-pending sampling systems that include MicroSilk(TM),  MicroDot(TM),  Snap
and Powder(TM), ColorDot(TM) and Ascent(TM).

Products

         Our company  offers a broad and  diversified  portfolio of  innovative,
interactive sampling systems for the fragrance,  cosmetics and consumer products
markets. Our major technologies are described below,  including a description of
the patent protection of each such product technology. Each of our products is a
cosmetic,  fragrance  or consumer  product  sample  delivery  system,  generally
designed  to perform the same basic  function,  and  generally  sold to the same
category of customers.
<TABLE>
<CAPTION>

----------------------- ------------------- ---------------------- --------------------- --------------------
                             Year of                                Patent Protection
       Product             Introduction            Origin                                   Target Market
----------------------- ------------------- ---------------------- --------------------- --------------------
<S>                     <C>                 <C>                    <C>                   <C>
----------------------- ------------------- ---------------------- --------------------- --------------------
ScentStrip              1979                Internally developed   None                  Fragrance,
                                                                                         consumer products

ScentStrip Plus         mid 1980's          Internally developed   None                  Fragrance

DiscCover               1994                Licensed               Patented              Fragrance,
                                                                                         consumer markets

Scent Seal              1995                Acquired               Patented              Fragrance

LiquaTouch              1997                Internally developed   Patent Pending        Fragrance, skin
                                                                                         care





                                       2
<PAGE>

Fragrance Burst and     1989                Acquired               Patented              Fragrance
Pearls

Fragrance Burst         1989                Acquired               Patented              Fragrance

Microfragrance                              Acquired               Trade secret          Fragrance,
Scratch `n Sniff                                                                         consumer markets

BeautiSeal              1997                Internally developed   Patented              Cosmetics

PowdaTouch              1997                Internally developed   Patent Pending        Cosmetics

LipSeal                 1998                Internally developed   Patented              Cosmetics

TouchDown Nail Color    1999                Internally developed   Patent   Application  Cosmetics
Sampler                                                            Pending

BeautiTouch             1999                Internally developed   Patent Pending        Cosmetics
Multi-well Sampler
----------------------- ------------------- ---------------------- --------------------- --------------------
</TABLE>


Fragrance Sampling Systems

         Our company's portfolio of seven traditional fragrance sampling systems
has historically  accounted for substantially all of our company's sales.  While
the  ScentStrip  technology  continues  to be the most  widely  used  technology
throughout the fragrance  industry,  management  believes that our company's new
and recently acquired sampling systems have maintained our company's competitive
position as an innovator in the industry.  These  sampling  systems have enabled
our company to participate in almost every major new fragrance  launch in recent
years.

     *   ScentStrip:   Our  company's  original  pull-apart,   microencapsulated
         fragrance sampling system continues to deliver the most cost-effective,
         quality fragrance rendition.

     *   ScentStrip Plus: The classic,  pull-apart,  microencapsulated fragrance
         format with the added feature of silky-to-the-touch, powdery texture.

     *   DiscCover:  A  peel-and-reveal,  non-encapsulated  sampling system that
         opens and reseals, delivering a quality aroma rendition up to 25 times.
         This  technology is  color-printable,  affixable to nearly any surface,
         including plastic and glass, and can be die-cut in nearly any shape and
         size.

     *   Scent Seal: A heat-sealed,  pouch-like,  pressure-sensitive format that
         peels open to reveal a moist,  wearable gel rendition  that offers both
         an olfactory and on-skin experience.











                                       3

<PAGE>


     *   Fragrance  Burst Perfume Pearls:  A multi-sensory  sampling system that
         features  silky-to-the-touch,  pearlized perfume pearls - formulated of
         85% liquid  perfume oil - that release a wearable  fragrance  rendition
         when "pearls" are touched.

     *   Fragrance Burst and Pearls: Combines the wearable, visible and tangible
         properties  of Perfume  Pearls with the classic,  pull-apart  fragrance
         burst format, delivering an olfactory and on-skin experience.

     *   Microfragrance Scratch `n Sniff: Microfragrance capsules are applied to
         paper or stickers  which  affix to nearly any  surface,  delivering  an
         accurate aroma  rendition when the sampling  system is scratched,  then
         sniffed.

New Products

         Our company has recently  introduced  six innovative new products which
management  believes  can account  for a  significant  portion of our  company's
future sales.  All of these sampling  systems have been designed for U.S. Postal
Service approval for subscription magazine periodical rates.

     *   BeautiSeal: A heat-sealed, pouch-like,  pressure-sensitive format peels
         open to deliver quality  renditions of cream and lotion  treatments and
         liquid  foundations.  BeautiSeal  is hygienic and  spillproof  and less
         expensive and more versatile than existing skincare/foundation sampling
         alternatives.  For example, a two-sided, printed insert incorporating a
         BeautiSeal  sampling system  generally costs less than half that of the
         manufacture and magazine distribution of an equivalent sample packet.

     *   PowdaTouch:  Applies up to four  different  powders on a single carrier
         and is ideal for trial of a single item shade range or a complete color
         story. Delivers a superior rendition of the shade, texture,  finish and
         application of eye shadow,  powder blush, face powder,  bronzer or body
         powder.  Management  estimates that PowdaTouch  sampling systems can be
         produced  approximately  ten  times  faster  than  currently  competing
         products and at a reduced production rate.

     *   LiquaTouch:  Delivers a rendition of finished  fragrance product (e.g.,
         eau de parfum, eau de toilette or after shave), any liquid treatment or
         personal  care  product and  contains  an  applicator.  Available  in a
         pressure sensitive format designed for U.S. Postal Service approval for
         subscription magazine periodical rates, LiquaTouch is also available in
         a  stand-alone  version,  which  is  a  cost-effective  alternative  to
         fragrance vials. In an independent study recently  conducted among male
         consumers of fragrance  products,  LiquaTouch was shown to be preferred
         among  sampling  systems  and was  also a  finalist  for the  Fragrance
         Foundation's 1997 "Innovation of The Year" award.

     *   LipSeal: A  pressure-sensitive  sampling system peels open to deliver a
         superior rendition of lipstick shade, finish and texture in any formula
         including volatile silicones.






                                       4

<PAGE>


     *   TouchDown Nail Color Sampler:  A  pressure-sensitive,  die-cut  sticker
         that  temporarily  "touches down" on the nail,  demonstrating  superior
         rendition of nail enamel shades without marring a manicure.

     *   BeautiTouch   Multi-Well  Sampler:  A   pressure-sensitive   technology
         featuring  multiple,  individually-sealed  wells on a  common  backing,
         which peel open to deliver renditions of liquid foundations,  cream and
         lotion  treatment  and  personal  care items,  lipstick  and  fragrance
         ancillaries.

Formats

         Our company produces a wide and versatile range of formats designed for
U.S. Postal Service  approval for  subscription  magazine  periodical  rates and
which can be incorporated  into almost any print media.  The most common formats
for the our company's products are described below.

         Magazine Inserts:  Magazine inserts are available in half-, full-, two-
and four-page formats, can be die-cut, can contain any of our company's sampling
systems  and are  the  most  commonly  produced  among  our  company's  formats,
accounting for approximately 44% of fiscal 1999 sales.

         Catalog  Inserts:  Full color  formats  can be produced in a variety of
sizes and inserted into retail or mail order  catalogs.  Catalog  inserts can be
produced  with or  without  an  attached  envelope,  which  may be  provided  to
facilitate the return of merchandise  order forms to the store.  Our company has
the ability to create and produce special formats,  to custom imprint with store
information and to incorporate most of our company's sampling systems.

         Remittance  Envelopes:  Remittance  envelopes,  which are inserted into
store  statement  mailings,  can  be  customized  with  a  store  logo  and  can
accommodate  may of our  company's  sampling  systems.  Our  company is the only
company in the sampling industry that can produce remittance envelopes in-house.
Remittance  envelopes  can be produced  with or without our  company's  sampling
systems.  Remittance envelope  production,  which is a highly customized service
business, reinforces our company's position as a fully-integrated enterprise.

         Statement  Enclosures:  Statement  enclosures  are available in various
formats and sizes.  Fragrance statement enclosures may contain a single scent in
their fold, one or two scents under the fragrance  panel, or they may be die-cut
so that the  fragrance  can be  sampled  by  removing  the  desired  die  shape.
Enclosures  are  normally   imprinted  with  store  logo  and  product   pricing
information.  The six inch  format is our  company's  design  and has become the
industry standard.

         Blow-ins:  Blow-ins,  which are available in all formats and sizes, can
accommodate  nearly  all of our  company's  sampling  systems  and  are  loosely
inserted  (blown in) rather  than bound into store  catalogues,  newspapers  and
magazines.

         In-Store  Handouts:  Our  company  has  made  significant  advances  in
replacing  and  expanding  current  methods of in-store  cosmetic and  fragrance





                                       5


<PAGE>


sampling.  Due to  the  lower  cost  and  design  flexibility  of our  company's
products,  marketers  have  expanded  the number and type of in-store  vehicles.
Working in partnership  with our customers,  new and creative  formats have been
developed.  These formats incorporate many of our company's sampling systems and
items such as postcards,  stickers,  wrist bands,  bookmarks and CD inserts. Our
company is also experiencing  significant  in-store business with the LiquaTouch
sampling  system,  as an  alternative  to vials,  and expects  increases for the
BeautiSeal  and  PowdaTouch  sampling  systems  for  trial of shade  ranges  and
formulae.

Patents and Proprietary Technology

         Our company currently holds patents covering the proprietary  processes
used to produce six of its products  and has  submitted  applications  for three
additional manufacturing processes. Our company has six trademarks registered in
the United  States and eight  trademarks  filed and awaiting  registration.  Our
company has also filed and registered trademarks in over 15 countries around the
world, including Europe, Australia, Japan and Brazil. See "--Products."

         Our company has ongoing research efforts and expects to seek additional
patents in the future covering patentable results of such research. There can be
no assurance that any pending patent applications filed by our company:

     *   will  result  in  patents  being  issued  or that  any  patents  now or
         hereafter  owned  by  our  company  will  afford   protection   against
         competitors with similar technology,

     *   will not be infringed upon or designed around by others or

     *   will  not  be   challenged   by  others  and  held  to  be  invalid  or
         unenforceable.

In addition,  many of our company's  manufacturing  processes are not covered by
any patent or patent  application.  As a result, the business of our company may
be adversely  affected by competitors  who  independently  develop  technologies
substantially equivalent to those employed by our company.

Customers

         Our  company  sells  its  products  to  prestige  and  mass   cosmetic,
fragrance,   consumer  products  companies,   department  stores  and  specialty
retailers including Avon Products,  Inc., Calvin Klein Cosmetics (Unilever Plc),
Chanel, Inc., Coty, Inc.,  Cosmair/L'Oreal S.A., Elizabeth Arden (Unilever Plc),
Estee Lauder,  Inc., Giorgio Beverly Hills and The Procter & Gamble Company. Our
company's top ten customers  accounted for  approximately 57% of sales in fiscal
1999. None of our company's  customers,  other than Estee Lauder,  accounted for
10% or more of net sales in fiscal 1999. Our company believes that its technical
expertise,  manufacturing  reliability and customer  support  capabilities  have
enabled it to develop  strong  relationships  with its  customers.  Our  company
employs  sales and  marketing  personnel  who  possess the  requisite  technical
backgrounds to communicate  effectively with both prospective  customers and our
company's manufacturing personnel.  Historically,  our company has had long-term
relationships with its major customers.





                                       6


<PAGE>


Sales and Marketing

         Our company's sales and marketing efforts are organized geographically.
Our company currently has a total of ten sales executives.  The U.S. sales group
consists  of seven  sales  executives  who are  supervised  by the  Senior  Vice
President  of Sales &  Marketing.  The European  sales  executives  are based in
Paris, France and London,  England and are managed by the Senior Vice President,
International,  who is based in Paris, France. Each sales executive is dedicated
to a certain number of identified  customers.  In addition,  these sales efforts
are supported by 15 production  managers/customer  service representatives which
are  based in  Chattanooga,  Tennessee  and  Paris,  France.  A  portion  of the
compensation for sales executives is commission-based.

         Our company's  marketing  activities include direct contact with senior
executives  in the cosmetic and  fragrance  industry,  major support of industry
events,  extensive  joint marketing  programs with magazines,  retailers and oil
houses, press coverage in industry trade publications, trade shows and seminars,
advertising in trade  publications  and  promotional  pieces.  In addition,  our
company  focuses its sales  efforts  toward three  principal  groups  within its
customers'  organizations  that  management  believes  influence the  customers'
purchasing decisions:

     *   marketing,  which selects the sampling  system  technology and controls
         the promotional budget;

     *   product  development,  which  approves our  company's  sampling  system
         rendition and approves stability testing; and

     *   purchasing, which buys the sampling system pieces and controls quality.

Management believes that as the pressure for creativity  increases with each new
product  introduction,  fragrance  marketers are increasingly  looking for their
vendors  to  contribute  to  the  overall  strategy-building  effort  for  a new
fragrance.  Our company's  executives  routinely  introduce new sampling  system
formats  and  ideas  based  on  our  company's  technologies  to  the  marketing
departments  of its  customers.  Our company's  in-house  creative and marketing
expertise and complete product line provides customers with maximum  flexibility
in designing promotional programs.

Manufacturing

         Our company's  manufacturing processes are highly technical and largely
proprietary.  Our company's  sampling  systems must meet  demanding  performance
specifications  regarding  fidelity to the product  being  sampled,  shelf-life,
resistance   to  pressure  and   temperature   variations   and  various   other
requirements. The manufacturing processes can be broken into three phases:

     *   formulation  of  cosmetic  and  fragrance  product  renditions  in  our
         company's slurry laboratories for use in sampling systems;





                                       7

<PAGE>


     *   manufacturing  the  sampler,  which  consists  of  either  printing  an
         encapsulated  slurry  onto  paper or  producing  sampling  labels  that
         contain fragrance or other cosmetic product renditions; and

     *   labeling technologies (DiscCover, Scent Seal, BeautiSeal,  LiquaTouch),
         affixing the labels onto a piece  preprinted  by our company or a third
         party contract supplier.

         Management believes that our company's formulation capabilities are the
best in the  cosmetics  sampling  industry.  The  formulation  process is highly
complex because our company is trying to replicate the fragrance of a product in
a bottle  containing an alcohol  solution  using  primarily  essential  oils and
paper.  Formulation  approval is an interactive  process between our company and
its customers. Our company has more than 125 different, proprietary formulations
that it utilizes in replicating different characteristics of over 500 fragrances
to obtain a  customer-approved  rendition.  Certain  of these  formulations  are
patented  and the  majority  of the  formulation  process is based on unique and
proprietary methods. Formulation of the fragrance and cosmetic product rendition
is performed  under very strict  tolerances  and in complete  conformity  to the
formula  that the  customer  has  preapproved.  Formulation  is conducted in our
company's specially designed formulation laboratories by trained specialists.

         The artwork for all printed  pieces has typically been furnished by the
customer  or its  advertising  agency.  Our  company's  prepress  department  is
currently  being  converted to state-of  -the-art  technology  by utilizing  the
receipt of customer-supplied computer disks and producing this material directly
on to plates.  Our company has the  capability  to produce high quality  printed
materials,  including the covers of major fashion magazines,  in connection with
fragrance sampling systems.

         Our  company  has  two  different  sampling   component   manufacturing
processes: (1) for its formulated offset paper samplers (ScentStrip,  ScentStrip
Plus, PowdaTouch) and (2) for its formulated letterpress or flexo label samplers
(DiscCover, Scent Seal, BeautiSeal,  LiquaTouch).  Formulated paper samplers are
produced in our company's  primary facility where our company  carefully applies
microencapsulated  slurry onto the paper during the  printing  process and, in a
continuous in-line operation,  folds, cuts and trims the samplers for packing. A
24-hour quality control function and hourly  accountability  provide significant
value to the product development  personnel at our company's customers,  who are
responsible for sample quality.

         All  sampling in a label form is produced on specially  modified  label
and finishing  equipment in our company's  second  facility.  In addition to the
patents pending on certain of its  manufacturing  processes,  our company uses a
number of proprietary  techniques in producing  label  samplers.  Similar to the
formulated paper  operation,  sampling  quality control  personnel  evaluate all
samples by roll and provide full accountability for our company's production.

         Our company also has  agreements  with certain  European and Australian
printers and labelers which produce some  quantities  for global  customers that
require  foreign  distribution.  Each of these  arrangements  are  protected  by
non-competition agreements.





                                       8

<PAGE>


         Our company was recently  awarded The Proctor & Gamble  Pinnacle  Award
which is presented to companies as  recognition  for having met certain  quality
requirements and having demonstrated  outstanding quality assurance. Our company
is currently  pursuing U.S. Food and Drug  Administration  approval  required by
other potential new customers.

Sources and Availability of Raw Materials

         Generally,  the raw materials used by our company in the  manufacturing
of its products have been readily  available  from  numerous  suppliers and have
been  purchased  by  our  company  at  prices  that  our  company  believes  are
competitive.  Our company's  encapsulated paper products utilize specific grades
of paper that are subject to comprehensive  evaluation and  certification by our
company for quality,  consistency  and fit. Our company has not  experienced any
material supply shortages in the past, nor are any anticipated.

Competition

         Our  company's  competitors,  some of whom have  substantially  greater
capital  resources  than our  company,  are  actively  engaged in  manufacturing
certain  products  similar to, or in  competition  with,  those of our  company.
Competition  in our  company's  markets is based upon product  quality,  product
technologies,  customer relationships, price and customer service. Our company's
principal  competitors in the printed fragrance  sampler market are Webcraft,  a
subsidiary of Big Flower Holdings, Inc., Orlandi Inc., Nord'est, Marietta Corp.,
Klocke,  Color  Prelude,  Rotocon,  Ascent and  Appliquesence.  Our company also
competes with numerous  manufacturers of miniatures,  vials,  packets,  sachets,
blisterpacks  and scratch and sniff  products.  In addition,  certain  cosmetics
companies produce sampling products for their own cosmetic products.

Environmental and Safety Regulation

         Our company's  operations are subject to extensive laws and regulations
relating to the storagage,  handling, emission,  transportation and discharge of
materials into the  environment  and the  maintenance of safe  conditions in the
workplace.  Our  company's  policy is to comply with all legal  requirements  of
applicable  environmental,  health and safety laws and regulations.  Our company
believes  that  it is in  general  compliance  with  such  requirements  and has
adequate  professional  staff and  systems  in place to  remain  in  compliance,
although there can be no assurances that this is the case. Our company considers
costs for  environmental  compliance  to be a normal cost of doing  business and
includes such costs in pricing decisions.

Employees

         As of August 31, 1999, our company employed 377 persons, which included
240 hourly and 137 salaried and management  personnel.  Substantially all of our
company's  hourly  employees  are  represented  by the  Graphics  Communications
International Union (GCIU) local 197-M.  Management considers its relations with
the union to be good.  The current  union  contract was signed in April 1999 and
will be in effect through March 31, 2003.






                                       9
<PAGE>



                                  RISK FACTORS

Substantial Leverage;  Restrictive Covenants - Our substantial  indebtedness and
restrictive  covenants imposed by the terms of our indebtedness  could adversely
affect the financial  health of our company and prevent us from  fulfilling  our
obligations under our notes and debentures.

         Our company has substantial  indebtedness and debt service obligations.
As of June 30,  1999,  Holding and AKI had total  consolidated  indebtedness  of
approximately  $146.7  million and $117.0  million,  respectively.  In addition,
Holding's and AKI's deficiency of earnings  available to cover fixed charges for
fiscal 1999,  was $5.5 million and $1.7 million,  respectively.  As of September
20, 1999,  AKI had letters of credit  outstanding  in the amount of $0.6 million
and outstanding borrowings of $16.3 million under its revolving credit agreement
with Heller Financial,  Inc. In addition,  as of such date,  borrowings of up to
approximately $3.1 million were available under the credit agreement, subject to
specified conditions.  The indenture governing Holding's 13 1/2% Senior Discount
Debentures due 2009 and the indenture  governing  AKI's 10 1/2% Senior Notes due
2008 and the credit agreement permit our company and its Restricted Subsidiaries
(as defined in the indentures),  in each case, to incur additional  indebtedness
if we meet specified requirements.

         The  level  of  our  company's   indebtedness   could  have   important
consequences  to holders  of the notes and the  debentures,  including,  but not
limited to, the following:

     *   a substantial portion of cash flow from operations must be dedicated to
         debt service and will not be available for other purposes;

     *   additional  debt financing in the future for working  capital,  capital
         expenditures or acquisitions may be limited;

     *   the level of  indebtedness  could  limit  flexibility  in  reacting  to
         changes in the operating environment and economic conditions generally;

     *   the level of  indebtedness  could  restrict  our  company's  ability to
         increase manufacturing capacity;

     *   our company may face  difficulties in satisfying its  obligations  with
         respect to its indebtedness; and

     *   a portion of our company's  borrowings  bear interest at variable rates
         of interest, which could result in higher interest expense in the event
         of an increase in market interest rates.

         The indentures and the credit agreement  contain  covenants that, among
other things,  limit the ability of our company and its Restricted  Subsidiaries
to:

     *   pay dividends or make certain restricted payments;





                                       10

<PAGE>


     *   incur additional indebtedness and issue preferred stock;

     *   create liens;

     *   incur dividend and other payment restrictions affecting subsidiaries;

     *   enter into mergers, consolidations or sales of all or substantially all
         of the assets of our company;

     *   enter into certain transactions with affiliates; and

     *   sell certain assets.

In addition,  the credit  agreement  requires our company to maintain  specified
financial ratios and satisfy specified  financial condition tests. Our company's
ability  to meet those  financial  ratios  and tests can be  affected  by events
beyond its  control,  and there can be no  assurance  that our company will meet
those tests.

Ability to Service Debt - To service our company's  indebtedness we will require
a  significant  amount of cash.  Our  ability to generate  cash  depends on many
factors beyond our control.

         The ability of our company to pay  principal  and interest on the notes
or principal on the  debentures and to satisfy its other debt  obligations  will
depend  upon  AKI's  future  operating   performance.   AKI's  future  operating
performance  will be affected by prevailing  economic  conditions and financial,
business and other factors,  which factors may be beyond our company's  control,
as well as the  availability  of revolving  credit  borrowings  under the credit
agreement.  Our company  anticipates that its operating cash flow, together with
borrowings under the credit agreement,  will be sufficient to meet its operating
expenses and to service its debt  requirements as they become due.  However,  if
our company is unable to service its  indebtedness,  our company may be required
to take  action  such as reducing  or  delaying  capital  expenditures,  selling
assets,  restructuring  or refinancing its  indebtedness  or seeking  additional
equity  capital.  There can be no  assurance  that any of these  remedies can be
effected on satisfactory terms, if at all.

Holding Company Structure - Holding's  debentures are structurally  subordinated
to indebtedness of its subsidiaries.

         Holding is a holding company and does not have any material  operations
or assets other than ownership of all of the capital stock of AKI.  Accordingly,
its  debentures  will be  effectively  subordinated  to all  existing and future
liabilities of Holding's  subsidiaries,  including indebtedness under the credit
agreement  and AKI's notes.  As of June 30,  1999,  Holding's  subsidiaries  had
$117.0  million  of  indebtedness   and  $17.1  million  of  other   outstanding
liabilities (including trade payables,  accrued liabilities and deferred taxes).
As of September  20,  1999,  AKI also had letters of credit  outstanding  in the
amount of $0.6 million and  outstanding  borrowings  of $16.3  million under the





                                       11
<PAGE>


credit  agreement.   In  addition,   as  of  such  date,  borrowings  of  up  to
approximately $3.1 million were available under the credit agreement, subject to
specified  conditions.  All such  indebtedness  effectively  ranks senior to the
debentures. At June 30, 1999, Holding had no outstanding indebtedness other than
the debentures.  Holding and its subsidiaries may incur additional  indebtedness
in the future, subject to the limitations contained in the instruments governing
their indebtedness.

         Any right of Holding to  participate in any  distribution  of assets of
its subsidiaries upon the liquidation,  reorganization or insolvency of any such
subsidiary  (and  the  consequent  right of the  holders  of the  debentures  to
participate  in the  distribution  of those assets) will be subject to the prior
claims of the respective subsidiary's creditors.

Limitation  on the Payment of Funds to Holding by its  Subsidiaries  - Holding's
ability to repay its  debentures  may depend on its  ability to raise cash other
than through its subsidiaries.

         Holding's  cash flow,  and  consequently  its ability to service  debt,
including its obligations under its debentures, is dependent upon the cash flows
of its subsidiaries and the payment of funds by such  subsidiaries to Holding in
the form of  loans,  dividends  or  otherwise.  Holding's  subsidiaries  have no
obligations,  contingent  or  otherwise,  to pay any amounts due pursuant to the
debentures  or to make any funds  available  for payment of the  debentures.  In
addition,  AKI's credit agreement and its note indenture impose,  and agreements
entered into in the future may impose,  significant  restrictions on the payment
of  dividends  and the making of loans by AKI and its  subsidiaries  to Holding.
Accordingly,  repayment of the debentures may depend upon the ability of Holding
to effect an equity offering or to refinance the debentures.

Effective  Subordination;  Assets  Subject to Security  Interest - Your right to
receive  payments  on the notes and  debentures  is junior to our  existing  and
future secured indebtedness.

         Under the terms of the credit agreement,  Heller  Financial,  Inc., the
lender under the credit agreement,  has a security interest in substantially all
of the  current and future  assets of AKI.  In the event of a default  under the
credit agreement, whether as a result of the failure to comply with a payment or
other  covenant,  a  cross-default  or otherwise,  such lender will have a prior
secured  claim on the  capital  stock of AKI and the  encumbered  assets  of our
company. As a result, the encumbered assets of our company would be available to
pay obligations on the notes and the debentures only after  borrowings under the
credit agreement and any other secured  indebtedness  have been paid in full. If
the  lender  should  attempt  to  foreclose  on its  collateral,  our  company's
financial  condition  and the  value of the  debentures  and the  notes  will be
materially adversely affected and could be eliminated. As of September 20, 1999,
AKI had  letters  of  credit  outstanding  in the  amount  of $0.6  million  and
outstanding borrowings of $16.3 million under the credit agreement. In addition,
as of such date,  borrowings of up to approximately  $3.1 million were available
under the credit agreement, subject to specified conditions.












                                       12


<PAGE>


Postal  Regulation - Our results of operations could be adversely  affected by a
change in the U.S. Postal Service  classification of our sampling systems or the
sampling products of our competitors.

         Our company's  sampling systems are approved by the U.S. Postal Service
for inclusion in subscription  magazines mailed at periodical postage rates. Our
company's  sampling  systems  have a  significant  cost  advantage  over certain
competing sampling products, such as miniatures,  vials, packettes,  sachets and
blisterpacks,  because such competing products cause an increase from periodical
postage  rates  to the  higher  third-class  rates  for  the  magazine's  entire
circulation.  Subscription  magazine  sampling  inserts  delivered  to consumers
through the U.S. Postal Service accounted for approximately 36% of our company's
net sales in fiscal 1999. There can be no assurance that the U.S. Postal Service
will  not  approve  other  competing  types  of  sampling  systems  for  use  in
subscription  magazines without  requiring a postal surcharge,  or that the U.S.
Postal Service will not reclassify our company's sampling systems such that they
would incur a postal surcharge. Any such action by the U.S. Postal Service could
have a  material  adverse  effect on our  company's  results of  operations  and
financial condition.

Reliance Upon  Significant  Customers - Our company  relies on a small number of
customers for a large portion of its revenues.

         Our  company's  top  ten  customers  by  sales  revenue  accounted  for
approximately  57% of our  company's  net  sales  in  fiscal  1999.  None of our
company's  customers  other than Estee Lauder  accounted  for 10% or more of net
sales in fiscal 1999.  Although our company has  long-established  relationships
with most of its major customers,  our company does not have long-term contracts
with any of its  customers.  Our company may be  required by some  customers  to
qualify its manufacturing operations under certain supplier standards. There can
be no  assurance  that our company will be able to qualify  under such  supplier
standards or that such customers will continue to purchase sampling systems from
our company if our company's  manufacturing  operations are not so qualified. An
adverse change in its relationships with significant customers,  including Estee
Lauder,  could  have a  material  adverse  effect on our  company's  results  of
operations and financial condition.

Competition - Our ability to compete with other companies  depends,  in part, on
our ability to meet customer needs on a  cost-effective  and timely basis and to
protect our proprietary technology.

         Our  company's  competitors,  some of whom have  substantially  greater
capital  resources  than our  company,  are  actively  engaged in  manufacturing
certain  products  similar  to those of our  company.  Our  company's  principal
competitors in the cosmetic  sampling  market are Webcraft,  a subsidiary of Big
Flower Holdings,  Inc., Orlandi Inc.,  Nord'est,  Marietta Corp.,  Klocke, Color
Prelude,  Rotocon,  Ascent and  Appliquessence.  Our company also  competes with
numerous manufacturers of miniatures, vials, packettes,  sachets,  blisterpacks,
and scratch and sniff products. In addition,  certain cosmetic companies produce
sampling products for their own cosmetic products.  Competition in our company's
market  is  based  upon  product   quality,   product   technologies,   customer
relationships,  price and customer service.  The future success of our company's
business  will depend in large part upon its  ability to market and  manufacture
products and services that meet customer  needs on a  cost-effective  and timely


                                       13
<PAGE>


basis.  There can be no  assurance  that  capital  will be  available  for these
purposes,  that investments in new technology will result in commercially viable
products  or that  our  company  will  be  successful  in  generating  sales  on
commercially favorable terms, if at all.

         In addition,  our company's success,  competitive position and revenues
will depend,  in part, upon its ability to protect its proprietary  technologies
and to operate without infringing on the proprietary rights of others.  Although
our company has certain patents and has filed,  and expects to continue to file,
other patent  applications,  there can be no assurance that our company's issued
patents are enforceable or that its patent  applications will mature into issued
patents.  The expense involved in litigation  regarding  patent  protection or a
challenge  thereto has been and could be significant and any future expense,  if
any,   cannot  be  estimated  by  our  company.   A  portion  of  our  company's
manufacturing processes are not covered by any patent or patent application.  As
a result,  the business of our company may be adversely  affected by competitors
who  independently  develop  technologies   substantially  equivalent  to  those
employed by our company.

Dependence on Fragrance Industry;  Seasonality - Our business is affected by the
advertising budgets of our customers and is seasonal in nature.

         The advertising budgets of our company's  customers,  and therefore the
revenues of our  company,  are  susceptible  to  prevailing  economic and market
conditions that affect advertising expenditures, the performance of the products
of our company's  customers in the marketplace and certain other factors.  There
can be no assurance  that  reductions  in  advertising  spending will not occur,
which  could  have a  material  adverse  effect  on  our  company's  results  of
operations and financial condition.

         In  addition,   our  company's   sales  and   operating   results  have
historically  reflected seasonal variations.  Such seasonal variations are based
on the timing of our  company's  customers'  advertising  campaigns,  which have
traditionally  been  concentrated  prior to the  Christmas  and  spring  holiday
seasons.  As a result,  a higher level of sales are  reflected in our  company's
first two fiscal  quarters  ended  December 31 when sales from such  advertising
campaigns are principally  recognized  while our company's fourth fiscal quarter
ended June 30  typically  reflects  the lowest  sales level of the fiscal  year.
These  seasonal  fluctuations  require our company to  accurately  allocate  its
resources to manage our company's manufacturing  capacity,  which often operates
at full capacity during peak seasonal demand periods.

Availability  of  Raw  Materials  - Our  results  of  operations  and  financial
condition may be adversely affected by an increase in paper prices or a decrease
in paper supply.

         Paper is the primary raw material  utilized by our company in producing
its sampling systems. Paper costs represented approximately 30% of our company's
cost of goods sold in each of fiscal 1997, 1998 and 1999.  Significant increases
in paper costs could have a material adverse effect on our company's  results of
operations  and financial  condition to the extent that our company is unable to




                                       14


<PAGE>


price its products to reflect such increases. There can be no assurance that our
company's  customers  would  accept such price  increases or the extent to which
such price  increases  would  impact  their  decision to utilize  our  company's
sampling systems.

         All of our company's encapsulated sampling systems, which accounted for
approximately  62% of our company's net sales in fiscal 1999,  utilize  specific
grades of paper that are subject to comprehensive  evaluation and  certification
by our company for  quality,  consistency  and fit.  Our  company  continues  to
research methods of replicating the advantages of these specific grades of paper
with other available grades of paper.  Until such methods are developed,  a loss
of such supply of paper could have a material  adverse  effect on our  company's
results of operations and financial  condition to the extent that our company is
unable to obtain such paper elsewhere.

Risks of International Operations;  Currency Fluctuations - Our company receives
a portion of its revenue from foreign countries which is subject to foreign laws
and regulations and political and economic events.

         Approximately  20% of our  company's  net  sales in  fiscal  1999  were
generated outside the United States.  Foreign  operations are subject to certain
risks inherent in conducting business abroad, including,  among others, exposure
to foreign  currency  fluctuations  and  devaluations  or  restrictions on money
supplies,  foreign and  domestic  export law and  regulations,  price  controls,
taxation, tariffs, import restrictions,  and other political and economic events
beyond our  company's  control.  Our company has not  experienced  any  material
effects of these risks as of yet, but there can be no  assurance  that they will
not have such an effect in the future.

Control by DLJMBII; Conflicts of Interest - Our company is controlled by DLJMBII
whose  interests may conflict with the interests of the holders of the notes and
debentures.

         DLJMBII  has  the  power  to  elect  a  majority  of the  directors  of
Acquisition Corp. and generally  exercises  control over the business,  policies
and affairs of Acquisition Corp.,  Holding, AKI and its subsidiaries through its
ownership  of  Acquisition  Corp.  DLJMBII may have  interests  that could be in
conflict  with  those of the  holders  of notes or the  debentures  and may take
actions  that  adversely  affect the  interests  of the holders of the notes and
debentures.

Labor Relations;  Expiration of Collective  Bargaining Agreement - Our company's
business may be adversely affected by a labor dispute.

         As of August 31, 1999,  approximately  64% of our  company's  employees
worked under a collective  bargaining  agreement that expires on March 31, 2003.
While our company believes that its relations with its employees are good, there
can be no assurance that our company's  collective  bargaining agreement will be
renewed in the future.  A prolonged  labor  dispute  (which could include a work
stoppage)  could  have a  material  adverse  effect on our  company's  business,
financial condition and results of operations.












                                       15

<PAGE>



Year 2000 Issues - Year 2000 problems could affect our day-to-day operations and
cause significant economic liabilities.

         Our  company  evaluated  its  information  technology  systems  and its
non-information  technology systems in order to assess its exposure to Year 2000
issues.  Our company expects to make the necessary  modifications  or changes to
its information systems to enable proper processing of transactions  relating to
the Year 2000 and  beyond  before  January  1,  2000.  While our  company is not
substantially  dependent  upon the proper  function of its computer  systems,  a
failure of its systems could cause, among other things, inaccurate or incomplete
accounting,  the  inability  to bill  customers  and the  inability  to  process
incoming  orders which may cause  business  interruption  or financial  loss. If
third parties with whom our company  interacts have Year 2000 problems which are
not resolved,  our company could experience,  among other things, the disruption
of services  including  telecommunications  and electrical power or financial or
accounting difficulties.  Our company currently estimates that the total cost of
Year 2000 compliance will be less than $100,000.  There can be no assurance that
our  company's  Year 2000 program will be effective or that our company will not
experience disruption or difficulties resulting from Year 2000 problems of third
parties.  See "Management's  Discussion and Analysis of Financial  Condition and
Results of Operations--Year 2000 Issues."

ITEM 2.  PROPERTIES

         Our company owns land and buildings in Chattanooga,  Tennessee that are
used for production,  administration  and warehousing.  Our company's  executive
offices and primary  facility at 1815 East Main Street are located on 2.55 acres
and encloses approximately 67,900 square feet. A second facility housing product
development  and  additional  manufacturing  areas at 1600 East  Main  Street is
located three blocks away on 2.49 acres and encloses approximately 36,700 square
feet.  Our  company  also  leases a third  facility  at 3501 St.  Elmo Avenue in
Chattanooga,  Tennessee  which  is used for  production  and  warehousing.  This
facility  is located on 1.875 acres and  encloses  approximately  29,500  square
feet.

         Our  company  currently  has a  number  of web  printing  presses  with
multi-color  capability  as  well  as  envelope-converting  machines  and  other
ancillary  equipment.  Our company operates a fully equipped  production lab for
the manufacture of  microcapsules  and slurry and separate  laboratories for our
company's   Encapsulated  Products  Division  and  our  company's  research  and
development  facility.  Our company also has a fully staffed and equipped  label
manufacturing  facility,  which includes  state-of-the-art  label  manufacturing
machines that have been specially modified to produce our company's products and
a complete label attaching  operation.  Our company also leases sales offices in
New York, New York, Paris, France and London, England.

ITEM 3.  LEGAL PROCEEDINGS

         Our  company  does  not  believe  that  there  are  any  pending  legal
proceedings that, if adversely determined,  would have a material adverse effect
on the financial  condition or results of operations of our company,  taken as a
whole.





                                       16


<PAGE>



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

         No matter was submitted to a vote of security holders of Holding during
the fourth quarter of fiscal 1999.


                                     PART II

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

         There is no  established  public  trading market for Holding's or AKI's
common stock. As of September 27, 1999, Acquisition Corp. was the sole holder of
record of  Holding's  common  stock and Holding was the sole holder of record of
AKI's common stock.  Generally,  neither  Holding nor AKI pays  dividends on its
shares of common  stock and neither  expects to pay  dividends  on its shares of
common stock in the foreseeable  future. The debentures contain  restrictions on
Holding's ability to pay dividends on its common stock. The notes and the credit
agreement  contain  restrictions on AKI's ability to pay dividends on its common
stock.  See  "Management's  Discussion  and Analysis of Financial  Condition and
Results of Operations--Liquidity and Capital Resources."

ITEM 6.  SELECTED FINANCIAL DATA

         The selected historical  consolidated financial data presented below as
of June 30, 1995,  1996 and 1997,  December  15, 1997,  and for the fiscal years
ended June 30, 1995, 1996 and 1997 and the periods from July 1, 1997 to December
15, 1997 have been derived from the historical consolidated financial statements
of Arcade Holding  Corporation,  the  predecessor  to our company.  The selected
historical  consolidated  financial data presented below as of June 30, 1998 and
1999 and for the period  from  December  16,  1997 to June 30, 1998 and the year
ended June 30, 1999 have been derived from the historical consolidated financial
statements  of our company.  The  information  contained in this table should be
read in  conjunction  with  "Management's  Discussion  and Analysis of Financial
Condition and Results of Operations," and our company's  Consolidated  Financial
Statements and the notes thereto included elsewhere in this report.


























                                       17

<PAGE>

<TABLE>
<CAPTION>



                                                        Predecessor                                    Holding
                                                        -----------                                    -------
                                                                              July 1, 1997      December
                                        Fiscal year ended June 30,                 to          16, 1997 to
                                                                              December 15,      June 30,      June 30,
                                   1995            1996           1997            1997            1998          1999
                                   ----            ----           ----            ----            ----          ----
<S>                            <C>            <C>             <C>            <C>              <C>            <C>
Statement of Operations Data:
Net sales                      $  61,794      $   73,486     $   77,723      $   35,186       $   36,066     $ 85,967
Cost of goods sold                38,333          49,862         49,467          22,809           24,518       55,199
                               ---------      ----------     ----------      ----------       ----------     --------
Gross profit                      23,461          23,624         28,256          12,377           11,548       30,768
Selling, general and
administrative expenses            8,483          10,635         13,333           5,703            5,587       14,500
Amortization of goodwill           1,113           1,234          1,234             568            2,101        4,606
                               ---------      -----------     ----------     ----------       ----------     --------
Income from operations            13,865          11,755         13,689           6,106            3,860       11,662
Interest expense, net              6,170           6,762          6,203           2,646           11,327       16,740
Fees to stockholders                 470             470            470             215              125          250
Other, net                           (22)            244           (101)             11              (47)         128
Income tax expense (benefit)       3,114           2,101          3,135           1,441           (2,052)        (340)
                               ---------      ----------      -----------    ----------       ----------     --------

Net income (loss)              $   4,133      $    2,178      $    3,982     $    1,793       $   (5,493)    $ (5,116)
                               =========      ==========      ==========     ==========       ==========     ========

Balance Sheet Data (at end
of period):
Cash and cash equivalents      $   4,196      $      626      $      303     $    4,481       $    3,842     $  7,015
Working capital (deficit)             39          (4,685)        (36,957)        (4,959)          15,046       14,853
Total Assets                      85,695          82,395          77,142         77,399          214,521      213,579
Total debt and redeemable
preferred stock                   64,655          60,736          54,964         55,408          144,448      146,688
Total stockholder's equity         6,572           7,932          11,225         12,716           57,084       49,797

Other Data:
Capital expenditures               1,325           2,051           2,462            807              514        2,856
Ratio of earnings to fixed
charges                              2.2x            1.6x            2.1x           2.2x             ---          ---

</TABLE>

_____________________
(1)  For  purposes  of  calculating  the  ratio of  earnings  to fixed  charges,
     "earnings"  represent income (loss) before income taxes plus fixed charges.
     "Fixed charges" consist of interest on all indebtedness and amortization of
     deferred  financing  costs.  Earnings  were not  sufficient  to cover fixed
     charges by $7,545 and $5,456 for the periods from December 16, 1997 to June
     30, 1998 and the year ended June 30, 1999, respectively.


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

General

         The sales of our company are derived from the sale of sampling  systems
to cosmetics and consumer products companies. Substantially all of our company's
sales are made directly to its customers  while a small portion are made through
advertising agencies.  Each customer's sampling program is unique and pricing is
negotiated  based on  estimated  costs plus a margin.  While our company and its
customers generally do not enter into long-term  contracts,  our company has had
long-standing  relationships  with  the  majority  of  its  customer  base.  The
introduction of our company's new products,  such as BeautiSeal,  PowdaTouch and
LiquaTouch,  has affected our company's results of operations for certain of the
periods discussed below.




                                       18


<PAGE>


The Acquisition

         DLJMBII and certain members of our company's management organized AHC I
Merger  Corp.  for  purposes  of  acquiring  Arcade  Holding  Corporation,   our
predecessor.  On December 15, 1997, the merger  corporation  acquired all of the
equity interests of the predecessor  corporation (the  "Acquisition") for $205.7
million  (including  related  fees,  expenses  and  cash for  working  capital).
Included in the total cost of the Acquisition were approximately $6.2 million in
non-cash costs  comprised of (1) the  assumption of a promissory  note issued by
the  predecessor  corporation in connection  with the 1995  acquisition of Scent
Seal, Inc. and certain  capital lease  obligations and (2) the exchange of stock
options  to  acquire  common  stock  in  the  predecessor   corporation  by  the
predecessor  corporation's  chief  executive  officer  for an option to  acquire
preferred stock in Acquisition Corp.

         To  provide  the  $199.5   million  of  cash   necessary  to  fund  the
Acquisition,  including  the equity  purchase  price and the  retirement  of all
previously existing preferred stock and debt of the predecessor  corporation not
assumed,  (1)  the  merger  corporation  issued  $123.5  million  of its  Senior
Increasing Rate Notes to Scratch & Sniff Funding, Inc., an affiliate of DLJMBII,
and (2)  Acquisition  Corp.  received $76.0 million from debt and equity (common
and preferred) financings,  including equity investments by certain stockholders
of the predecessor corporation, which was contributed to the merger corporation.
Immediately  following the Acquisition,  the merger  corporation merged with and
into the predecessor  corporation and the combined entity assumed the name "AKI,
Inc."  Acquisition  Corp.  then  contributed $1 of cash and all of its ownership
interest in AKI to Holding for 1,000 shares of Holding's common stock.

         The merger corporation's senior increasing rate notes were subsequently
repaid on June 25, 1998 from the proceeds of AKI's issuance of $115.0 million of
AKI's notes and from a capital  contribution  from  Holding.  On June 25,  1998,
Holding  issued and sold its  debentures  totaling  $50.0  million in  aggregate
principal  amount at maturity for gross proceeds of $26.0 million,  the majority
of which were used to fund Holding's equity contribution to AKI.

         The  Acquisition  was  accounted  for  using  the  purchase  method  of
accounting  and resulted in the  recognition of $153.9 million of goodwill and a
significant increase in amortization expense.

3M Acquisition

         On June 22, 1998,  we acquired the fragrance  sampling  business of the
Industrial and Consumer  Products division of Minnesota Mining and Manufacturing
Company  (3M) for $7.25  million in cash and the  assumption  of a liability  of
$182,000 to one of the  customers of the business.  Our company  financed the 3M
acquisition  with borrowings  under the credit  agreement.  Such borrowings were
subsequently repaid.

RetCom Acquisition

         On September  15, 1999,  we acquired all of the issued and  outstanding
shares  of  capital  stock  of  RetCom  Holdings  Ltd.  at a  purchase  price of



                                       19

<PAGE>


approximately  $12.2 million and  refinanced  working  capital  indebtedness  of
approximately  $5.1 million of RetCom  Holdings Ltd. and its  subsidiaries.  The
purchase  price and  refinancing  of  indebtedness  were  initially  financed by
borrowings under the credit agreement. See "--Liquidity and Capital Resources."

Results of Operations

         For purposes of the following discussion, the results of operations for
the year  ended  June  30,  1998  reflect  the  combination  of the  results  of
operations of the  predecessor  corporation  for the period July 1, 1997 through
December 15, 1997, the date of the  Acquisition,  with the results of operations
of our company for the period  December 16, 1997  through June 30, 1998.  Due to
the effects of purchase accounting applied in the Acquisition and the additional
interest  expense  associated with the debt incurred to finance the Acquisition,
the results of operations  of our company are not  comparable in all respects to
the results of operations of the predecessor corporation.

Fiscal Year Ended June 30, 1999 Compared to Fiscal Year Ended June 30, 1998

         Net Sales.  Net sales for the fiscal year ended June 30, 1999 increased
$14.7 million,  or 20.6%,  to $86.0 million as compared to $71.3 million for the
fiscal year ended June 30, 1998.  The increase was primarily  attributable  to a
$9.1 million increase in domestic sales of cosmetic sampling products,  the $5.7
million  growth of our  company's  European  revenues and  increases in sales of
consumer product samples, offset by decreases in sales to the domestic fragrance
industry.

         Gross  Profit.  Gross  profit for the fiscal  year ended June 30,  1999
increased $6.9 million,  or 28.9%, to $30.8 million as compared to $23.9 million
for fiscal year ended June 30, 1998.  Gross profit as a percentage  of net sales
increased  to 35.8% in the fiscal  year ended June 30,  1999,  from 33.5% in the
fiscal year ended June 30,  1998.  The increase in gross profit and gross profit
as a percentage  of net sales is primarily  attributable  to the increase in net
sales discussed above and reductions in raw material costs, offset by a decrease
in certain  fragrance samples pricing,  changes in product sales mix,  increased
costs associated with the outsourcing of European production and increased costs
associated with the initial production runs of certain customer products.

         Selling,  General and  Administrative  Expenses.  Selling,  general and
administrative  expenses for the fiscal year ended June 30, 1999  increased $3.2
million,  or 28.3% to $14.5  million as compared to $11.3 million for the fiscal
year ended June 30, 1998.  The increase in selling,  general and  administrative
expenses was  primarily  due to severance  charges  related to former  executive
officers,  changes in  executive  compensation  following  the  Acquisition  and
increased  sales staffing and  commissions  related to the increase in net sales
and costs associated with the transition of the 3M acquisition, offset partially
by reduced advertising  expenditures and staff reductions.  As a result of these
factors,  selling, general and administrative expenses as a percent of net sales
increased  to 16.9% in the fiscal  year  ended  June 30,  1999 from 15.8% in the
fiscal year ended June 30, 1998.








                                       20

<PAGE>


         Income  from  Operations.  Income from  operations  for the fiscal year
ended June 30,  1999  increased  $1.7  million,  or 17.0%,  to $11.7  million as
compared to $10.0  million for the fiscal year ended June 30, 1998.  Income from
operations  as a percentage  of net sales  decreased to 13.6% in the fiscal year
ended  June 30,  1999  from  14.0%  in the  fiscal  year  ended  June 30,  1998,
principally  as a result of the increase in  amortization  of goodwill and other
intangibles  resulting  from  the  Acquisition  and the 3M  acquisition  and the
factors described above.

         Interest  Expense.  Interest expense for the fiscal year ended June 30,
1999  increased $2.7 million,  or 19.3% to $16.7  million,  as compared to $14.0
million  for the  fiscal  year  ended  June  30,  1998.  Interest  expense  as a
percentage  of net sales  decreased  to 19.4% in the fiscal  year ended June 30,
1999 from 19.6% in the fiscal year ended June 30, 1998. The increase in interest
expense is due to the increased indebtedness as a result of the recapitalization
of our  company in  connection  with the  Acquisition,  partially  offset by the
refinancing of the merger  corporation's  senior  increasing rate notes with the
notes and debentures.

         Interest  expense  for AKI for the  fiscal  year  ended  June 30,  1999
decreased $0.9 million,  or 6.5%, to $13.0 million, as compared to $13.9 million
for the fiscal year ended June 30, 1998. Interest expense as a percentage of net
sales  decreased  to 15.1% in the fiscal  year ended June 30, 1999 from 19.5% in
the fiscal year ended June 30, 1998. The decrease in interest  expense is due to
the  decreased  indebtedness  as a  result  of the  refinancing  of  the  merger
corporation's  senior  increasing rate notes with the notes and Holding's equity
contribution to AKI partially offset by the recapitalization of AKI.

         Management Fees and Other, Net.  Management fees and other, net for the
fiscal  year ended June 30, 1999 were $0.4  million as compared to $0.3  million
for the fiscal year ended June 30,  1998.  Management  fees and other,  net as a
percentage of net sales were relatively constant for the fiscal years ended June
30, 1999 and 1998.

         Income Tax  Expense.  The income tax  benefit for the fiscal year ended
June 30, 1999  decreased  $0.3  million to ($0.3)  million as compared to ($0.6)
million  for the fiscal  year ended June 30,  1998.  The  decrease is due to the
increase in non-deductible  goodwill amortization and non-deductible  portion of
the interest  expense on the debentures,  offset  partially by the increased net
loss before income taxes as a result of the factors described above.

         Income  tax  expense  for AKI for the fiscal  year ended June 30,  1999
increased  $1.4  million to $0.8  million as compared to ($0.6)  million for the
fiscal year ended June 30,  1998.  The  increase is due to the  decrease in loss
before income taxes as a result of the factors  described  above and increase in
non-deductible goodwill amortization.

         EBITDA.  EBITDA for the fiscal year ended June 30, 1999, increased $3.7
million,  or 22.6%, to $20.1 million as compared to $16.4 million for the fiscal
year ended  June 30,  1998,  principally  as a result of the  factors  described
above.  EBITDA is income from operations plus  depreciation  and amortization of
goodwill and other intangibles.





                                       21

<PAGE>


Fiscal Year Ended June 30, 1998 Compared to Fiscal Year Ended June 30, 1997

         Net Sales. Net Sales for fiscal year ended June 30, 1998 decreased $6.4
million,  or 8.2%, to $71.3 million as compared to $77.7 million for fiscal year
ended June 30, 1997.  The majority of this  decrease was  attributable  to three
core  customers'  advertising  decreases  on new product  launches  and existing
products as a result of a management restructuring at two of these customers and
the sale of one of them. In addition  there was a decrease in domestic  sales of
products for  fragrance  sampling.  These  decreases  were  partially  offset by
increased  domestic and European sales of sampling  products to other categories
of the cosmetics  industry as well as increased  sales to the consumer  products
market.

         Gross  Profit.  Gross  profit  for  fiscal  year  ended  June 30,  1998
decreased $4.4 million,  or 15.5%, to $23.9 million as compared to $28.3 million
for fiscal year ended June 30, 1997.  Gross profit as a percentage of nets sales
decreased  to 33.5% in fiscal year ended June 30, 1998 from 36.4% in fiscal year
ended June 30, 1997. The gross profit decline was primarily  attributable to the
absorption of fixed overhead,  depreciation costs and equipment  reconfiguration
costs created by shorter production runs due to lower volume and the increase in
cost of goods sold in the period subsequent to the Acquisition from the write-up
of inventory in purchase accounting.

         Selling,  General and  Administrative  Expenses.  Selling,  general and
administrative  expenses  for fiscal  year ended June 30,  1998  decreased  $2.1
million or 15.7%,  to $11.3 million as compared to $13.4 million for fiscal year
ended June 30,  1997.  The  decrease  in  selling,  general  and  administrative
expenses was primarily attributable to a decrease in sales commissions resulting
from the  decreased  level of sales and a decrease in legal costs related to our
company's pursuit of a patent  infringement  claim in fiscal year ended June 30,
1997. In addition,  our company also had decreased expenses in fiscal year ended
June  30,  1998  versus   fiscal  year  ended  June  30,  1997  related  to  the
consolidation of certain acquired  technologies and certain expenses relating to
reorganizing the management structure at our company's European subsidiary. As a
result of these  factors,  selling,  general  and  administrative  expenses as a
percentage  of net sales  decreased  to 15.8% in fiscal year ended June 30, 1998
from 17.2% in fiscal year ended June 30, 1997.

         Income from  Operations.  Income from  operations for fiscal year ended
June 30, 1998 decreased $3.7 million,  or 27.0%, to $10.0 million as compared to
$13.7 million for fiscal year ended June 30, 1997.  Income from  operations as a
percentage  of net sales  decreased  to 14.0% in fiscal year ended June 30, 1998
from 17.6% in fiscal  year ended June 30,  1997  principally  as a result of the
factors  described above and the increase in amortization of goodwill  resulting
from the Acquisition.

         Interest Expense.  Interest expense for fiscal year ended June 30, 1998
increased  $7.8 million,  or 125.8% to $14.0 million as compared to $6.2 million
for fiscal year ended June 30, 1997.  Interest  expense as a  percentage  of net
sales  increased to 19.6% in fiscal year ended June 30, 1998 from 8.0% in fiscal
year ended June 30, 1997.  The  increase in interest  expense is a result of the
refinancing of our company in connection with the Acquisition.







                                       22

<PAGE>


         Interest  expense for AKI for fiscal year ended June 30, 1998 increased
$7.7 million,  or 124.2% to $13.9 million as compared to $6.2 million for fiscal
year  ended  June 30,  1997.  Interest  expense  as a  percentage  of net  sales
increased  to 19.5% in fiscal  year ended June 30, 1998 from 8.0% in fiscal year
ended  June 30,  1997.  The  increase  in  interest  expense  is a result of the
refinancing of our company in connection with the Acquisition.

         Other  Income/Expense  and Management  Fees. Other  income/expense  and
management  fees for fiscal year ended June 30, 1998 decreased $0.1 million,  or
25.0% to $0.3 million as compared to $0.4 million for fiscal year ended June 30,
1997.  Other  income/expense  and  management  fees as a percentage of net sales
decreased  to 0.4% in fiscal  year ended June 30,  1998 from 0.5% in fiscal year
ended June 30, 1997. The decrease in other income/expense and management fees is
related to the decrease in  management/advisory  fees  subsequent to the sale of
our company.

         Income Tax Expenses.  Income tax expense for fiscal year ended June 30,
1998  decreased  $3.7  million or 119.4% to $(0.6)  million as  compared to $3.1
million for fiscal year ended June 30, 1997.  The  Company's  effective tax rate
was 36.8% in 1998 and 37.6% in 1997.

         EBITDA.  EBITDA for fiscal  year ended  June 30,  1998  decreased  $2.4
million,  or 12.8% to $16.4 million as compared to $18.8 million for fiscal year
ended June 30, 1997, principally as a result of the factors described above.

Liquidity and Capital Resources

         Our company has substantial  indebtedness  and significant debt service
obligations.  As of June 30, 1999, our company had consolidated  indebtedness in
an  aggregate  amount of  $146.7  million  (excluding  trade  payables,  accrued
liabilities and deferred taxes), of which (1) approximately  $29.7 million was a
direct  obligation of Holding  relating to its debentures and (2)  approximately
$117.0 million was a direct  obligation of AKI relating to its notes and capital
leases.  At June 30, 1999, AKI also had $17.1 million in additional  outstanding
liabilities  (including trade payables,  accrued liabilities and deferred taxes)
and letters of credit  outstanding  under the credit  agreement in the amount of
$0.6 million. As of September 20, 1999, AKI had letters of credit outstanding in
the amount of $0.6 million and outstanding borrowings of $16.3 million under the
credit agreement.

          Borrowings  under the credit agreement are limited to a maximum amount
equal to  $20.0  million.  At June 30,  1999 and  September  27,  1999,  AKI had
borrowings  of  approximately  $19.4  million  and $3.1  million,  respectively,
available,  subject to a  borrowing  base  calculation  and the  achievement  of
specified  financial  ratios  and  compliance  with  specified  conditions.  The
interest rate for borrowings under the credit agreement are determined from time
to time based on our  company's  choice of formulas,  plus a margin.  The credit
agreement will mature on December 31, 2002.

         The  indentures  and  the  credit  agreement  permit  Holding  and  its
Restricted Subsidiaries to incur additional  indebtedness,  subject to specified





                                       23

<PAGE>


limitations.  In addition,  the indentures contains restrictive  covenants that,
among other things, limit the ability of Holding and its Restricted Subsidiaries
to:

     *   pay dividends or make certain restricted payments;

     *   incur additional indebtedness and issue preferred stock;

     *   create liens;

     *   incur dividend and other payment restrictions affecting subsidiaries;

     *   enter into mergers, consolidations or sales of all or substantially all
         of the assets of our company;

     *   enter into certain transactions with affiliates; and

     *   sell certain assets.

         Payment of Holding's  debentures is not guaranteed by AKI or any of its
subsidiaries.   Because  Holding  is  a  holding  company  with  no  substantive
operations,  it is dependent upon the cash flows of AKI and its subsidiaries and
the  payment  of funds by AKI and its  subsidiaries  to  Holding  in the form of
loans, dividends or otherwise to pay its obligations. See "Risk Factors--Holding
Company Structure."

         Holding's  principal  liquidity   requirements  are  for  debt  service
requirements under the debentures.  AKI's principal  liquidity  requirements are
for debt service requirements and fees under the notes and the credit agreement.
Historically,  our company has funded its capital,  debt  service and  operating
requirements  with a combination  of net cash provided by operating  activities,
which was $9.8 million for fiscal 1999, together with borrowings under revolving
credit  facilities.  In fiscal  1998,  cash  totaling  $3.9  million was used by
operating activities primarily due to the assumption, and subsequent settlement,
of a $5.8 million current liability  arising from, and directly  attributable to
the Acquisition.  Net cash provided by operating  activities  during fiscal 1999
resulted from net income before depreciation and amortization, the collection of
an income tax refund  receivable  and increases in accounts  payable and accrued
expenses.  These factors were partially offset by increased accounts  receivable
and inventory levels.

         In fiscal 1998 and fiscal 1999, our company had capital expenditures of
approximately  $1.3  million  and  $2.9  million,  respectively.  These  capital
expenditures   consisted   primarily  of  the  purchase   and   maintenance   of
manufacturing equipment and furniture and fixtures and maintaining and upgrading
its computer systems.

         On September  15, 1999,  we acquired all of the issued and  outstanding
shares  of  capital  stock  of  RetCom  Holdings  Ltd.  at a  purchase  price of
approximately  $12.2 million and  refinanced  working  capital  indebtedness  of
approximately  $5.1 million of RetCom  Holdings Ltd. and its  subsidiaries.  The



                                       24

<PAGE>


purchase  price and  refinancing  of  indebtedness  were  initially  financed by
borrowings under the credit agreement.  Our company is exploring options for the
longer-term financing of a portion of the borrowings incurred in connection with
the acquisition.

         Our  company  may  from  time to  time  evaluate  additional  potential
acquisitions.  There can be no assurance that additional capital sources will be
available  to our  company  to fund  additional  acquisitions  on terms that our
company finds acceptable, or at all.

         In August 1998, Acquisition Corp. repurchased from Roger Barnett 80,000
shares of preferred stock of Acquisition Corp. for approximately $2.0 million in
cash  pursuant to the  exercise by Mr.  Barnett of a put option on July 30, 1998
with the proceeds of a dividend from Holding.

         At June 30, 1999,  Acquisition Corp. had outstanding (1) $30 million of
Floating  Rate Notes  which bear  interest  at  approximately  15% per annum and
mature on December  15,  2009,  and (2)  approximately  $50.8  million of Senior
Preferred Stock which accrue  dividends at 15% per annum and must be redeemed by
December 15,  2012.  Interest on the  floating  rate notes and  dividends on the
senior  preferred  stock may be  settled  through  the  issuance  of  additional
floating rate notes and senior  preferred stock through  maturity or redemption,
respectively.  The floating  rate notes are general,  unsecured  obligations  of
Acquisition  Corp. and are not obligations of, or guaranteed by Holding,  AKI or
any of its subsidiaries. Acquisition Corp. is a holding company and is dependant
upon the cash flows of its  subsidiaries  and the  payment to it of funds by its
subsidiaries.  The indenture relating to the debentures restricts the payment of
dividends or the making of other  restricted  payments by Holding to Acquisition
Corp.

         In September 1999, Acquisition Corp. consummated a private placement to
DLJMBII of  15,000,000  shares of its common stock at a purchase  price of $1.00
per share.  A portion of the  proceeds  may become  available  to the Company to
reduce  outstanding  indebtedness  of Holding or AKI or for  working  capital or
other  general  corporate  purposes,  but there is no  obligation on the part of
Acquisition Corp. to make any of these funds available.

         Capital  expenditures  for the fiscal  year  ending  June 30,  2000 are
budgeted to be  approximately  $4.0  million.  Based on  borrowings  outstanding
(other than pursuant to the credit agreement) as of June 30, 1999 and borrowings
outstanding  under the credit  agreement as of September  20, 1999,  our company
expects total cash payments for debt service in fiscal 2000 to be  approximately
$14.0  million,  consisting of $12.1 million in interest  payments on the notes,
$0.9 million in capital lease  obligations and $1.0 million in interest and fees
under the credit agreement. Our company also expects to make royalty payments of
approximately $1.1 million during fiscal 2000. *

         Our company believes that, in the absence of future acquisitions,  cash
flows from existing  operations and available  borrowings  will be sufficient to
fund budgeted capital  expenditures,  working capital  requirements and interest
and principal  payments on its  indebtedness,  including the  debentures and the
notes for fiscal  2000.  In the event our  company  consummates  any  additional
acquisitions  it may  seek  additional  debt or  equity  financings  subject  to
compliance with the terms of the indentures.









                                       25

<PAGE>


         At June 30,  1999,  our  company's  cash and cash  equivalents  and net
working capital were $7.0 million and $14.9 million, respectively,  representing
an increase in cash and cash  equivalents  of $3.2 million and a decrease in net
working capital of $0.2 million from June 30, 1998. Account receivables, net, at
June 30, 1999  increased  20.2% or $2.7  million  over the June 30, 1998 amount,
primarily due to increased sales and an increase in days sales outstanding.

Seasonality

         Our company's sales and operating results have  historically  reflected
seasonal  variations.  Such seasonal  variations  are based on the timing of our
company's  customers'  advertising  campaigns,  which  have  traditionally  been
concentrated  prior to the Christmas and spring holiday seasons.  As a result, a
higher level of sales are reflected in our company's  first two fiscal  quarters
ended  December 31 when sales from such  advertising  campaigns are  principally
recognized  while our company's  fourth  fiscal  quarter ended June 30 typically
reflects the lowest sales level of the fiscal year. These seasonal  fluctuations
require our company to accurately allocate its resources to manage our company's
manufacturing  capacity,  which  often  operates  at full  capacity  during peak
seasonal demand periods.

Recently Issued Accounting Standards

         In June  1998,  the  FASB  issued  Statement  of  Financial  Accounting
Standards  No.  133,   "Accounting   for  Derivative   Instruments  and  Hedging
Activities"  which is effective for fiscal years  beginning after June 15, 1999.
SFAS No. 133  established  accounting  and reporting  standards  for  derivative
instruments,   including  certain  derivative   instruments  embedded  in  other
contracts and for hedging activities. In June 1999, the FASB issued Statement of
Financial Accounting  Standards No. 137, "Accounting for Derivative  Instruments
and Hedging Activities Deferral of Effective Date" which is effective for fiscal
years  beginning  after June 15, 2000. Our company has only utilized  derivative
financial  instruments  to hedge  our  company's  exposure  to  certain  foreign
currencies.  Such hedging activity has historically been minor and, as a result,
adoption of this  Statement  is not  expected  to have a material  impact on our
company's financial  condition or results of operations.  Our company will adopt
the provisions of this Statement on July 1, 2000.

Year 2000 Issues

         Our company is currently working to resolve the potential impact of the
Year  2000  on  its  information  technology  systems  and  its  non-information
technology  systems so they will  properly  recognize  and utilize  dates beyond
December 31, 1999.

         Our company has in place a Year 2000 program which is being executed by
an internal project team. The objective of the Year 2000 program is to determine
and assess the risks of the Year 2000 issue and to plan and institute mitigating
actions to  minimize  those  risks to  acceptable  levels.  To date,  all of our
company's  systems  have been  assessed  for Year 2000  compliance.  Our company
relies on five computerized  systems all of which required  remediation,  two of
which are  maintained  internally  and the others are  maintained by third party





                                       26
<PAGE>

vendors.  Our company believes that all of these systems are currently Year 2000
compliant. Upon review of our company's  non-information  technology systems our
company believes that none of its manufacturing  equipment is date sensitive. Of
the remaining non-information  technology systems, our company believes all such
systems are Year 2000  compliant.  If,  however,  all necessary  actions are not
taken on a timely  basis to ensure  Year 2000  compliance,  the Year 2000  issue
could have a material  adverse  effect on our company.  See "Risk  Factors--Year
2000 Issues."

         To date,  our  company  has spent  approximately  $80,000  on Year 2000
compliance.  Although our company expects the above referenced expenditures will
be  sufficient  to ensure our  company is Year 2000  compliant,  our company has
budgeted an additional $20,000 for any unforeseen  problems which may arise with
respect to Year 2000  compliance  between  July 1, 1999 and the Year  2000.  All
expenditures  with respect to Year 2000  compliance  will be funded from working
capital.

         Our company is communicating with its significant customers and vendors
to understand  their Year 2000 issues and how they might  prepare  themselves to
manage  those  issues as they relate to our  company.  To date,  no  significant
customers or vendors have  informed our company that a material  Year 2000 issue
exists which will have a material effect on our company.

         Our company has not  formulated a  contingency  plan in the event it or
its significant customers or vendors are not Year 2000 compliant.

Forward-Looking Statements

         The  information  provided in this  document  contains  forward-looking
statements that involve a number of risks and uncertainties. A number of factors
could cause actual results, performance, achievements of our company or industry
results to be  materially  different  from any future  results,  performance  or
achievements  expressed  or implied by such  forward-looking  statements.  These
factors  include,  but are not limited to: o the competitive  environment in the
sampling industry in general and in our company's specific market areas;

     *   changes in prevailing interest rates;

     *   inflation;

     *   changes in cost of goods and services;

     *   economic  conditions  in general and in our company's  specific  market
         areas;

     *   changes  in or  failure  to comply  with  postal  regulations  or other
         federal, state and/or local government regulations;

     *   liability and other claims asserted against our company;

     *   changes in operating strategy or development plans;






                                       27

<PAGE>


     *   the ability to attract and retain qualified personnel;

     *   the significant indebtedness of our company;

     *   labor disturbances;

     *   changes in our company's capital expenditure plans;

     *   and other factors.

In addition,  such  forward-looking  statements are  necessarily  dependent upon
assumptions,  estimates and dates that may be incorrect or imprecise and involve
known and  unknown  risk,  uncertainties  and other  factors.  Accordingly,  any
forward-looking  statements  included herein do not purport to be predictions of
future  events  or  circumstances  and  may  not  be  realized.  Forward-looking
statements can be identified by, among other things,  the use of forward-looking
terminology  such as  "believes,"  "expects,"  "may,"  "should,"  "seeks,"  "pro
forma,"  "anticipates,"  "intends"  or the  negative of any such word,  or other
variations  or  comparable  terminology,   or  by  discussions  of  strategy  or
intentions.  Given these  uncertainties,  readers are  cautioned not place undue
reliance  on  such  forward-looking   statements.   Our  company  disclaims  any
obligations  to update any such  factors or to publicly  announce the results of
any  revisions  to any of  the  forward-looking  statements  contained  in  this
document to reflect future events or developments.


ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

         Our company  generates  approximately  20% of its sales from  customers
outside the United States,  principally in Europe.  International sales are made
mostly from our company's foreign subsidiary located in France and are primarily
denominated in the local currency.  Our company's foreign subsidiary also incurs
the majority of its expenses in the local  currency and uses the local  currency
as its functional currency.

         Our company's major  principal cash balances are held in U.S.  dollars.
Cash  balances in foreign  currencies  are held to minimum  balances for working
capital purposes and therefore have a minimum risk to currency fluctuations.

         Our company  periodically enters into forward foreign currency exchange
contracts to hedge certain exposures  related to selected  transactions that are
relatively  certain  as to both  timing and amount and to hedge a portion of the
production costs expected to be denominated in foreign  currencies.  The purpose
of entering into these hedge  transactions  is to minimize the impact of foreign
currency  fluctuations  on the results of operations  and cash flows.  Gains and
losses on the hedging activities are recognized  concurrently with the gains and
losses from the underlying transactions. At June 30, 1999, our company's forward
exchange  contracts  consisted of forward contracts to sell Euros at an exchange
rate of 1.0461 per U.S.  dollar and to buy British pound sterling at an exchange
rate of 1.6123 per U.S.  dollar.  The notational  principal  amounts under these
foreign exchange contracts were $1.1 million and $0.7 million, respectively.







                                       28

<PAGE>


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         Reference is made to the Consolidated  Financial  Statements of each of
Holding and AKI, the related notes and the Report of Independent Accountants for
each of Holding and AKI commencing at page F-1 of this report,  which  financial
statements, notes and reports are incorporated by reference into this report.

ITEM 9.  CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE

         None.







































                                       29



<PAGE>


                                    PART III

ITEM 10.  EXECUTIVE OFFICERS AND DIRECTORS OF REGISTRANT

         The following table sets forth certain  information with respect to the
directors and executive officers of Holding.

Name                    Age      Position
----                    ---      --------
Thompson Dean           40       Chairman of the Board and Director
William J. Fox          43       President, Chief Executive Officer and Director
Kenneth A. Budde        50       Chief Financial Officer
Hugh R. Kirkpatrick     62       Director
Mark P. Michaels        39       Director
David M. Wittels        35       Director
Roger L. Barnett        35       Director

         Thompson  Dean has served as  Chairman  of the Board and a Director  of
Holding since December  1997.  Mr. Dean is the Managing  Partner of DLJ Merchant
Banking  II,  Inc.  ("DLJ  Merchant  Banking")  and the  general  partner of DLJ
Merchant  Banking  Partners  II, L.P. Mr. Dean serves as a director of Commvault
Inc.,  Von  Hoffman  Press,  Inc.,  Manufacturers'  Services  Limited  and Phase
Metrics, Inc.

         William J. Fox has served as President,  Chief Executive  Officer and a
Director of Holding and as Chairman, President and Chief Executive Officer and a
Director of AKI, Inc. since February 1999. Mr. Fox was President,  Strategic and
Corporate  Development of Revlon  Worldwide,  Senior Executive Vice President of
Revlon,   Inc.  and  Revlon   Consumer   Products   Corporation   ("RCPC")  (and
collectively,  "Revlon") and Chief Executive  Officer,  Revlon  Technologies,  a
division of Revlon,  from January 1998 through  January  1999.  He was Executive
Vice  President  from  1991  through  January  1997 and  Senior  Executive  Vice
President from January 1997 through January 1999 and Chief Financial  Officer of
Revlon from 1991 to 1997.  Mr. Fox served as a director  from  November  1995 of
Revlon,  Inc. and from September  1994 of RCPC,  until April 1999. He was Senior
Vice  President of MacAndrews  and Forbes  Holding Inc.,  the indirect  majority
shareholder  of Revlon,  from August 1990  through  January  1999.  Mr. Fox is a
Director and Vice Chairman of the Board of The Hain Food Group, Inc.
(NASDAQ: HAIN).

         Kenneth A. Budde has served as Chief Financial Officer of Holding since
November  1994.  From October 1988 to June 1994,  Mr. Budde served as Controller
and Chief Financial Officer of Southwestern  Publishing Company.  Prior to that,
Mr. Budde spent 12 years with KPMG Peat Marwick.

         Hugh R.  Kirkpatrick  has  served as a director  of Holding  since June
1998.  Mr.  Kirkpatrick  is  a  former  director  of  International   Flavors  &
Fragrances,  Inc.  where he served  as  Senior  Vice  President  and  President,
Worldwide Fragrance Division, from 1991 through his retirement in 1996.









                                       30

<PAGE>


         Mark P.  Michaels has served as a director of Holding  since June 1998.
Mr.  Michaels  has been a Principal of DLJ Merchant  Banking  since 1997.  Prior
thereto,  Mr. Michaels was a consultant with McKinsey & Company,  Inc. from 1987
to 1996.

         David M.  Wittels  has served as a director of Holding  since  December
1997.  Mr.  Wittels is a  Principal  of DLJ  Merchant  Banking and has served in
various capacities with DLJ Merchant Banking since 1986. Mr. Wittels serves as a
director of Wilson Greatbatch Limited.

         Roger  L.  Barnett  has  served  as  director  of our  company  (or its
predecessor)  since November 1993. Mr. Barnett is the chief executive officer of
Beauty.Com.  From 1995 to February  1999,  Mr.  Barnett  served as President and
Chief  Executive  Officer  of our  company  and from 1994 to 1995,  he served as
Senior Vice President and Vice President of our company.

Compensation of Directors

         Except for Messrs.  Kirkpatrick and Barnett,  directors of Holding will
not receive  compensation  for services  rendered in that capacity,  but will be
reimbursed for out-of-pocket  expenses incurred by them in connection with their
travel to and attendance at board meetings and committees of the board.  Messrs.
Kirkpatrick  and  Barnett  will  receive an annual fee of $20,000  per year plus
reasonable out-of-pocket expenses in connection with travel to and attendance at
meetings of the board of directors and committees of the board.

ITEM 11.  EXECUTIVE COMPENSATION

         The following  table sets forth certain  information for the three most
recently  completed  fiscal years with respect to the  compensation  of (1) each
person who served as our company's chief  executive  officer in fiscal 1999, (2)
our  other  most  highly  compensated   executive  officer  whose  total  annual
compensation  exceeded  $100,000  and  (3) our  other  most  highly  compensated
executive officer whose total annual compensation exceed $100,000 but was not an
employee  of our company at June 30, 1999  (collectively,  the "named  executive
officers").































                                       31

<PAGE>
<TABLE>
<CAPTION>




                                                       Summary Compensation Table
                                                                                            Long Term
                                                   Annual Compensation                    Compensation
                                                   -------------------                    ------------

                                              Fiscal                                         Securities             All Other
        Name and Principal Position            Year        Salary         Bonus         Underlying Options     Compensation(1)
        ---------------------------            ----        ------         -----         ------------------     ---------------
<S>                                            <C>        <C>            <C>            <C>                    <C>
William J. Fox(2)                              1999       $242,308       $250,000              ------(3)            ------
   President, Chief Executive Officer          1998         ------         ------              ------               ------
   And Director                                1997         ------         ------              ------               ------

Roger L. Barnett(2)                            1999        309,711         ------(4)           ------               $3,577
   President, Chief Executive Officer          1998        367,083         ------              32,500(5)             3,670
   And Director                                1997        210,000        275,000              ------                5,700

Kenneth A. Budde                               1999        154,327         80,625              ------                9,077
   Chief Financial Officer                     1998        120,000         75,000              ------               ------
                                               1997        100,000         50,000              ------               ------

Barry Miller(6)                                1999        219,153         ------              ------                  120
   Chief Operating Officer                     1998         23,692         ------              ------               ------
                                               1997         ------         ------              ------               ------

</TABLE>

(1)  Represents  amounts  contributed  on behalf of the named  executive  to our
     company's 401(k) retirement savings plan.

(2)  On February 1, 1999, Mr. Barnett  resigned as president and chief executive
     officer of our  company  and Mr. Fox was  engaged  as  president  and chief
     executive officer.

(3)  Pursuant to the terms of his employment  agreement,  Mr. Fox is entitled to
     receive options to acquire 5% of Acquisition Corp.'s issued and outstanding
     common  stock on a fully  diluted  basis,  which  options have not yet been
     granted.   See  "--Equity  Based   Compensation"   and  "--Fox   Employment
     Agreement."

(4)  Does not include  $353,275 to which Mr.  Barnett is entitled in  connection
     with his  resignation  from our  company.  See "Certain  Relationships  and
     Related Transactions--Employment Arrangements."

(5)  These  options  were  forfeited  upon Mr.  Barnett's  resignation  from our
     company.

(6)  Mr.  Miller's  employment  with our company  commenced  in May 1998 and was
     terminated in May 1999.

Equity-Based Compensation

         No options were granted by Acquisition Corp.,  Holding or AKI in fiscal
1999. Pursuant to the terms of his employment agreement,  Mr. Fox is entitled to
receive  options to acquire 5% of  Acquisition  Corp.'s  issued and  outstanding
common stock on a fully diluted basis,  which options have not yet been granted.
See "--Fox Employment  Agreement." In addition, no options for shares of capital
stock of Acquisition Corp., Holding or AKI were exercised in fiscal 1999.

         Acquisition  Corp.  adopted the 1998 Stock  Option Plan for certain key
employees  and  directors  of  Acquisition  Corp.  and any parent or  subsidiary





                                       32
<PAGE>




corporation  of  Acquisition  Corp. The objectives of the option plan are (1) to
retain the services of persons  holding key positions and to secure the services
of  persons  capable  of  filling  such  positions  and (2) to  provide  persons
responsible for the future growth of Acquisition Corp. an opportunity to acquire
a  proprietary  interest in our company and thus create in such key employees an
increased interest in and a greater concern for the welfare of our company.

         The option  plan  authorizes  the  issuance of options to acquire up to
100,000  shares of common  stock of  Acquisition  Corp.  The option plan will be
administered  by the  board  of  directors  or a  compensation  committee  to be
designated by the board of directors.  Pursuant to the option plan,  Acquisition
Corp.  may  grant  options,   including  options  that  become   exercisable  as
performance  standards determined by the committee are met, to key employees and
directors of  Acquisition  Corp. and any parent or subsidiary  corporation.  The
terms of any such grant will be  determined  by the committee and set forth in a
separate grant agreement.  The exercise price will be at least equal to the fair
market value per share of Acquisition  Corp.  common stock on the date of grant,
provided that the exercise price shall not be less than $1.00 per share. Options
may be  exercisable  for  up to ten  years.  The  committee  has  the  right  to
accelerate  the right to  exercise  any option  granted  under the  option  plan
without  effecting the expiration date thereof.  Upon the occurrence of a change
in control (as defined in the option  plan) of  Acquisition  Corp.,  each option
may, at the discretion of the committee, be terminated upon notice to the holder
and each such holder will receive, in respect of each share of Acquisition Corp.
common stock for which such option is then  exercisable,  an amount equal to the
excess of the then fair market value of such share of Acquisition Corp.
common stock over the per share exercise price.

Fox Employment Agreement

         On  January  27,  1999,  William  J.  Fox  entered  into an  employment
agreement with our company effective February 1, 1999. The term of the agreement
began  on the  effective  date  and will  end on the  third  anniversary  of the
effective  date,  provided,  that  beginning  on the  first  anniversary  of the
effective date, the term shall  automatically be extended for one additional day
each day, unless either party provides notice not to extend.

         Pursuant to his employment agreement, Mr. Fox's base salary is $600,000
and he will be eligible  to receive a  performance-based  bonus of 25%,  100% or
200% of his base salary upon  achievement of targeted goals, and other incentive
payments.

         Pursuant to the terms of his employment agreement,  Mr. Fox is entitled
to receive  options to acquire 5% of Acquisition  Corp.'s issued and outstanding
common stock on a fully  diluted  basis,  subject to  anti-dilution  protection,
which options have not yet been granted.  Once granted,  these options will vest
at specified dates and upon the occurrence of specified conditions. In addition,
upon a change in control  (as  defined in the  employment  agreement),  all time
vested options vest and all performance  vested options vest if the DLJ Entities
(as defined in the  employment  agreement)  achieve  certain levels of return on
their equity investments.

         If Mr. Fox's  employment is terminated by our company  without cause or
by Mr.  Fox for good  reason,  our  company  will pay Mr. Fox two times his base
salary,  50% of such amount on  termination  of employment and 50% paid in equal
monthly   installments  over  a  twelve  month  period  following  the  date  of




                                       33

<PAGE>

termination.  In addition, Mr. Fox will receive a pro-rata bonus for the year of
termination  if he would  have been  entitled  to such a bonus  had he  remained
employed  during the year of  termination.  If such  termination  occurs  within
6-months of a time where a tranche of time vested options would otherwise become
exercisable, then a pro-rata portion of such tranche will become exercisable.

         The employment agreement contains  confidentiality,  noncompetition and
nonsolicitation   provisions.  The  restricted  period  for  the  noncompetition
provisions upon  termination of employment is two years if Mr. Fox's  employment
is  terminated  by our company  without cause or by our company for good reason,
and one year if Mr. Fox's employment is terminated for any other reason.

Compensation Committee Interlocks and Insider Participation

         None of Acquisition Corp., Holding or AKI had a compensation  committee
during fiscal 1999. No executive officer participated in deliberations regarding
executive  compensation.  Each of  William  J.  Fox and  Roger L.  Barnett  were
executive officers during fiscal 1999 and served on the board of directors.


ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT


         All of AKI's issued and outstanding  capital stock is owned by Holding.
All of Holding's  issued and  outstanding  capital stock is owned by Acquisition
Corp.  The following  table sets forth certain  information  as of September 27,
1999 with respect to the beneficial  ownership of Acquisition Corp. common stock
by (1) owners of more than five percent of such Acquisition  Corp. common stock,
(2) each director and named  executive  officer of Holding and (3) all directors
and executive officers of Holding, as a group.


<TABLE>
<CAPTION>

                                                                                                      Percentage of
                                                                                     Shares            Outstanding
                                                                                  Beneficially      Acquisition Corp.
                                                                                     Owned            Common Stock
                               Beneficial Owner

<S>                                                                              <C>                <C>
DLJ Merchant Banking Partners, II, L.P. and related investors (1) (2)            15,921,111              98.8%
William J. Fox                                                                        ---                 ---
Thompson Dean (3)                                                                     ---                 ---
Roger L. Barnett (2)                                                                134,325                *
Hugh R. Kirpatrick                                                                    ---                 ---
Mark Michaels (3)                                                                     ---                 ---
David M. Wittels (3)                                                                  ---                 ---
Kenneth A. Budde                                                                      ---                 ---
All directors and executive officers as a group (2) (3)                             134,325                *


</TABLE>





                                       34

<PAGE>


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

*        Less than one percent.


(1)      Consists of shares held directly by the following affiliated investors:
         DLJ Merchant  Banking  Partners II, L.P; DLJ Merchant  Banking Partners
         II-A,  LP  ("DLJMBII-A);  DLJ  Offshore  Partners  II, C.V.  ("Offshore
         Partners II"); DLJ Diversified Partners, L.P. ("Diversified Partners");
         DLJ  Diversified  Partners-A,  L.P  ("Diversified  Partners-A");  DLJMB
         Funding II, Inc.  ("DLJ Funding II");  DLJ  Millennium  Partners,  L.P.
         ("Millennium Partners");  DLJ Millennium Partners-A,  L.P, ("Millennium
         Partners-A");  DLJ EAB Partners,  L.P ("EAB  Partners");  UK Investment
         Plan 1997  Partners  ("UK  Partners");  and DLJ  First ESC L.P  ("First
         ESC"). See "Certain Relationships and Related Transactions-Transactions
         with DLJMBII,  and their  Affiliates."  The address of each of DLJMBII,
         DLJMBII-A,  Diversified Partners,  Diversified Partners-A,  DLJ Funding
         II, Millennium Partners,  Millennium Partners-A, EAB Partners and First
         ESC is 277 Park  Avenue,  New York,  New York  10172.  The  address  of
         Offshore  Partners 11 is John B.  Gorsiraweg 14,  Willemstad,  Curacao,
         Netherlands Antilles.  The address of UK Partners is 2121 Avenue of the
         Stars, Fox Plaza,  Suite 3000, Los Angeles,  California 90067. Does not
         include 18,000 shares of Acquisition  Corp.  Common Stock held directly
         by the Scratch & Sniff Funding, Inc., an affiliate of DLJMBII.

(2)      See "Certain Relationships and Related Transactions."

(3)      Messrs.  Dean,  Michaels  and  Wittels  are  officers  of DLJ  Merchant
         Banking, an affiliate of DLJMBII. Share data shown for such individuals
         excludes shares shown as held by DLJMBII,  as to which such individuals
         disclaim  beneficial  ownership.  The address of each of Messrs.  Dean,
         Michaels and Wittels is 277 Park Avenue, New York, New York 10172.



ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Transactions with DLJMBII and their Affiliates

         Messrs.  Dean,  Michaels  and  Wittels,  who are  directors  of AKI and
officers and  directors of Holding and  Acquisition  Corp.,  are officers of DLJ
Merchant Banking. DLJ Merchant Banking, together with DLJMBII, beneficially own,
in the  aggregate,  approximately  98.8%  of the  outstanding  common  stock  of
Acquisition Corp.

         Pursuant  to  an  agreement  between   Donaldson,   Lufkin  &  Jenrette
Securities Corporation ("DLJ") and Acquisition Corp., DLJ will receive an annual
fee of $250,000 for acting as the  exclusive  financial and  investment  banking
advisor to our  company  ending  December  31,  2002.  Our company has agreed to
indemnify DLJ in connection with its acting as financial advisor.

Stockholders Agreement

         In connection with the Acquisition, Acquisition Corp., DLJMBII, certain
investors in our company prior to the  Acquisition,  including  Roger L. Barnett
and certain other signatories  thereto,  entered into a Stockholders  Agreement,
dated as of December 15, 1997,  that sets forth certain rights and  restrictions
relating to the ownership of the capital stock of Acquisition  Corp.  (including
securities  exercisable for or convertible or exchangeable into capital stock of
Acquisition Corp.) and agreements among the parties thereto as to the governance
of Acquisition Corp. and, indirectly, Holding and AKI.

         Pursuant  to the  stockholders  agreement,  the board of  directors  of
Acquisition  Corp.  consists of six  members.  DLJMBII has the right to nominate




                                       35


<PAGE>


four of the directors of  Acquisition  Corp.  and the prior  investors  have the
right to nominate one director of Acquisition  Corp.,  provided that DLJMBII and
the prior investors  maintain a specified  minimum level of equity investment in
Acquisition  Corp. In addition,  the  stockholders  agreement  provides that the
Chief  Executive  Officer of  Acquisition  Corp.  be  nominated as a director of
Acquisition Corp.

         The stockholders agreement contains restrictions on the ability of each
holder of capital  stock of  Acquisition  Corp. to transfer any capital stock of
Acquisition  Corp.  to any  person  designated  by the  board  of  directors  of
Acquisition  Corp. to be an "Adverse  Person." In addition,  the prior investors
are restricted in their ability to transfer  capital stock of Acquisition  Corp.
prior to the date that is the earlier of (1) the  consummation  of a  qualifying
initial public  offering or (2) December 15, 2002,  except to DLJMBII or a party
who is a prior  investor,  or  pursuant  to an  offering  of  equity  securities
registered under the Securities Act.

         The other material  provisions of the stockholders  agreement  provide,
subject to specified exceptions, (1) certain preemptive rights to the holders of
capital  stock of  Acquisition  Corp.,  (2) "drag  along"  rights to  DLJMBII to
require the remaining  holders of capital stock of  Acquisition  Corp. to sell a
percentage  of their  ownership  and (3) "tag  along"  rights to the  holders of
capital stock of Acquisition Corp., other than DLJMBII, with respect to sales of
capital stock of Acquisition Corp. by DLJMBII.

         Pursuant to the stockholders  agreement,  DLJMBII was granted the right
to  demand  up to  three  registrations  on Form S-1 or the  equivalent  to sell
Acquisition  Corp. common stock (or if Acquisition Corp. is eligible to use Form
S-3, the number of demand rights is unlimited)  and all holders of capital stock
of Acquisition  Corp. were granted certain  customary  "piggyback"  registration
rights to register  their common stock in any  registration  statement  filed by
Acquisition Corp.

Employment Arrangements

         On June 17, 1998,  Roger  Barnett was  retained as president  and chief
executive  officer  of our  company  pursuant  to the  terms  of his  employment
agreement.  On February 1, 1999,  Mr.  Barnett  resigned as president  and chief
executive  officer and our company engaged William J. Fox as president and chief
executive officer. Under the terms of his employment agreement,  Mr. Barnett was
entitled  to  receive  payments  aggregating  $500,000,  of which  $353,275  was
required  to be paid in fiscal 1999 and the  remainder  of which will be paid in
fiscal 2000.

Put Option

         In August 1998, Acquisition Corp. repurchased from Roger Barnett 80,000
shares of preferred stock of Acquisition Corp. for approximately $2.0 million in
cash  pursuant to the  exercise by Mr.  Barnett of a put option on July 30, 1998
with the proceeds of a dividend from Holding.











                                       36

<PAGE>



                                     PART IV



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

         (a)   1.       Financial Statements

                        The financial  statements  listed on the accompanying
                        index to such financial  statements are filed as part
                        of this report.

               2.       Financial Statement Schedule

                        None.

               3.       Exhibits and Exhibit Index.



3.1             Certificate of Incorporation of Holding.*

3.2             Certificate of Incorporation of AKI.**

3.3             Bylaws of Holding.*

3.4             Bylaws of AKI.**

4.1             Indenture  dated as of June 25, 1998  between  Holding and State
                Street Bank and Trust Company, as Trustee.*

4.2             Indenture dated as of June 25, 1998 between AKI and IBJ Schroder
                Trust Company, as Trustee.**

4.3             Form of 13 1/2%  Senior  Discount  Debentures  due July 1,  2009
                (included in Exhibit 4.1(a)).

4.4             Form of 10 1/2%  Senior  Discount  Debentures  due July 1,  2008
                (included in Exhibit 4.1(b)).

4.5             Registration  Rights Agreement of Holding,  dated as of June 25,
                1998  between   Holding  and  Donaldson,   Lufkin  and  Jenrette
                ("DLJ").*

4.6             Registration Rights Agreement of AKI, dated as of June 25, 1998,
                between AKI and DLJ.**

10.1            Acquisition Corp. Stock Option Plan.*

10.2            Option  Letter  Agreement  relating to the Time Vesting  Options
                dated as of June 17, 1998 between Acquisition Corp. and Roger L.
                Barnett.*

10.3            Option Letter Agreement relating to the Standard Option dated as
                of  June  17,  1998  between  Acquisition  Corp.  and  Roger  L.
                Barnett.*

10.4            Employment  Agreement  dated as of June 17, 1998 between Holding
                and Roger L. Barnett.*








                                       38


<PAGE>


10.5            Employment  Agreement  dated as of May 12, 1998 between  Holding
                and Barry Miller.*

10.6            Employment  Agreement  dated  as of  February  1,  1999  between
                Holding and William J. Fox.***

10.7            Stockholders  Agreement  dated as of December  15, 1997  between
                Acquisition Corp., DLJMBII and certain other investors including
                Roger L. Barnett.*

10.8            Credit  Agreement,  dated as of April 30,  1996,  as  amended by
                Amendment No. 1, dated December 12, 1997, and as further amended
                by Amendment No. 2, dated October 30, 1998,  between the Company
                and Heller Financial, Inc.*

10.9            Amendment No. 3 to the Credit Agreement,  dated August 30, 1999,
                between the Company and Heller Financial.+

10.10           Amendment  No. 4 to the Credit  Agreement,  dated  September 21,
                1999, between the Company and Heller Financial, Inc.+

10.11           Securities  Purchase  Agreement  dated as of  December  15, 1997
                between Holding and Scratch & Sniff Funding, Inc.*

10.12           Asset  Purchase  Agreement  dated as of May 28, 1998 between AKI
                and Minnesota, Mining and Manufacturing Company.*

10.13           Stock  Purchase  Agreement  dated as of November  14,  1997,  as
                amended on  December  2, 1997 and  December  12,  1997 among the
                Company and DLJMBII and certain related investors.*

10.14           Financial  Advisory  Agreement  dated as of  December  12,  1997
                between Acquisition Corp. and DLJ.*

10.15           Replacement Stock Option Agreement dated as of December 15, 1997
                between Acquisition Corp. and Roger L. Barnett.*

10.16           Option  Substitution  Agreement  dated as of  December  15, 1997
                among Holding, Acquisition Corp., and Roger L. Barnett.*

10.17           Put and Call Agreement dated as of December 15, 1997, as amended
                on February 2, 1998 and April 1, 1998,  among Roger L.  Barnett,
                Acquisition Corp., and DLJMBII.*

10.18           Termination of Put and Call Agreement  dated June 17, 1997 among
                DLJMBII, Barnett, and Acquisition Corp.*

10.19           Stock Purchase  Agreement,  by and among AKI and each of Michael
                Berman,  Paul Pearl, Stuart Fleischer,  Jay Gartlan,  Retail TCA
                Corporation,  a New York corporation,  Retail TCB Corporation, a
                New York corporation, and Sleepeck Printing Company, an Illinois
                corporation, dated as of September 2, 1999.+

12.1            Computation of Ratio of Earnings to Fixed Charges.+

21.1            Subsidiaries of Holding.+

23.1            Consent of PricewaterhouseCoopers LLP.+

23.2            Consent of PricewaterhouseCoopers LLP.+






                                       39


<PAGE>


27.1            Financial Data Schedule.+

27.2            Financial Data Schedule.+
--------------

*        Incorporated by reference from Registrant's  Registration  Statement on
         Form S-4, File No.  333-60991  filed with the  Securities  and Exchange
         Commission on August 7, 1998.

**       Incorporated by reference from Registrant's  Registration  Statement on
         Form S-4, File No.  333-60989  filed with the  Securities  and Exchange
         Commission on August 7, 1998.

***      Incorporated by reference from Registrant's  Current Report on Form 8-K
         filed with the Securities and Exchange Commission on February 4, 1999.

+        Filed herewith.


         (b)      Reports on Form 8-K.

                  No  reports on Form 8-K were  filed  during  the three  months
ended June 30, 1999.






















                                       40
<PAGE>



                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934, AKI Holding Corp. has duly caused this report to be signed
on its behalf by the  undersigned,  thereunto duly authorized on the 28th day of
September, 1999.

                                      AKI HOLDING CORP.

                                      (Registrant)


                                      By: /S/ WILLIAM J. FOX
                                          _________________________________
                                          William J. Fox
                                          President and Chief Executive Officer

         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this report has been signed by the following persons in the capacities indicated
on the 28th day of September, 1999.

     SIGNATURE                       TITLE

/S/ THOMPSON DEAN               Chairman and Director
------------------------
Thompson Dean

/S/ WILLIAM J. FOX              President, Chief Executive Officer and Director
------------------------        (Principal Executive Officer)
William J. Fox

/S/ KENNETH BUDDE               Chief Financial Officer (Principal Financial and
------------------------        Accounting Officer)
Kenneth Budde

/S/ DAVID WITTELS               Director
------------------------
David Wittels

/S MARK MICHAELS                Director
------------------------
Mark Michaels

/S/ HUGH KIRKPATRICK            Director
------------------------
Hugh Kirkpatrick

                                Director
------------------------
Roger L. Barnett









                                       41
<PAGE>



                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934,  AKI, Inc. has duly caused this report to be signed on its
behalf  by  the  undersigned,  thereunto  duly  authorized  on  the  28th day of
September, 1999.

                                      AKI, INC.

                                      (Registrant)


                                      By: /S/ WILLIAM J. FOX
                                          _________________________________
                                          William J. Fox
                                          President, Chief Executive Officer and
                                          Chairman


         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this report has been signed by the following persons in the capacities indicated
on the 28th day of September, 1999.

     SIGNATURE                       TITLE


/S/ WILLIAM J. FOX              President, Chief Executive Officer, Chairman and
------------------------        Director (Principal Executive Officer)
William J. Fox

/S/ KENNETH BUDDE               Chief Financial Officer (Principal Financial and
------------------------        Accounting Officer)
Kenneth Budde

/S/ DAVID WITTELS               Director
------------------------
David Wittels

/S/ THOMPSON DEAN               Director
------------------------
Thompson Dean

/S MARK MICHAELS                Director
------------------------
Mark Michaels

/S/ HUGH KIRKPATRICK            Director
------------------------
Hugh Kirkpatrick

                                Director
------------------------
Roger L. Barnett












                                       42
<PAGE>



         SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO
SECTION 15(d) OF THE ACT BY  REGISTRANTS  WHICH HAVE NOT  REGISTERED  SECURITIES
PURSUANT TO SECTION 12 OF THE ACT.

         No annual  report or proxy  material has been or is expected to be sent
to security holders of the registrants.











































                                       43


<PAGE>



                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


CONSOLIDATED FINANACIAL STATEMENTS OF AKI HOLDING CORP.:

Report of Independent Accountants........................................... F-2

Report of Independent Accountants........................................... F-3

Consolidated Balance Sheets at June 30, 1998 and 1999....................... F-4

Consolidated  Statements of Operations for the year ended June 30, 1997 and
    for the period from July 1, 1997 through  December 15, 1997 and for the
    period from December 16, 1997
    through June 30, 1998 and for the year ended June 30, 1999.............. F-5

Consolidated  Statements of Changes in  Stockholder(s)  Equity for the year
    ended  June 30,  1997 and for the  period  from  July 1,  1997  through
    December  15, 1997 and for the period from  December  16, 1997  through
    June 30, 1998 and for the year ended
    June 30, 1999........................................................... F-6

Consolidated  Statements of Cash Flows for the year ended June 30, 1997 and
    for the period from July 1, 1997 through  December 15, 1997 and for the
    period from December 16, 1997
    through June 30, 1998 and for the year ended June 30, 1999.............. F-7

Notes to Consolidated Financial Statements.................................. F-8

CONSOLIDATED FINANACIAL STATEMENTS OF AKI, INC.:

Report of Independent Accountants...........................................F-31

Report of Independent Accountants...........................................F-32

Consolidated Balance Sheets at June 30, 1998 and 1999.......................F-33

Consolidated  Statements of Operations for the year ended June 30, 1997 and
    for the period from July 1, 1997 through  December 15, 1997 and for the
    period from December 16, 1997
    through June 30, 1998 and for the year ended June 30, 1999..............F-34

Consolidated  Statements of Changes in  Stockholder(s)  Equity for the year
    ended  June 30,  1997 and for the  period  from  July 1,  1997  through
    December  15, 1997 and for the period from  December  16, 1997  through
    June 30, 1998 and for the year
    ended June 30, 1999.....................................................F-35

Consolidated  Statements of Cash Flows for the year ended June 30, 1997 and
    for the period from July 1, 1997 through  December 15, 1997 and for the
    period from December 16, 1997
    through June 30, 1998 and for the year ended June 30, 1999..............F-36

Notes to Consolidated Financial Statements..................................F-37


                                      F-1

<PAGE>







                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and Stockholder of
  AKI Holding Corp. and Subsidiaries

     In our  opinion,  the  accompanying  consolidated  balance  sheets  and the
related  consolidated  statements  of  operations,  of changes in  stockholder's
equity and of cash flows present fairly, in all material respects, the financial
position of AKI Holding  Corp. (a  wholly-owned  subsidiary of AHC I Acquisition
Corp.) and Subsidiaries  (the  "Successor"),  at June 30, 1998 and 1999, and the
results of their  operations  and their cash flows for the period from  December
16, 1997  through  June 30, 1998 and the year ended June 30, 1999 in  conformity
with generally accepted accounting  principles.  These financial  statements are
the responsibility of management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements  in accordance  with  generally  accepted  auditing  standards  which
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,  assessing the  accounting  principles
used and  significant  estimates made by management,  and evaluating the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for the opinion expressed above.






PricewaterhouseCoopers LLP
Nashville, Tennessee
July 31, 1999 except for Note 19
which is as of September 15, 1999
























                                      F-2
<PAGE>







                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and Stockholder of
  AKI Holding Corp. and Subsidiaries

     In our opinion, the accompanying  consolidated statements of operations, of
changes in stockholders'  equity and of cash flows of Arcade Holding Corporation
and Subsidiaries (the  "Predecessor")  present fairly, in all material respects,
the results of their operations and their cash flows for the year ended June 30,
1997 and the period from July 1, 1997 through  December  15, 1997 in  conformity
with generally accepted accounting  principles.  These financial  statements are
the responsibility of management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements  in accordance  with  generally  accepted  auditing  standards  which
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,  assessing the  accounting  principles
used and  significant  estimates made by management,  and evaluating the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for the opinion expressed above.




PricewaterhouseCoopers LLP
Nashville, Tennessee
July 31, 1998





















                                      F-3
<PAGE>
<TABLE>
<CAPTION>


                                        AKI HOLDING CORP. AND SUBSIDIARIES
                              (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                                            CONSOLIDATED BALANCE SHEETS
                                 (dollars in thousands, except share information)



              The accompanying  notes are an integral part of these consolidated
financial statements.


                                                                                              Successor
                                                                                              ---------
                                                                                   June 30, 1998    June 30, 1999
                                                                                   -------------    -------------

<S>                                                                                <C>              <C>

ASSETS
Current assets
Cash and cash equivalents.....................................                      $     3,842      $     7,015
Accounts receivable, net......................................                           13,550           16,287
Inventory.....................................................                            2,078            5,109
Income tax refund receivable..................................                            5,155               32
Prepaid expenses..............................................                              379              452
Deferred income taxes.........................................                              827              400
                                                                                    -----------      -----------
      Total current assets....................................                           25,831           29,295

Property, plant and equipment, net............................                           18,936           18,511
Goodwill, net ................................................                          151,842          147,990
Deferred charges, net.........................................                            6,535            6,839
Other intangible assets, net..................................                            7,289            6,560
Deferred income taxes.........................................                            3,888            4,338
Other assets..................................................                              200               46
                                                                                    -----------      -----------
      Total assets............................................                      $   214,521      $   213,579
                                                                                    ===========      ===========

LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of capital lease obligations..................                      $       609      $       688
Current portion of other notes payable........................                            1,330                -
Accounts payable, trade.......................................                            4,293            3,400
Accrued income taxes..........................................                              100              497
Accrued compensation..........................................                            2,497            2,527
Accrued interest..............................................                              167            6,047
Accrued expenses..............................................                            1,789            1,283
                                                                                    -----------      -----------
      Total current liabilities...............................                           10,785           14,442

Long-term portion of capital lease obligations................                            1,489            1,349
Senior notes..................................................                          115,000          115,000
Senior discount debentures....................................                           26,020           29,651
Deferred income taxes.........................................                            4,143            3,340
                                                                                    -----------      -----------
      Total liabilities.......................................                          157,437          163,782

Commitments and contingencies (see Note 14)

Stockholder's equity
Common stock, $0.01 par, 1,000 shares authorized; 1,000
    shares issued and outstanding at June 30, 1998 and June 30, 1999                          -                -
Additional paid-in capital....................................                           78,364           78,364
Accumulated deficit...........................................                           (5,493)         (12,472)
Accumulated other comprehensive loss..........................                              (57)            (365)
Carryover basis adjustment....................................                          (15,730)         (15,730)
                                                                                    -----------      ------------
      Total stockholder's equity..............................                           57,084           49,797
                                                                                    -----------      -----------
      Total liabilities and stockholder's equity..............                      $   214,521      $   213,579
                                                                                    ===========      ===========

</TABLE>

        The accompanying notes are an integral part of these consolidated
                              financial statements.


                                      F-4
<PAGE>
<TABLE>
<CAPTION>


                                        AKI HOLDING CORP. AND SUBSIDIARIES
                              (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                                       CONSOLIDATED STATEMENTS OF OPERATIONS
                                              (dollars in thousands)



                                                                   Predecessor                     Successor
                                                                   -----------                     ---------
                                                                             July 1,     December 16,
                                                                              1997           1997
                                                           Year Ended        through        through      Year Ended
                                                            June 30,      December 15,     June 30,       June 30,
                                                              1997            1997           1998           1999
                                                              ----            ----           ----           ----



<S>                                                         <C>            <C>            <C>             <C>

Net sales.................................                  $  77,723      $  35,186      $  36,066       $  85,967
Cost of goods sold........................                     49,467         22,809         24,518          55,199
                                                            ---------      ---------      ---------       ---------
     Gross profit.........................                     28,256         12,377         11,548          30,768

Selling, general and administrative expenses                   13,333          5,703          5,587          14,500
Amortization of goodwill
   and other intangible assets............                      1,234            568          2,101           4,606
                                                            ---------      ---------      ---------       ---------

     Income from operations...............                     13,689          6,106          3,860          11,662

Other expenses (income):
   Interest expense to stockholder(s) and
      affiliate...........................                      5,196          2,143         10,785               -
   Interest expense, other................                      1,007            503            542          16,740
   Management fees to stockholders........
     and affiliate........................                        470            215            125             250
   Other, net.............................                       (101)            11            (47)            128
                                                            ---------      ---------      ---------       ---------

     Income (loss) before income taxes....                      7,117          3,234         (7,545)         (5,456)

Income tax expense (benefit)..............                      3,135          1,441         (2,052)           (340)
                                                            ---------      ---------      ---------       ----------

     Net income (loss)....................                  $   3,982      $   1,793      $  (5,493)      $  (5,116)
                                                            =========      =========      =========       =========




</TABLE>

                                      F-5
<PAGE>

<TABLE>
<CAPTION>


                                        AKI HOLDING CORP. AND SUBSIDIARIES
                              (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                            CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER(S) EQUITY
                                 (dollars in thousands, except share information)



                                                                     Retained    Accumulated
                                                Additional  Stock    Earnings       Other      Carryover
                                Common  Stock    Paid-in Purchase  (Accumulated Comprehensive    Basis
                                Shares  Amount   Capital Warrants    Deficit)       Loss      Adjustment    Total
                                ------  ------   ----------------    -------        ----      ----------    -----

                                                                      Predecessor
                                                                      -----------
<S>                             <C>     <C>      <C>      <C>        <C>          <C>          <C>        <C>

Balances, June 30, 1996.......  48,000  $     1  $4,889   $1,923     $  1,199     $    (80)    $       -  $   7,932
Net Income....................       -        -       -        -        3,982            -             -      3,982
Other comprehensive income, net
  of tax:
    Foreign currency translation
      adjustment..............       -        -       -        -            -          (73)            -        (73)
                                                                                                          ----------
Comprehensive income..........                                                                                3,909
Preferred stock dividend......       -        -       -        -         (616)           -             -       (616)
                               -------  -------  ------   ------     --------     --------     ---------  ---------

Balances, June 30, 1997.......  48,000        1   4,889    1,923        4,565         (153)            -     11,225
Net income....................       -        -       -        -        1,793            -             -      1,793
Other comprehensive income, net
  of  tax :
    Foreign currency translation
      adjustment..............       -        -       -        -            -          (19)            -        (19)
                                                                                                          ----------
Comprehensive income..........                                                                                1,774
Preferred stock dividend......       -        -       -        -         (283)           -             -       (283)
                               -------  -------  ------   ------     --------     --------     ---------  ---------

Balances, December 15, 1997...  48,000  $     1  $4,889   $1,923     $  6,075     $   (172)    $       -  $  12,716
                               =======  =======  ======   ======     ========     ========     =========  =========


___________________________________________________________________________________________________________________

                                                                       Successor
                                                                       ---------


Balances, December 16, 1997...       -  $     - $     -   $    -     $      -     $      -     $       -  $       -
Initial capitalization           1,000        -  78,364        -            -            -             -     78,364
  (see Note 13)...............
Carryover basis adjustment....       -        -       -        -            -            -       (15,730)   (15,730)
Net loss......................       -        -       -        -       (5,493)           -             -     (5,493)
Other comprehensive loss, net
  of tax:
    Foreign currency translation
      adjustment..............       -        -       -        -            -          (57)            -        (57)
                                                                                                          ----------
Comprehensive loss............                                                                               (5,550)
                               -------  -------  ------   ------     --------     --------     ---------  ---------

Balances, June 30, 1998.......   1,000        -  78,364        -       (5,493)         (57)      (15,730)    57,084
Net loss......................       -        -       -        -       (5,116)           -             -     (5,116)
Other comprehensive loss, net of tax:
    Foreign currency translation
      adjustment..............       -        -       -        -            -         (308)            -       (308)
                                                                                                          ----------
Comprehensive loss............                                                                               (5,424)
Dividend to AHC I Acquisition Corp.  -        -       -        -       (1,863)           -             -     (1,863)
                                   ---      ---    ----   ------     --------     --------     ---------  ----------


Balances, June 30, 1999.......   1,000  $     - $78,364   $    -     $(12,472)    $   (365)    $ (15,730) $  49,797
                               =======  ======= =======   ======     ========     =========    =========  =========




      The accompanying notes are an integral part of these consolidated financial statements.

</TABLE>

                                      F-6
<PAGE>
<TABLE>
<CAPTION>

                                        AKI HOLDING CORP. AND SUBSIDIARIES
                              (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                                       CONSOLIDATED STATEMENTS OF CASH FLOWS
                                              (dollars in thousands)



                                                             Predecessor                         Successor
                                                             -----------                         ---------
                                                                       July 1,         December 16,
                                                        Year             1997              1997             Year
                                                        ended           through           through           ended
                                                      June 30,       December 15,         June 30,        June 30,
                                                        1997             1997              1998             1999
                                                        ----             ----              ----             ----
<S>                                                  <C>               <C>              <C>              <C>
Cash flows from operating activities:
   Net income (loss).....................            $   3,982         $   1,793        $  (5,493)       $   (5,116)
   Adjustment to reconcile net income (loss) to
     net cash provided by (used in) operating activities:
     Depreciation and amortization of goodwill
       and other intangibles.............                5,084             2,456            3,954             8,487
     Amortization of debt discount.......                  560               233              139             3,631
     Amortization of loan closing costs..                  258               101            3,808               727
     Deferred income taxes...............                 (297)             (460)          (2,035)             (544)
          Gain on sale of equipment......                    -                 -                -               (50)
     Other...............................                 (138)              (18)             (57)             (308)
     Changes in operating assets and liabilities:
       Accounts receivable...............                2,546             1,153           (4,562)           (2,737)
       Inventory.........................                 (550)               69              543            (3,031)
       Prepaid expenses, deferred charges and
         other assets....................                 (101)              (62)            (453)             (975)
       Income taxes......................               (1,163)              699              767             5,238
       Accounts payable and accrued expenses            (1,239)           (1,036)          (5,432)            4,511
                                                     ---------         ---------           ------            ------


       Net cash provided by (used in) operating
         activities......................                8,942             4,928           (8,821)            9,833
                                                     ---------         ---------        ---------         ---------

Cash flows from investing activities:
   Purchases of equipment................               (2,462)             (807)            (514)           (2,856)
   Proceeds from sale of equipment.......                   38                 -                -                50
   Payments for acquisitions, net of cash acquired           -                 -         (141,403)                -
                                                       -------         ---------        ---------         ---------

       Net cash used in investing activities            (2,424)             (807)        (141,917)           (2,806)
                                                     ---------         ---------        ---------         ---------

Cash flows from financing activities:
   Payments under capital leases for equipment          (2,359)             (249)            (308)             (661)
   Net proceeds (repayments) on line of credit           4,338             2,362           (6,700)                -
   Proceeds from issuance of senior increasing rate
      notes, net of offering costs.......                    -                 -          119,735                 -
   Payments on senior increasing rate notes                  -                 -         (123,500)                -
   Proceeds from issuance of senior notes, net
     of offering costs...................                    -                 -          110,158                 -
   Proceeds from issuance of senior discount
     debentures, net of offering costs...                    -                 -           24,699                 -
   Proceeds from issuance of common stock                    -                 -           76,001                 -
   Redemption of preferred stock.........                    -                 -           (8,678)                -
   Repayment of loans payable to stockholder            (7,004)           (1,851)         (36,649)                -
   Repayment of other notes payable......               (1,200)              (50)             (50)           (1,330)
   Dividends paid on preferred stock.....                 (616)             (155)            (128)                -
     Dividend paid to AHC I Acquisition Corp.                -                 -                -            (1,863)
                                                    ----------          --------        ---------         ---------

     Net cash provided by (used in)
       financing activities..............               (6,841)               57          154,580            (3,854)
                                                     ---------         ---------        ---------         ---------

Net increase (decrease) in cash and cash equivalents      (323)            4,178            3,842             3,173
Cash and cash equivalents, beginning of period             626               303                -             3,842
                                                     ---------          --------        ---------         ---------
Cash and cash equivalents, end of period.            $     303         $   4,481        $  3,842          $   7,015
                                                     =========         =========        ========          =========


Supplemental information:
   Cash paid (received) during the period for:
         Interest to stockholder(s)......            $   4,559         $   1,146        $  11,503         $       -
     Interest, other.....................                  917               459              214             6,512
     Income taxes........................                4,594             1,222             (784)           (5,123)

Significant non-cash activities:
   Assets acquired under capital lease...            $       -         $       -        $       -         $     600
</TABLE>

                                       F-7
<PAGE>


                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)

1.   ORGANIZATION AND BUSINESS

         Arcade Holding  Corporation (the  "Predecessor")  was organized for the
     purpose  of  acquiring  all the  issued and  outstanding  capital  stock of
     Arcade,  Inc.  ("Arcade")  on  November  4,  1993.  Arcade  is  engaged  in
     interactive advertising for consumer products companies and has a specialty
     in the design,  production and  distribution  of sampling  systems from its
     Chattanooga,  Tennessee facilities,  and distributes its products in Europe
     through  its  French  subsidiary,  Arcade  Europe  S.A.R.L.  As more  fully
     described  in Note 3, DLJ  Merchant  Banking  Partners II, L.P. and certain
     related  investors  (collectively,  "DLJMBII")  and certain  members of the
     Predecessor organized AHC I Acquisition Corp. ("Acquisition Corp.") and AHC
     I Merger Corp.  ("Merger Corp.") for purposes of acquiring the Predecessor.
     On December 15, 1997, Merger Corp.  acquired all of the equity interests of
     the  Predecessor  and then  merged  with and into the  Predecessor  and the
     combined  entity  assumed  the name AKI,  Inc.  and  Subsidiaries  ("AKI").
     Subsequent to the Acquisition,  Acquisition Corp. contributed $1 and all of
     its  ownership  interest  in AKI  to  AKI  Holding  Corp.  ("Holding,"  the
     "Successor" or the "Company") for all of the outstanding equity of Holding.

         Unless  otherwise  indicated,  all  references  to  years  refer to the
     Predecessor's, AKI's and Holding's fiscal year, June 30.


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Principles of Consolidation

         The accompanying consolidated financial statements include the accounts
     of  the  Company  and  its  wholly  owned  subsidiaries.   All  significant
     intercompany transactions have been eliminated.

     Reclassification

         Certain prior year amounts have been  reclassified  to conform with the
     current year presentation.

     Cash and Cash Equivalents

         For purposes of the consolidated  statements of cash flows, the Company
     considers all highly liquid  investments with an original maturity of three
     months or less at the time of purchase to be cash equivalents.

     Concentration of Credit Risk

         The Company  maintains  its cash in bank  deposit  accounts  which,  at
     times, may exceed federally insured limits. The Company has not experienced
     any losses in such accounts;  in addition,  the Company  believes it is not
     exposed to any significant  credit risk on cash and cash  equivalents.  The
     Company  grants  credit  terms in the  normal  course  of  business  to its
     customers and as part of its ongoing  procedures,  the Company monitors the
     credit worthiness of its customers. The Company does not believe that it is
     subject to any unusual  credit risk beyond the normal credit risk attendant
     in its business.





                                      F-8

<PAGE>


                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

         Two customers  accounted for 23.5% and 35.3% of the  Predecessor's  net
     sales  during the year ended June 30, 1997 and the period from July 1, 1997
     through December 15, 1997,  respectively.  One customer accounted for 13.3%
     of net sales  during the period from  December  16, 1997  through  June 30,
     1998. Two customers  accounted for 26.8% of net sales during the year ended
     June 30, 1999.

     Concentration of Purchasing

         Products  accounting  for a majority of the Company's net sales utilize
     specific  grades of paper that are produced  exclusively for the Company by
     one domestic supplier.  The Company does not have a purchase agreement with
     the  supplier  and is not aware of any other  suppliers  of these  specific
     grades of paper.  These products can be manufactured  using other grades of
     paper; however, the Company believes these specific grades of paper provide
     the  Company  with an  advantage  over  its  competitors.  The  Company  is
     currently  researching  methods  of  replicating  the  advantages  of these
     specific grades of paper with other grades of paper available from multiple
     suppliers.  Until such  methods  are  developed,  a loss of supply of these
     specific  grades of paper and the  resulting  competitive  advantage  could
     cause a possible  loss of sales  which  could  adversely  affect  operating
     results.

     Revenue Recognition and Accounts Receivable

         Product sales are recognized upon shipment, net of estimated discounts.
     Accounts  receivable  are  accounted  for net of  allowances  for  doubtful
     accounts.

     Inventory

         Paper  inventory  is stated  at the  lower of cost or market  using the
     last-in,  first-out (LIFO) method;  all other inventories are stated at the
     lower of cost or market using the first-in, first-out (FIFO) method.

     Property, Plant and Equipment

         Property,  plant and  equipment are stated at cost.  Expenditures  that
     extend the  economic  lives or improve  the  efficiency  of  equipment  are
     capitalized. The costs of maintenance and repairs are expensed as incurred.
     Upon retirement or disposal, the related cost and accumulated  depreciation
     are removed from the respective accounts and any gain or loss is recorded.

         Depreciation  is computed using the  straight-line  method based on the
     estimated  useful lives of the assets as indicated in Note 6 for  financial
     reporting  purposes and  accelerated  methods for tax  purposes.  Leasehold
     improvements  are depreciated  over the shorter of their  estimated  useful
     lives or the lease term.







                                      F-9

<PAGE>


                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

     Goodwill

         The aggregate purchase price of business  acquisitions was allocated to
     the  assets  and  liabilities  of the  acquired  companies  based  on their
     respective fair values as of the acquisition dates. Goodwill represents the
     excess purchase price paid over the fair value of net  identifiable  assets
     acquired and is amortized over forty years using the straight-line  method.
     Accumulated  amortization  was $2,087 and $5,939 at June 30,  1998 and June
     30, 1999, respectively.

         Management  periodically  reviews the value of its  goodwill  and other
     long-lived assets to determine if an impairment has occurred. The potential
     impairment of recorded  goodwill and other long-lived assets is measured by
     the undiscounted  value of expected future operating cash flows in relation
     to its net capital  investment.  Based on its review,  management  does not
     believe that an impairment of its goodwill or its other  long-lived  assets
     has occurred.

     Deferred Charges

         Deferred  charges are primarily  comprised of debt issuance costs which
     are being amortized  using the effective  interest method over the terms of
     the related debt. Such costs are included in the accompanying  consolidated
     balance sheets, net of accumulated amortization.

     Other Intangible Assets

         Other  intangible  assets  include a covenant  not to compete and other
     intangible assets resulting from the acquisition of the fragrance  sampling
     business of Minnesota Mining and Manufacturing  Company ("3M") (see Note 3)
     in June 1998 and are being amortized over ten years using the straight-line
     method.  Accumulated  amortization related to these intangibles was $729 at
     June 30, 1999.

     Fair Value of Financial Instruments

         SFAS No. 107, "Disclosures About Fair Values of Financial Instruments,"
     requires the  disclosure  of the fair value of financial  instruments,  for
     assets and liabilities  recognized and not recognized on the balance sheet,
     for which it is practicable  to estimate fair value.  The fair value of the
     Company's Senior Notes and Senior Discount  Debentures,  as determined from
     quoted market prices, was $112,000 and $22,508,  respectively,  at June 30,
     1999 compared to a carrying value of $115,000 and $29,651, respectively, as
     of the same  date.  The  carrying  value of the  Senior  Notes  and  Senior
     Discount Debentures  approximated fair value at June 30, 1998. The carrying
     value of all other financial  instruments  approximated  fair value at June
     30, 1998 and June 30, 1999.






                                      F-10

<PAGE>


                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

     Foreign Currency Transactions

          Gains and losses on foreign currency  transactions  with third parties
     have been included in the  determination  of net income in accordance  with
     SFAS No. 52, "Foreign  Currency  Translation."  Foreign currency losses and
     (gains) amounted to $387, $(44),  $(52) and $91 for the year ended June 30,
     1997,  the period from July 1, 1997 through  December 15, 1997,  the period
     from  December  16, 1997  through June 30, 1998 and the year ended June 30,
     1999, respectively.

     Research and Development Expenses

          Research and development  expenditures are charged to selling, general
     and   administrative   expenses  in  the  period  incurred.   Research  and
     development  expenses  totaled  $1,263,  $664, $717 and $1,136 for the year
     ended June 30,  1997,  the period from July 1, 1997  through  December  15,
     1997,  the period from  December 16, 1997 through June 30, 1998 and for the
     year ended June 30, 1999, respectively.

     Income Taxes

          Income taxes are provided in  accordance  with  Statement of Financial
     Accounting  Standards No. 109,  "Accounting for Income Taxes." Accordingly,
     deferred tax assets and liabilities are recognized at the applicable income
     tax rates  based upon  future tax  consequences  of  temporary  differences
     between  the  tax  bases  and  financial  reporting  bases  of  assets  and
     liabilities  using  enacted  tax  rates in effect in the years in which the
     differences  are expected to reverse.  Deferred tax assets are reduced,  if
     necessary,  by the  amount of any tax  benefits  that,  based on  available
     evidence, are not expected to be realized.

     Use of Estimates

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

     Comprehensive Income (Loss)

         The Company adopted the provisions of Statement of Financial Accounting
     Standards  No.  130  ("SFAS  No.  130")  on July 1,  1998.  This  statement
     establishes standards for reporting and displaying comprehensive income and
     its  components in the financial  statements.  This statement also requires
     that comparative  information for earlier periods be  reclassified.  As the
     Company only has two items of comprehensive  income, net income and foreign
     currency  translations,  adoption of this statement did not have a material
     effect upon the Company's financial position or results of operations.






                                      F-11
<PAGE>


                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


3.   SIGNIFICANT ACQUISITIONS

         DLJMBII and certain  members of the Predecessor  organized  Acquisition
     Corp.  and Merger Corp. for purposes of acquiring the  Predecessor.  Merger
     Corp. was a wholly-owned  subsidiary of Acquisition Corp. and was initially
     capitalized by Acquisition  Corp.  with an equity  contribution of $78,363,
     comprised  of  $76,000  of cash  (see  Note  12)  and  $2,363  of  non-cash
     consideration  in the form of an option to purchase Senior  Preferred Stock
     of  Acquisition  Corp.  (see Note 17).  Immediately  following  this equity
     contribution,  Merger Corp. issued $123,500 of senior increasing rate notes
     (the "Bridge Loans") to an entity with an ownership interest in Acquisition
     Corp.  The Bridge Loans had a stated  maturity of December 15, 1998 and had
     an  interest  rate  equal to the  greater of (i) 10.0% per annum and (ii) a
     daily  floating  rate of prime  plus 2.25%  plus an  additional  percentage
     amount equal to (a) 1.0% from and  including  the interest  payment date on
     June 15, 1998 or (b) 1.5% from and including  the interest  payment date on
     September 15, 1998.  Merger Corp.  received cash proceeds from the issuance
     of the Bridge Loans of $119,735,  net of $3,765 of associated debt issuance
     costs.

         On December 15, 1997, Merger Corp. acquired all of the equity interests
     of the Predecessor (the  "Acquisition")  for a total cost of $197,730 which
     consisted  of  $138,634   cash  paid  for  equity   interests   and  direct
     acquisitions  costs,  $2,363 in  non-cash  consideration  in the form of an
     option to purchase Senior  Preferred  Stock of Acquisition  Corp. (see Note
     17) and the  assumption  of $56,733 in debt,  preferred  stock and  related
     interest and dividends,  including a capital lease obligation.  Included in
     the amount of direct acquisition costs was approximately  $2,022 paid to an
     entity that has an ownership  interest in  Acquisition  Corp.  Merger Corp.
     then merged with and into the  Predecessor  and the combined entity assumed
     the name AKI. Subsequent to the Acquisition,  Acquisition Corp. contributed
     $1 of cash and all of its  ownership  interest in AKI to Holding for all of
     the  outstanding  equity of Holding.  Since all  companies are under common
     control and since Holding and Acquisition  Corp.  have no operations  other
     than those related to AKI, the contribution was accounted for as if it were
     a pooling of interests.

         The  Acquisition  was  accounted  for  using  the  purchase  method  of
     accounting. In accordance with the consensus reached by the Emerging Issues
     Task Force of the  Financial  Accounting  Standards  Board in Issue  88-16,
     "Basis in Leveraged  Buyout  Transactions,"  the purchase price  allocation
     required  an  adjustment  for  the  continuing  interest   attributable  to
     management's   ownership  interest  in  the  Predecessor  carried  over  in
     connection with the Acquisition.  As a result, a reduction in stockholders'
     equity of $15,730 was recorded which represents the difference  between the
     fair value of the Company's assets and the related book value  attributable
     to  the  interest  of  the  continuing   shareholders'  investment  in  the
     Predecessor.  The remaining purchase price has been allocated to assets and
     liabilities  based  upon  estimates  of  their  respective  fair  value  as
     determined  by  management  and  third-party  appraisals  with  respect  to
     property, plant and equipment.

         In connection with the Acquisition,  the Company repaid the outstanding
     balance  and  related  interest  of the  Predecessor's  loans  payable to a
     shareholder of $37,374, the outstanding balance and related interest of the
     Predecessor's  line of credit of $6,278  and the  outstanding  balance  and
     related dividends on the Predecessor's preferred stock of $8,806.




                                      F-12

<PAGE>


                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


3.   SIGNIFICANT ACQUISITIONS (Continued)

     The  following  shows  the  acquisition  costs  and the  allocation  of the
purchase price:

Acquisition costs
     Cash paid for stock..........................................  $   134,403
     Direct acquisition costs.....................................        4,231
                                                                    -----------
                                                                        138,634
     Non-cash consideration for stock
       in the form of an option to purchase Senior
       Preferred Stock of Acquisition Corp. (see Note 17).........        2,363
                                                                    -----------

     Total.......................................................       140,997
     Less--Carryover basis adjustment............................       (15,730)
                                                                    -----------

     Purchase price to be allocated..............................   $   125,267
                                                                    ===========

Summary allocation of purchase price
     Cash........................................................   $     4,481
     Other current assets........................................        17,782
     Property, plant and equipment...............................        20,132
     Deferred income taxes.......................................         2,953
     Other assets................................................           329
     Goodwill....................................................       153,929
                                                                    -----------

     Total allocation to assets..................................   $   199,606
                                                                    ===========

     Current liabilities.........................................   $    13,190
     Long-term debt (including current portion) and related interest     47,927
     Deferred income taxes..........................................      4,416
     Preferred stock and related dividends..........................      8,806
                                                                    -----------

     Total liabilities assumed..................................... $    74,339
                                                                    ===========


           Included in cash paid for stock of $134,403 is $19,342 related to the
     purchase and retirement of 11,201 options of the Predecessor.  In addition,
     the non-cash  consideration for stock of $2,363 was incurred to acquire and
     retire the remaining 1,370 options of the Predecessor (see Note 17).

            On June 22, 1998, the Company  acquired (the "3M  Acquisition")  the
     fragrance  sampling  business  of  the  Industrial  and  Consumer  Products
     division  of 3M for  approximately  $7,250  in cash and the  assumption  of
     liabilities of  approximately  $182. The only tangible assets acquired were
     approximately  $143 of equipment.  The  acquisition was accounted for using
     the  purchase  method of  accounting  and  resulted in  assigning  value to
     certain  intangible assets,  including a covenant not to compete,  totaling
     approximately  $7,289 which are being  amortized  on a straight  line basis
     over a period of 10 years.




                                      F-13

<PAGE>


                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


3.   SIGNIFICANT ACQUISITIONS (Continued)

         Unaudited pro forma results for the Company  assuming the  Acquisition,
     the 3M Acquisition  and the Refinancing had occurred as of the beginning of
     each applicable fiscal year are presented below:

                                          Unaudited Pro Forma Results
                                               for the Year Ended
                                               ------------------

                                             June 30,       June 30,
                                               1997           1998
                                               ----           ----

         Net sales.......................   $  87,771       $ 81,831
         Income from operations..........       9,565          5,838
         Interest expense, net...........      16,640         16,730
         Net loss........................      (6,102)        (8,573)

         On June 25, 1998, the Bridge Loans were repaid,  without penalty,  with
     the  proceeds  from the Senior  Note  offering  (see Note 9) and the Senior
     Discount   Debenture   offering   (see   Note   10)   (collectively,    the
     "Refinancing"). Contemporaneous with the repayment of the Bridge Loans, the
     Company wrote-off the unamortized balance of debt issuance costs associated
     with the Bridge Loans of $1,795 to interest expense.

4.       ACCOUNTS RECEIVABLE

     The following table details the components of accounts receivable:

                                                   June 30,         June 30,
                                                     1998           1999
                                                     ----           ----

         Trade accounts receivable.............. $  13,782       $ 16,349
         Allowance for doubtful accounts........      (277)          (251)
                                                 ----------      ---------
                                                    13,505         16,098
         Other accounts receivable..............        45            189
                                                 ---------       --------

                                                 $  13,550       $ 16,287
                                                 =========       ========




                                      F-14


<PAGE>



                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


5.   INVENTORY

     The following table details the components of inventory:

                                                         June 30,       June 30,
                                                           1998           1999
                                                           ----           ----
         Raw materials
           Paper....................................    $     556       $  1,088
           Other raw materials......................        1,024          2,328
                                                        ---------       --------
              Total raw materials...................        1,580          3,416
         Work in process............................          498          1,693
                                                        ---------       --------

         Total inventory............................    $   2,078       $  5,109
                                                        =========       ========

         The difference  between the carrying value of paper inventory using the
     FIFO method as compared to the LIFO method was not  significant at June 30,
     1998 or June 30, 1999.

6.       PROPERTY, PLANT AND EQUIPMENT

         The  following  table  details the  components  of property,  plant and
     equipment as well as their estimated useful lives:

                                           Estimated      June 30,     June 30,
                                         Useful Lives       1998          1999
                                         ------------       ----          ----

         Land...........................                $     256      $    258
         Building....................... 7 - 15 years       1,048         1,648
         Leasehold improvements......... 1 -  3 years         153           579
         Machinery and equipment........ 5 -  7 years      17,146        19,483
         Furniture and fixtures......... 3 -  5 years       1,634         2,084
         Construction in progress.......                      552           193
                                                        ---------      --------
                                                           20,789        24,245
         Accumulated depreciation.......                   (1,853)       (5,734)
                                                        ---------     ---------
                                                         $ 18,936     $  18,511
                                                        =========     =========

         Depreciation expense amounted to $3,850,  $1,888, $1,853 and $3,881 for
     the year ended June 30, 1997, the period from July 1, 1997 through December
     15, 1997,  the period from  December 16, 1997 through June 30, 1998 and the
     year ended June 30, 1999, respectively.









                                      F-15

<PAGE>





                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)



6.   PROPERTY, PLANT AND EQUIPMENT (Continued)

         Property  held  under  capital  lease  is  included  in the  respective
     property, plant and equipment category as follows:

                                                    June 30,       June 30,
                                                     1999           1998
                                                     ----           ----

         Machinery and equipment.................. $   3,000       $  3,000
         Building.................................         -            600
                                                   ---------       --------
                                                       3,000          3,600
         Less accumulated depreciation............      (275)          (790)
                                                   ---------       ---------
                                                   $   2,725       $  2,810
                                                   =========       ========


         Depreciation of assets under capital lease totaled $633, $232, $275 and
     $515 for the year ended June 30, 1997, the period from July 1, 1997 through
     December 15, 1997,  the period from December 16, 1997 through June 30, 1998
     and the year  ended  June 30,  1999,  respectively.  Future  minimum  lease
     payments under the remaining lease are as follows:

                                                         Payment       Interest

                           2000......................  $     884       $    197
                           2001......................        948            100
                           2002......................        529             27
                                                       ---------       --------

                                                       $   2,361       $    324
                                                       =========       ========

7.       LINE OF CREDIT

         On April  30,  1996,  the  Predecessor  entered  into a line of  credit
     agreement (the "Credit Agreement"), which was amended on December 12, 1997,
     in  connection  with the  Acquisition,  and amended  again on September 30,
     1998. The Credit Agreement provides for a revolving loan commitment up to a
     maximum of $20,000 and expires on December 31, 2002. Borrowings are limited
     to a borrowing  base  consisting  of  accounts  receivable,  inventory  and
     property, plant and equipment which serve as collateral for the borrowings.
     As of June  30,  1999,  the  Company's  borrowing  base  was  approximately
     $17,500.  Interest on amounts borrowed accrue at a floating rate based upon
     either  prime or LIBOR (9.25% and 8.50% at June 30, 1998 and June 30, 1999,
     respectively).  The  weighted  average  interest  rate  on the  outstanding
     balance under the Credit  Agreement was 9.31%,  9.50%,  9.25% and 8.51% for
     the year ended June 30, 1997, the period from July 1, 1997 through December
     15, 1997,  the period from  December 16, 1997 through June 30, 1998 and the
     year ended June 30, 1999, respectively.







                                      F-16

<PAGE>



                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


7.   LINE OF CREDIT (Continued)

         The Company is required to pay commitment fees on the unused portion of
     the revolving loan commitment at a rate of approximately 0.5% per annum. In
     addition,  the Company is required to pay fees equal to 2.5% of the average
     daily  outstanding  amount of lender  guarantees.  The  Company had $600 of
     lender  guarantees  outstanding  at June 30, 1998 and June 30, 1999.  These
     fees totaled $109,  $30, $59 and $111 for the year ended June 30, 1997, the
     period  from July 1, 1997  through  December  15,  1997,  the  period  from
     December  16, 1997  through June 30, 1998 and the year ended June 30, 1999,
     respectively. The Credit Agreement contains certain financial covenants and
     other restrictions  including  restrictions on additional  indebtedness and
     restrictions on the payment of dividends.

         As of June  30,  1999,  the  Company  was in  compliance  with all debt
     covenants.  However, the Company expects to be in violation of certain loan
     covenants  in Fiscal  2000.  Management  expects to obtain loan  amendments
     and/or waivers in Fiscal 2000 with respect to such covenants. If management
     is unable to obtain loan  amendments  and/or  waivers in Fiscal  2000,  the
     Company may need to seek additional sources of financing.

8.   LOANS PAYABLE TO STOCKHOLDER

         The   Predecessor   entered  into  a  Senior  Loan  Agreement  and  two
     Subordinated Loan Agreements  (collectively,  the "Loan Agreements") with a
     party that had owned the  Predecessor's  preferred  stock and a significant
     portion of its common stock.  The Loan  Agreements were  collateralized  by
     substantially  all the  assets  of the  Predecessor.  The  Loan  Agreements
     limited the  Predecessor's  ability to incur additional  indebtedness,  pay
     dividends and purchase  fixed  assets.  Additionally,  the Loan  Agreements
     required that certain  financial  covenants be maintained.  The Predecessor
     was not in compliance  with all such  covenants at June 30, 1997.  However,
     this debt was subsequently  retired upon the acquisition of the Predecessor
     as  discussed  in Note 3.  All  amounts  borrowed  under  the  Senior  Loan
     Agreement bore interest at prime plus 1.50%.

         The  Predecessor   borrowed   $30,000  under  the   Subordinated   Loan
     Agreements,  of which  $23,000  was  designated  as Loan I and  $7,000  was
     designated  as Loan II. Loan I bore  interest,  payable  quarterly,  at 12%
     until  November 4, 1998,  and then would have  converted  to prime plus 4%.
     Loan II bore interest,  payable quarterly, at 7%. The outstanding amount of
     the subordinated  loans was net of unamortized  debt discounts,  which were
     being amortized over the term of the related loan.

         In  connection  with  Loan II,  the  Predecessor  issued a  warrant  to
     purchase 19,233 shares of common stock at $0.05 per share.  The warrant was
     exercisable until November 4, 2003. The Predecessor  valued the warrants at
     $100  each  based on the  fair  market  value of a share of the  underlying
     common stock  resulting from a sale with a third party.  In connection with
     the warrant issued, the Predecessor  recorded a debt discount of $1,923. In
     connection  with the sale of the Predecessor on December 15, 1997 (see Note
     3), all outstanding warrants were purchased from the holder by the buyer of
     the Predecessor and retired.





                                      F-17
<PAGE>




                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


9.   SENIOR NOTES

         On June 25,  1998,  AKI  completed a private  placement  of $115,000 of
     Senior Notes (the "Senior Notes").  The Senior Notes are general  unsecured
     obligations  of  AKI  and  bear  interest  at  10.5%  per  annum,   payable
     semi-annually  on January 1 and July 1. The Senior  Notes mature on July 1,
     2008 and may be redeemed at the option of AKI, in whole or in part,  at any
     time  on or  after  July  1,  2003  at a  price  equal  to  105.25%  of the
     outstanding  principal  balance  plus  accrued  and  unpaid  interest.  The
     placement  of the Senior Notes  yielded AKI net proceeds of $110,158  after
     deducting  offering  expenses of $4,842,  including  $3,450 of underwriting
     fees  paid  to an  affiliate  of the  stockholder.  The  Senior  Notes  are
     redeemable  at the  option of the  Company,  in whole or part,  at any time
     after July 1, 2003 at a price of up to 105.25% of the outstanding principal
     balance plus  accrued and unpaid  interest.  Prior to July 1, 2003,  AKI is
     permitted to repurchase up to 35% of the Senior Notes at a redemption price
     equal to 110.5% of the aggregate  principal  amount plus accrued and unpaid
     interest with the net proceeds of one or more public equity offerings.  The
     Senior Notes contain certain customary covenants including  restrictions on
     the  declaration and payment of dividends by AKI to Holding and limitations
     on the  incurrence of additional  indebtedness.  On December 22, 1998,  AKI
     completed  the  registration  of its Senior Notes with the  Securities  and
     Exchange Commission.

10.      SENIOR DISCOUNT DEBENTURES

         On June 25,  1998,  Holding  completed  a private  placement  of Senior
     Discount Debentures (the "Debentures") with a stated value of $50,000.  The
     Debentures are general unsecured  obligations of Holding and mature on July
     1, 2009.  The  Debentures do not accrue or pay interest  until July 1, 2003
     and  were  issued  with an  original  issuance  discount  of  $24,038.  The
     placement  of the  Debentures  yielded the Company net  proceeds of $24,699
     after  deducting   offering   expenses  of  $1,263,   including  $1,038  of
     underwriting  fees paid to an  affiliate of the  stockholder.  The original
     issuance  discount  of $24,038 on the  Debentures  is being  accreted  from
     issuance  through July 1, 2003 at an effective rate of 13.5% per annum. The
     unamortized  balance of the  original  issuance  discount  was  $23,980 and
     $20,349 at June 30,  1998 and June 30,  1999,  respectively.  After July 1,
     2003,  the  Debentures  will accrue  interest at a rate of 13.5% per annum,
     payable  semi-annually,  commencing  January 1, 2004.  The  Debentures  are
     redeemable at the option of Holding, in whole or in part, at any time on or
     after July 1, 2003 at a price up to 106.75%  of the  outstanding  principal
     balance plus accrued and unpaid interest. Prior to July 1, 2003, Holding is
     permitted to  repurchase  up to 35% of the  aggregate  principal  amount at
     maturity of the Debentures originally issued at a redemption price equal to
     113.5% of the accreted value of the Debentures with the net proceeds of one
     or more public equity offerings.  The Debentures  contain certain customary
     covenants  including   restrictions  on  the  declaration  and  payment  of
     dividends and limitations on the incurrence of additional indebtedness.  On
     December 22, 1998,  the Company  completed the  registration  of its Senior
     Discount Debentures with the Securities and Exchange Commission.




                                      F-18
<PAGE>





                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)

11.  OTHER NOTES PAYABLE

         On June  9,  1995,  the  Predecessor  acquired  all of the  issued  and
     outstanding  stock of Scent Seal Inc.  ("Scent  Seal").  The acquisition of
     Scent  Seal did not have a material  impact on the  financial  position  or
     results  of  operations  of the  Predecessor  and  was  accounted  for as a
     purchase  transaction  whereby the purchase  cost was allocated to the fair
     value of the net assets  acquired.  In connection  with the  acquisition of
     Scent Seal, the Predecessor issued $3,627 in noninterest bearing promissory
     notes (the "Notes") to an employee of the  Predecessor who was previously a
     Scent Seal stockholder. The Predecessor recorded a debt discount of $649 in
     connection with the issuance of the Notes to reflect an effective  interest
     rate of 10%. The discount was being amortized over the term of the Notes.

         Under certain provisions of the Scent Seal acquisition  agreement,  the
     Company was permitted to reduce the  outstanding  principal  balance of the
     Notes based upon the ultimate realization of assets acquired and settlement
     of liabilities assumed. In June 1998, the Company reached a settlement with
     the  holder of the Notes  under  these  provisions  which  resulted  in the
     reduction of the  outstanding  principal  balance of the Notes of $120. The
     remaining  principal balance of the Notes of $1,330 was repaid in July 1998
     in accordance with the terms of the Notes.

12.  REDEEMABLE PREFERRED STOCK OF THE PREDECESSOR

         In connection  with the 1993  acquisition  of Arcade,  the  Predecessor
     authorized  and  issued  8,000  shares  of  7%  cumulative,  $1  par  value
     redeemable  preferred stock at $1,000 per share.  The redeemable  preferred
     stock prohibited the Predecessor from acquiring its common stock as long as
     the preferred  stock was  outstanding  and restricted the payment of common
     stock  dividends.  Accrued and unpaid  dividends  of $678  accrued  through
     December 31, 1994,  were added to the outstanding  balance.  The redeemable
     preferred  stock  would have been  redeemable  on  December  31,  2001,  at
     liquidation value of $1,000 per share plus accrued and unpaid dividends. In
     conjunction with the sale of the Predecessor on December 15, 1997 (see Note
     3), all outstanding  redeemable  preferred stock was redeemed at $1,000 per
     share plus accrued and unpaid dividends.

13.  INITIAL CAPITALIZATION

         In conjunction with the Acquisition,  Acquisition  Corp. issued $30,000
     of Floating Rate Notes, $50,279 of Manditorily  Redeemable Senior Preferred
     Stock (the "Senior  Preferred  Stock") and $1,111 of its Common Stock.  The
     Floating  Rate Notes were  issued  with an  original  issuance  discount of
     $5,389  and bear  interest  at a rate  equal to the rate in  effect  on the
     Bridge  Loans  (see  Note  3)  plus  2.50%.  After  the  completion  of the
     Refinancing  (see Note 3) on June 25, 1998,  the  Floating  Rate Notes bear
     interest at 15% per annum. Interest is payable quarterly and can be settled
     through the issuance of additional  Floating Rate Notes through maturity at
     the  discretion of  Acquisition  Corp.  The original  issuance  discount of
     $5,389 is being amortized using the effective interest method over the life
     of the  Floating  Rate  Notes.  The  unamortized  balance  of the  original
     issuance discount was $5,152 and $4,470 at June 30, 1998 and June 30, 1999,
     respectively.  The Floating  Rate Notes mature on December 15, 2009 and are
     held by affiliates of the primary  shareholder  of  Acquisition  Corp.  The
     Senior  Preferred  Stock  accretes  in value at 15% per  annum  and must be
     redeemed by December 15, 2012. The Floating Rate Notes and Senior Preferred
     Stock are general unsecured obligations of Acquisition Corp.




                                      F-19

<PAGE>

                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


13.  INITIAL CAPITALIZATION (Continued)

         The cash proceeds from the issuance of the Floating Rate Notes,  Senior
     Preferred Stock and Common Stock of approximately $76,000 and a Manditorily
     Redeemable  Senior  Preferred  Stock  Option of  $2,363  (see Note 17) were
     contributed  by  Acquisition  Corp.  to AKI in exchange for 1,000 shares of
     AKI's Common Stock.  Subsequent to the  capitalization of AKI,  Acquisition
     Corp.  contributed  $1 of cash and all of its ownership  interest in AKI to
     Holding for all of the outstanding equity of Holding.

         Acquisition  Corp.  has no other  operations  other  than the  Company.
     Absent addition  financing by Acquisition  Corp., the Company's  operations
     represent  the only  current  source  of funds  available  to  service  the
     Floating Rate Notes and  Manditorily  Redeemable  Senior  Preferred  Stock;
     however,  the Company is not  obligated to pay or otherwise  guarantee  the
     Floating Rate Notes and Manditorily Redeemable Senior Preferred Stock.

14.  COMMITMENTS AND CONTINGENCIES

     Operating Leases

         Equipment and office,  warehouse and production  space under  operating
     leases expire at various dates.  Rent expense was $443, $192, $198 and $338
     for the year ended June 30,  1997,  the  period  from July 1, 1997  through
     December 15, 1997,  the period from December 16, 1997 through June 30, 1998
     and the year  ended  June 30,  1999,  respectively.  Future  minimum  lease
     payments under these leases are as follows:

                                         2000..............  $    162
                                         2001..............       138
                                                             --------

                                                             $    300
                                                             ========

     Royalty Agreements

           Royalty  agreements are maintained for certain  technologies  used in
     the  manufacture  of  certain  products.  Under  the  terms of one  royalty
     agreement,  payments  are required  based on a  percentage  of net sales of
     those products  manufactured with the specific technology,  or a minimum of
     $500 per year. This agreement expires in 2003 or when a total of $12,500 in
     cumulative royalty payments has been paid. The Company expensed $761, $437,
     $516 and $500 under this  agreement  for the year ended June 30, 1997,  the
     period  from July 1, 1997  through  December  15,  1997,  the  period  from
     December  16, 1997  through June 30, 1998 and the year ended June 30, 1999,
     respectively.  The Company has paid $4,576 in cumulative  royalty  payments
     under this agreement through June 30, 1999.

         Under the terms of another  agreement,  royalty  payments  are required
     based on the  number  of  products  sold that  were  manufactured  with the
     specific licensed technology,  or a minimum payment per year. These minimum
     payments for years after fiscal 1999 are $625 through the expiration of the
     agreement in 2012.  The Company  expensed $475,  $241,  $284 and $575 under
     this  agreement  for the year ended June 30, 1997,  the period from July 1,
     1997 through  December 15, 1997,  the period from December 16, 1997 through
     June 30, 1998 and the year ended June 30, 1999, respectively.




                                      F-20
<PAGE>

                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)



14.  COMMITMENTS AND CONTINGENCIES (Continued)

     Employment Agreements

         The Company has employment  agreements with certain officers with terms
     through  February  1,  2002.  Such  agreements  provide  for base  salaries
     totaling $825 per year. One officer has an incentive bonus of up to 200% of
     base salary which is payable if certain  financial and management goals are
     attained  and  certain  other  incentive  payments.  One of the  employment
     agreements  also  provides  severance  benefits  of up to two years of base
     salary if the officer's services are terminated under certain conditions.

         During fiscal 1999,  two executive  officers  employment was terminated
     with the  Company.  In  accordance  with  the  terms  of  former  officers'
     employment agreements,  the Company was obligated for severance benefits of
     approximately  $610.  The  Company  had  paid  approximately  $457 of these
     benefits by June 30,  1999.  The  remaining  balance of $153 is included in
     accrued compensation at June 30, 1999.

     Litigation

         The Company is a party to litigation  arising in the ordinary course of
     business  which,  in the  opinion of  management,  will not have a material
     adverse effect on the Company's financial condition,  results of operations
     or cash flows.

15.  RETIREMENT PLANS

         A 401(k)  defined  contribution  plan (the  "Plan") is  maintained  for
      substantially all full-time salaried employees.  Applicable  employees who
      have six  months of  service  and have  attained  age 21 are  eligible  to
      participate in the Plan. Employees may elect to contribute a percentage of
      their  earnings to the Plan in accordance  with limits  prescribed by law.
      Contributions  to the Plan are  determined  annually  by the  Company  and
      generally  are a matching  percentage  of  employee  contributions.  Costs
      associated  with the Plan totaled  $180,  $95,  $113 and $201 for the year
      ended June 30,  1997,  the period from July 1, 1997  through  December 15,
      1997, the period from December 16, 1997 through June 30, 1998 and the year
      ended June 30, 1999, respectively.

         Certain  hourly  employees  are covered under a  multiemployer  defined
     benefit plan administered under a collective  bargaining  agreement.  Costs
     (determined by union  contract)  under the defined  benefit plan were $143,
     $80, $81 and $204 for the year ended June 30, 1997, the period from July 1,
     1997 through  December 15,  1997,  from  December 16, 1997 through June 30,
     1998 and for the year ended June 30, 1999, respectively.












                                      F-21
<PAGE>

                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)



16.  INCOME TAXES

         The Company is included in the  consolidated  federal income tax return
     filed by  Acquisition  Corp.  for periods  subsequent to December 15, 1997.
     Income taxes  related to the Company for the period from  December 16, 1997
     through  June 30, 1999 were  determined  on a separate  entity  basis.  The
     Company files  separate  state income tax returns and  calculates its state
     tax  provision on a separate  company  basis.  Any income taxes  payable or
     receivable  by the  consolidated  group are settled or received by AKI. The
     Predecessor was not part of a consolidated group.

         For  financial  reporting  purposes,  income (loss) before income taxes
includes the following components:

<TABLE>
<CAPTION>
                                                                    July 1,       December 16,
                                                                     1997             1997
                                                Year Ended          through          through         Year Ended
                                                 June 30,        December 15,       June 30,          June 30,
                                                   1997              1997             1998              1999
                                                   ----              ----             ----              ----
         <S>                                     <C>             <C>                <C>              <C>

         Income (loss) before income taxes:
           United States....................     $   7,609        $   3,298         $  (8,227)       $  (5,978)
           Foreign..........................          (492)             (64)              682              522
                                                 ----------       ----------        ---------        ---------

                                                 $   7,117        $     3,234       $  (7,545)       $  (5,456)
                                                 ==========       ==========        =========        =========



     Significant  components of the provision  (benefit) for income taxes are as
follows:

                                                                    July 1,       December 16,
                                                                     1997             1997
                                                Year Ended          through          through         Year Ended
                                                 June 30,         December 15       June 30,          June 30,
                                                   1997              1997             1998              1999
                                                   ----              ----             ----              ----

         Current expense (benefit):
           Federal..........................     $   2,880        $   1,623         $       -        $       -
           Foreign..........................             -                -               104              204
           State............................           552              278              (121)               -
                                                 ---------        ---------         ----------       ---------
                                                     3,432            1,901               (17)             204
                                                 ---------        ---------         ----------       ---------

         Deferred expense (benefit):

           Federal..........................           (90)            (376)           (1,916)            (481)
           Foreign..........................          (165)             (25)              162                -
           State............................           (42)             (59)             (281)             (63)
                                                 ----------       ---------         ----------       ----------
                                                      (297)            (460)           (2,035)            (544)
                                                 ----------       ---------         ---------        ----------

                                                 $    3,135       $   1,441         $  (2,052)       $    (340)
                                                 ==========       =========         =========        =========



</TABLE>




                                      F-22
<PAGE>

                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)



16.  INCOME TAXES (Continued)

         The  significant  components  of deferred  tax assets and  deferred tax
     liability at June 30, 1998 and 1999, were as follows:

<TABLE>
<CAPTION>


                                                           June 30, 1998                      June 30, 1999
                                                       ----------------------             ---------------------
                                                       Current     Noncurrent             Current    Noncurrent
                                                       ----------------------             ---------------------
         <S>                                         <C>          <C>                   <C>         <C>

         Deferred income tax assets:
           Accrued expenses........................  $     719    $       -             $     308    $       -
           Allowance for doubtful accounts.........        108            -                    92            -
           Net operating loss carryforwards........          -        2,966                     -        4,338
           Preferred stock option..................          -          922                     -            -
                                                     ---------    ---------             ---------    ---------
                                                           827        3,888                   400        4,338

         Deferred income tax liability:
             Property, plant and equipment.........          -        4,143                     -        3,340
                                                     ---------    ---------             ---------    ---------

                                                     $     827    $    (255)            $     400    $     998
                                                     =========    ==========            =========    =========

         The income tax provision recognized by the Predecessor for the year ended June 30, 1997 and the period
     from July 1, 1997  through  December  15, 1997 and by the Company  for the period from  December  16, 1997
     through June 30, 1998 and the year ended June 30, 1999 differs from the amount  determined by applying the
     applicable U.S. statutory federal income tax rate to pretax income as a result of the following:


                                                                    July 1,            December 16,
                                                                     1997                  1997
                                                     Year Ended     through               through    Year Ended
                                                      June 30,   December 15,            June 30,     June 30,
                                                        1997         1997                  1998         1999
                                                        ----         ----                  ----         ----
         <S>                                         <C>          <C>    <C>    <C>    <C>           <C>

         Computed tax provision (benefit)
           at the statutory rate...................  $   2,420    $   1,100            $   (2,565)   $   (1,855)
         State income tax provision (benefit),
           net of federal effect...................        335          145                  (265)         (152)
         Nondeductible expenses....................        455          193                   723         1,655
         Other, net................................        (75)           3                    55            12
                                                     ----------   ---------            ----------    ----------

                                                     $   3,135    $   1,441            $   (2,052)   $     (340)
                                                     =========    =========            ==========    ==========


         In conjunction with the Acquisition, the Company recognized an income tax benefit of $7,327 related to
     the  excess of the  redemption  price  over the  strike  price of  certain  non-qualified  options  of the
     Predecessor redeemed and retired by the Company. This benefit was recorded as a reduction to goodwill.


</TABLE>




                                                     F-23


<PAGE>

                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)



16.    INCOME TAXES (continued)

         Due to the Company's current year losses and certain  transactions made
     in conjunction with the  Acquisition,  the Company has recorded a long-term
     deferred  tax asset of $4,338  reflecting  cumulative  net  operating  loss
     carryforwards   available  to  offset  future  federal  taxable  income  of
     approximately  $10,000 and future  state  taxable  income of  approximately
     $17,500 at June 30, 1999. These cumulative net operating loss carryforwards
     expire in  varying  amounts  through  2019.  Realization  is  dependent  on
     generating  sufficient  taxable  income  prior  to  expiration  of the loss
     carryforwards.  Although  realization is not assured,  management  believes
     that it is more likely than not that all of the  deferred tax asset will be
     realized.  The  amount of the  deferred  tax asset  considered  realizable,
     however,  could be reduced in the near term if estimates of future  taxable
     income during the carryforward period are reduced.

17.  STOCK OPTIONS

            The  Predecessor  sponsored a key  employee  stock option plan under
     which a maximum of 12,571 shares of the Predecessor's common stock could be
     reserved for nonqualified  options;  all stock options were granted with an
     exercise  price  equal to the fair  market  value  of $100 per  share.  All
     options  vested  ratably  over five years and would have  expired ten years
     from the grant date.

           The  Predecessor  accounted  for its  employee  stock  options  under
     Accounting  Principles Board Opinion No. 25, Accounting for Stock Issued to
     Employees  ("APB  25").  Under APB 25,  because the  exercise  price of the
     Predecessor's  employee  stock  options  equaled  the  market  value of the
     underlying  stock  on the  date  of  grant,  no  compensation  expense  was
     recognized.

         A summary  of the  Predecessor's  stock  option  activity  and  related
information follows:

                                                  June 30, 1997
                                                     Weighted
                                                      Average
                                                      Exercise
                                                 Options     Price

         Outstanding, beginning of year......     12,571    $   100
           Granted...........................          -          -
           Exercised.........................          -          -
           Forfeited.........................          -          -
                                                --------    -------

         Outstanding, end of year............     12,571    $   100
                                                ========    =======

         Exercisable, end of year............      5,866    $   100
                                                ========    =======

         Weighted average remaining
           contractual life..................         7.3 years




                                      F-24
<PAGE>

                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)



17.  STOCK OPTIONS (Continued)

         Statement of Financial  Accounting  Standards No. 123,  Accounting  for
     Stock-Based  Compensation  ("SFAS 123"),  requires  disclosure of pro forma
     information  regarding net income for option grants  subsequent to December
     15, 1995.  Because all of the  Predecessor's  options were granted prior to
     that  date,  no pro  forma  adjustments  to net  income  or  disclosure  of
     information would apply under SFAS 123.

         As a result of the sale of the  Predecessor  on December  15, 1997 (see
     Note 3), all outstanding  options became immediately vested and exercisable
     under the terms of the  original  individual  stock option  agreements.  In
     connection with the Acquisition,  the Company  purchased and retired 11,201
     options of the Predecessor for $19,342.  The remaining 1,370 options of the
     Predecessor,  which had a cumulative exercise price of $137, were exchanged
     at fair  value for an  option to  purchase  100,000  shares of  Acquisition
     Corp.'s Senior  Preferred  Stock with a cumulative  stated valued of $2,500
     ("the  Preferred  Stock  Option").  The  1,370  options  were  subsequently
     retired.  The  Preferred  Stock Option had an exercise  price of $137.  The
     total  consideration of $21,705 used to purchase and retire the outstanding
     options of the Predecessor was included in the cost of the Acquisition (see
     Note 3).

         The  Preferred  Stock Option was issued with a Put and Call Option (the
     "Put and Call  Option")  which  granted  the  officer  the  right to compel
     DLJMBII to purchase the 100,000 shares of Senior Preferred Stock obtainable
     under the  Preferred  Stock  Option,  together  with certain  common equity
     interests in Acquisition Corp. held by the officer, for $2,590. The Put and
     Call  Option  also  granted  DLJMBII  the  right  to  purchase  the  equity
     interests,  both common and preferred,  of the officer for the same amount.
     The Put and Call  Option had a stated  termination  of June 30,  1998.  The
     officer  agreed to  terminate  the Put and Call Option and enter into a new
     put option (the "Put Option")  dated June 17, 1998.  The Put Option granted
     the officer an irrevocable option to require  Acquisition Corp. to purchase
     80,000 shares of the Senior  Preferred Stock obtainable under the Preferred
     Stock  Option,  for  $2,000 in cash.  As the terms of the Put  Option  were
     generally more  restrictive  than the Put and Call Option,  no compensation
     expense was  recognized as a result of the  transaction.  On July 30, 1998,
     the officer exercised the Preferred Stock Option and Put Option. To provide
     Acquisition Corp. the funds to redeem the 80,000 shares of Senior Preferred
     Stock,  Holding  issued  Acquisition  Corp. a dividend of $1,863 in cash on
     such date.

         Subsequent to the Acquisition, Acquisition Corp. adopted the 1998 Stock
     Option Plan  ("Option  Plan") for certain key  employees  and  directors of
     Acquisition  Corp.  and any parent or subsidiary of  Acquisition  Corp. The
     Option  Plan  authorizes  the  issuance of options to acquire up to 100,000
     shares of  Acquisition  Corp.  Common Stock.  The terms of each  individual
     options grant are determined by the Board of Directors.  The exercise price
     for each  grant is  required  to be set at least  equal to the fair  market
     value per share of Acquisition Corp. provided that the exercise price shall
     not be less than $1.00 per share.  Options may be exercisable for up to ten
     years.







                                      F-25

<PAGE>

                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)



17.  STOCK OPTIONS (Continued)

         On June 17, 1998,  Acquisition Corp.  granted an officer of the Company
     options to purchase 32,500 shares of Acquisition  Corp.  Common Stock.  All
     options  have an exercise  price of $1.00 per share and a term of 10 years.
     These  options  were  forfeited  during  1999 upon the  resignation  of the
     officer.

         The Company  has  elected to account  for its stock based  compensation
     with employees under the intrinsic value method as permitted under FAS 123.
     Under the intrinsic value method,  because the stock price of the Company's
     employee stock options  equaled the fair value of the  underlying  stock on
     the date of grant, no compensation  expense was recognized.  If the Company
     had elected to recognize  compensation  expense  based on the fair value of
     the options at grant date as  prescribed  by FAS 123,  the net loss for the
     period from December 16, 1997 through June 30, 1998 and the year ended June
     30, 1999 would have been  $(5,494) and  $(5,119),  respectively.  In making
     this determination, fair value was estimated on the date of grant using the
     minimum value method and a risk-free  interest  rate of 5.4%.  The weighted
     average  fair value at date of grant of  options  granted  during  1998 was
     approximately $0.41 per option.

18.  RELATED PARTY TRANSACTIONS

         The Predecessor made payments to a company  controlled by a stockholder
     of the  Predecessor  of $612 for the year ended June 30,  1997 and $160 for
     the period from July 1, 1997  through  December 15,  1997,  for  management
     fees, bonuses and expense reimbursements.

          The Predecessor  made payments to another  stockholder of $120 for the
     year ended June 30, 1997 and $55 for the period  from July 1, 1997  through
     December 15, 1997, for management fees.

          The  Successor  made  payments to an  affiliate of DLJMBII of $125 and
     $250 for the period from  December  16, 1997  through June 30, 1998 and the
     year ended June 30, 1999,  respectively,  for financial  advisory  fees. In
     addition,  the Company had  approximately  $2,401 of cash on deposit with a
     financial institution affiliated with DLJMBII as of June 30, 1998.

19.      SUBSEQUENT EVENT

          On  September  15, 1999,  AKI acquired all of the equity  interests in
     RetCom Holdings Ltd. and its subsidiaries for a total cost of approximately
     $12,000 and refinanced working capital indebtedness of approximately $4,500
     of RetCom  Holdings  Ltd.  and its  subsidiaries.  The  purchase  price and
     refinancing of indebtedness were initially financed by borrowings under the
     credit agreement.









                                      F-26

<PAGE>

                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)




20.  GEOGRAPHIC INFORMATION

         The following table illustrates geographic information for revenues and
     long-lived  assets.  Revenues  are  attributed  to  countries  based on the
     receipt of sales orders,  and long-lived  assets are based upon the country
     of domicile.

<TABLE>
<CAPTION>

                                                 United
                                                 States                France                 Total

                                                                     Predecessor
                                                                     -----------
     <S>                                       <C>                   <C>                  <C>

     Net sales:

     Year ended June 30, 1997.............     $    70,660           $     7,063          $    77,723
     Period from July 1, 1997
       through December 15, 1997..........          32,600                 2,586               35,186




                                                                      Successor
                                                                      ---------
     Net sales:

     Period from December 16, 1997
       through June 30, 1998..............     $    29,162           $     6,904          $    36,066
     Year ended June 30, 1999.............          71,056                14,911               85,967

     Long-lived assets:

     June 30, 1998........................         188,532                   158              188,690
     June 30, 1999........................         184,177                   107              184,284


</TABLE>





                                      F-27
<PAGE>

                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)



21.  CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS

         The  following  condensed  balance  sheet at June 30, 1998 and June 30,
     1999 and condensed statement of operations, changes in stockholder's equity
     and cash flows for the period from  December 16, 1997 through June 30, 1998
     and the year ended June 30, 1999 for Holding  should be read in conjunction
     with the consolidated financial statements and notes thereto.

<TABLE>
<CAPTION>

                                                BALANCE SHEETS

                                                                                 June 30,          June 30,
                                                                                   1998              1999
                                                                                   ----              ----
     <S>                                                                        <C>              <C>
     Assets
     Cash..............................................................         $    2,201       $         -
     Investment in subsidiaries........................................             95,408            92,817
     Deferred charges..................................................              1,263             1,520
     Deferred income taxes.............................................                 19             1,206
                                                                                ----------       -----------
       Total assets....................................................         $   98,891       $    95,543
                                                                                ==========       ===========

     Liabilities
     Senior Discount Debentures........................................         $   26,020       $    29,651

     Stockholder's equity
     Common Stock, $0.01 par value, 1,000 shares authorized;
       1,000 shares issued and outstanding.............................                  -                 -
     Additional paid-in capital........................................             78,364            78,364
     Accumulated deficit...............................................             (5,493)          (12,472)
                                                                                ----------       -----------
       Total stockholder's equity......................................             72,871            65,892
                                                                                ----------       -----------
       Total liabilities and stockholder's equity......................         $   98,891       $    95,543
                                                                                ==========       ===========




                                            STATEMENT OF OPERATIONS

                                                                               December 16,
                                                                                   1997
                                                                                 through          Year ended
                                                                                 June 30,           June 30
                                                                                   1998              1999
                                                                                   ----              ----

     Equity in losses of subsidiaries..................................         $   (5,454)      $    (2,591)
     Interest expense, net.............................................                (58)           (3,712)
                                                                                ----------       ------------

       Loss before income taxes........................................             (5,512)           (6,303)

     Income tax benefit................................................                (19)           (1,187)
                                                                                ----------       -----------

       Net loss........................................................         $   (5,493)      $    (5,116)
                                                                                ==========       ============

</TABLE>




                                      F-28

<PAGE>


                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


21.  CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS (Continued)
<TABLE>
<CAPTION>

                                 STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY

                                                                 Additional
                                             Common Stock          Paid-in      Accumulated
                                          Shares     Amount        Capital        Deficit         Total
                                          ------     ------        -------        -------         -----
     <S>                                  <C>        <C>        <C>             <C>            <C>
     Balances, December 16, 1997......          -    $     -    $         -     $        -     $         -
     Initial capitalization...........      1,000          -         78,364              -          78,364
     Net loss.........................          -          -              -         (5,493)         (5,493)
                                          -------    -------    -----------     -----------    ------------

     Balances, June 30, 1998..........      1,000          -         78,364         (5,493)         72,871
     Net loss.........................          -          -              -         (5,116)         (5,116)
     Dividend to AHC I
       Acquisition Corp...............          -          -              -         (1,863)         (1,863)
                                          -------    -------    -----------     ----------     -----------

     Balances, June 30, 1999..........      1,000    $     -    $    78,364     $  (12,472)    $    65,892
                                          =======    =======    ===========     ==========     ===========



                                            STATEMENT OF CASH FLOWS

                                                                                December 16,
                                                                                   1997
                                                                                  through      Year ended
                                                                                 June 30,       June 30,
                                                                                   1998           1999
                                                                                   ----           ----
     <S>                                                                        <C>            <C>
     Cash flows from operating activities:
       Net loss............................................................     $   (5,493)    $    (5,116)
       Adjustments to reconcile net loss to
         net cash provided by (used in) operating activities:
         Net change in investment in subsidiaries..........................          5,454           2,591
         Amortization of original issuance discount and loan closing costs.             58           3,722
         Deferred income taxes.............................................            (19)         (1,187)
         Increase in deferred charges......................................              -            (348)
                                                                                ----------     -----------
           Net cash provided by (used in) operating activities.............              -            (338)
                                                                                ----------     ------------

     Cash flows from investing activities:
       Capital contributed to subsidiary...................................        (22,499)              -
                                                                                ----------     -----------

     Cash flows from financing activities:
       Proceeds from issuance of stock.....................................              1               -
       Proceeds from issuance of Senior Discount Debentures................         24,699               -
       Dividend paid to AHC I Acquisition Corp.............................              -          (1,863)
                                                                                ----------     -----------
           Net cash provided by (used in) financing activities.............         24,700          (1,863)
                                                                                ----------     ------------

     Net increase (decrease) in cash and cash equivalents..............              2,201          (2,201)
     Cash and cash equivalents, beginning of period....................                  -           2,201
                                                                                ----------     -----------
     Cash and cash equivalents, end of period..........................         $    2,201     $         -
                                                                                ==========     ===========

</TABLE>


                                      F-29
<PAGE>

                       AKI HOLDING CORP. AND SUBSIDIARIES
             (a wholly-owned subsidiary of AHC I Acquisition Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)



22.  UNAUDITED QUARTERLY RESULTS OF OPERATIONS

     The following is a summary of the unaudited quarterly results of operations
for Fiscal 1998 and Fiscal 1999.

<TABLE>
<CAPTION>


                                       Predecessor                                    Successor
                                            October 1,    December 16,
                                               1997           1997
                           Quarter Ended      through        through     Quarter  Ended  Quarter Ended
                           September 30,   December 15,   December 31,      March 31,      June 30,         Full
     Fiscal 1998               1997            1997           1997             1998          1998           Year
                               ----            ----           ----             ----          ----           ----
     <S>                     <C>            <C>           <C>              <C>            <C>           <C>
     Net sales.............  $  21,928      $  13,258     $  2,791         $  19,191      $  14,084     $    71,252
     Gross profit..........      8,306          4,071          813             7,256          3,479          23,925
     Income from operations      4,680          1,426          153             3,603            104           9,966
     Interest expense, net.      1,451          1,195          759             4,404          6,164          13,973
     Net income (loss).....      1,796             (3)        (443)             (887)        (4,163)         (3,700)





                                                                      Successor
                                  Quarter Ended     Quarter Ended    Quarter Ended     Quarter Ended
                                  September 30,     December 31,       March 31,         June 30,           Full
     Fiscal 1999                      1998              1998             1999              1999             Year
                                      ----              ----             ----              ----             ----
     <S>                           <C>              <C>               <C>              <C>                <C>
     Net sales.............         $ 24,024         $  20,437         $  24,518        $  16,988         $  85,967
     Gross profit..........            8,603             6,777             9,691            5,697            30,768
     Income from operations            4,337             2,331             4,616              378            11,662
     Interest expense, net.            4,096             4,149             4,258            4,237            16,740
     Net loss..............             (324)           (1,579)             (364)          (2,849)           (5,116)
















</TABLE>





                                      F-30

<PAGE>

                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and Stockholder of
  AKI, Inc. and Subsidiaries

     In our  opinion,  the  accompanying  consolidated  balance  sheets  and the
related  consolidated  statements  of  operations,  of changes in  stockholder's
equity and of cash flows present fairly, in all material respects, the financial
position  of AKI,  Inc. (a  wholly-owned  subsidiary  of AKI Holding  Corp.) and
Subsidiaries  (the  "Successor"),  formerly known as Arcade Holding  Corporation
(the  "Predecessor"),  at June  30,  1998  and  1999  and the  results  of their
operations  and their cash flows for the period from  December  16, 1997 through
June 30,  1998 and the year ended June 30,  1999 in  conformity  with  generally
accepted   accounting   principles.   These   financial   statements   are   the
responsibility  of management;  our  responsibility  is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements  in accordance  with  generally  accepted  auditing  standards  which
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,  assessing the  accounting  principles
used and  significant  estimates made by management,  and evaluating the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for the opinion expressed above.






PricewaterhouseCoopers LLP
Nashville, Tennessee
July 31, 1999 except for Note 18
which is as of September 15, 1999


















                                      F-31
<PAGE>


                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and Stockholder of
  AKI, Inc. and Subsidiaries

     In our opinion, the accompanying  consolidated statements of operations, of
changes in stockholders'  equity and of cash flows of Arcade Holding Corporation
and Subsidiaries present fairly, in all material respects,  the results of their
operations  and their cash flows for the year ended June 30, 1997 and the period
from July 1,  1997  through  December  15,  1997 in  conformity  with  generally
accepted   accounting   principles.   These   financial   statements   are   the
responsibility  of management;  our  responsibility  is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements  in accordance  with  generally  accepted  auditing  standards  which
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,  assessing the  accounting  principles
used and  significant  estimates made by management,  and evaluating the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for the opinion expressed above.




PricewaterhouseCoopers LLP
Nashville, Tennessee
July 31, 1998











                                      F-32



<PAGE>
<TABLE>
<CAPTION>


                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                           CONSOLIDATED BALANCE SHEETS
                       (dollars in thousands, except share
                                  information)


                                                                                             Successor
                                                                                             ---------
                                                                                  June 30, 1998    June 30, 1999
                                                                                  -------------    -------------
<S>                                                                               <C>              <C>
ASSETS
Current assets
Cash and cash equivalents.....................................                      $   1,641        $   7,015
Accounts receivable, net......................................                         13,550           16,287
Inventory.....................................................                          2,078            5,109
Income tax refund receivable..................................                          5,155               32
Prepaid expenses..............................................                            379              452
Deferred income taxes.........................................                            827              400
                                                                                    ---------        ---------
      Total current assets....................................                         23,630           29,295

Property, plant and equipment, net............................                         18,936           18,511
Goodwill, net ................................................                        151,842          147,990
Deferred charges, net.........................................                          5,272            5,319
Other intangible assets, net..................................                          7,289            6,560
Deferred income taxes.........................................                          3,869            3,132
Other assets..................................................                            200               46
                                                                                    ---------        ---------
      Total assets............................................                      $ 211,038        $ 210,853
                                                                                    =========        =========

LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of capital lease obligation...................                      $     609        $     688
Current portion of other notes payable........................                          1,330                -
Accounts payable, trade.......................................                          4,293            3,400
Accrued income taxes..........................................                            100              497
Accrued compensation..........................................                          2,497            2,527
Accrued interest..............................................                            167            6,047
Accrued expenses..............................................                          1,789            1,283
                                                                                    ---------        ---------
      Total current liabilities...............................                         10,785           14,442

Long-term portion of capital lease obligation.................                          1,489            1,349
Senior notes..................................................                        115,000          115,000
Deferred income taxes.........................................                          4,143            3,340
                                                                                    ---------        ---------
      Total liabilities.......................................                        131,417          134,131

Commitments and contingencies (see Note 13)

Stockholder's equity
Preferred stock, $0.01 par, 8,700 shares authorized; no shares
    issued or outstanding at June 30, 1998 and June 30, 1999..                              -                -
Common stock, $0.01 par, 100,000 shares authorized; 1,000
    shares issued and outstanding at June 30, 1998 and June 30, 1999                        -                -
Additional paid-in capital....................................                        100,862          100,862
Accumulated deficit...........................................                         (5,454)          (8,045)
Accumulated other comprehensive loss..........................                            (57)            (365)
Carryover basis adjustment....................................                        (15,730)         (15,730)
                                                                                    ---------        ---------
      Total stockholder's equity..............................                         79,621           76,722
                                                                                    ---------        ---------
      Total liabilities and stockholder's equity..............                      $ 211,038        $ 210,853
                                                                                    =========        =========




</TABLE>

        The accompanying notes are an integral part of these consolidated
                             financial statements.



                                      F-33
<PAGE>


                                            AKI, INC. AND SUBSIDIARIES
                                (a wholly-owned subsidiary of AKI Holding Corp.)
                                       CONSOLIDATED STATEMENTS OF OPERATIONS
                                              (dollars in thousands)

<TABLE>
<CAPTION>

                                                                      Predecessor                        Successor
                                                                                 July 1,       December 16,
                                                                                  1997              1997
                                                                Year Ended       through          through       Year Ended
                                                                 June 30,     December 15,       June 30,        June 30,
                                                                   1997           1997             1998            1999
                                                                   ----           ----             ----            ----


<S>                                                           <C>            <C>               <C>              <C>
Net sales..........................................           $    77,723    $     35,186      $   36,066       $  85,967
Cost of goods sold.................................                49,467          22,809          24,518          55,199
                                                              -----------    ------------      ----------       ---------

     Gross profit..................................                28,256          12,377          11,548          30,768

Selling, general and administrative expenses.......                13,333           5,703           5,587          14,500
Amortization of goodwill and
   other intangibles...............................                 1,234             568           2,101           4,606
                                                              -----------    ------------      ----------       ---------

     Income from operations........................                13,689           6,106           3,860          11,662

Other expenses (income):
   Interest expense to stockholder(s) and
      affiliate....................................                 5,196           2,143          10,785               -
   Interest expense, other.........................                 1,007             503             484          13,028
   Management fees to stockholders
     and affiliate.................................                   470             215             125             250
   Other, net......................................                  (101)             11             (47)            128
                                                              -----------    ------------      ----------       ---------

     Income (loss) before income taxes.............                 7,117           3,234          (7,487)         (1,744)

Income tax expense (benefit).......................                 3,135           1,441          (2,033)            847
                                                              -----------    ------------      ----------       ---------

     Net income (loss).............................           $     3,982    $      1,793      $  (5,454)       $  (2,591)
                                                              ===========    ============      =========        =========



</TABLE>









        The accompanying notes are an integral part of these consolidated
                             financial statements.

                                      F-34




<PAGE>
<TABLE>
<CAPTION>


                                            AKI, INC. AND SUBSIDIARIES
                                 (a wholly-owned subsidiary of AKI Holding Corp.)
                            CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER(S) EQUITY
                                 (dollars in thousands, except share information)


                                                   Retained     Accumulated
                                                Addititonal  Stock    Earnings        Other     Carryover
                                 Common  Stock    Paid-in  Purchase (Accumulated  Comprehensive   Basis
                                 Shares  Amount   Capital  Warrants   Deficit)        Loss     Adjustment    Total
                                 ------  ------   ------   --------   -------         ----     ----------    -----

                                                                      Predecessor
                                                                      -----------
<S>                             <C>     <C>      <C>        <C>        <C>          <C>         <C>        <C>
Balances, June 30, 1996......   48,000  $     1  $   4,889  $1,923     $   1,199    $     (80)  $      -   $  7,932
Net income...................        -        -          -       -         3,982            -          -      3,982
Other comprehensive income, net
  of tax:
   Foreign currency translation
     adjustment..............        -        -          -       -             -          (73)         -        (73)
                                                                                                           --------
Comprehensive income.........                                                                                 3,909
Preferred stock dividend.....        -        -          -       -          (616)           -          -       (616)
                               -------  -------  ---------  ------     ----------   ---------   --------   ---------

Balances, June 30, 1997......   48,000        1      4,889   1,923         4,565         (153)         -     11,225
Net income...................        -        -          -       -         1,793            -          -      1,793
Other comprehensive income, net
  of  tax:
   Foreign currency translation
     adjustment..............        -        -          -       -             -          (19)         -        (19)
                                                                                                           --------
Comprehensive income.........                                                                                 1,774
Preferred stock dividend.....        -        -          -       -          (283)           -          -       (283)
                               -------  -------  ---------  ------     ----------   ---------   --------   ---------

Balances, December 15, 1997..   48,000  $     1  $   4,889  $1,923     $   6,075    $    (172)  $      -   $ 12,716
                               =======  =======  =========  ======     =========    =========   ========   ========


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

                                                                          Successor
                                                                          ---------
Balances, December 16, 1997..        -  $     -  $       -  $    -     $       -    $       -   $      -   $      -
Initial capitalization           1,000        -     78,363       -             -            -          -     78,363
   (see Note 12)
Carryover basis adjustment...        -        -          -       -             -            -    (15,730)   (15,730)
Equity contribution by Holding       -        -     22,499       -             -            -          -     22,499
Net loss.....................        -        -          -       -        (5,454)           -          -     (5,454)
Other comprehensive loss, net of tax:
   Foreign currency translation
     adjustment..............        -        -          -       -             -          (57)         -        (57)
                                                                                                           --------
Comprehensive loss...........                                                                                (5,511)
                               -------  -------  ---------  ------     ---------    ---------   --------   --------

Balances, June 30, 1998......    1,000        -    100,862       -        (5,454)         (57)   (15,730)    79,621
Net loss.....................        -        -          -       -        (2,591)           -          -     (2,591)
Other comprehensive loss, net
  of tax:
   Foreign currency translation
     adjustment..............        -        -          -       -             -         (308)         -       (308)
                                                                                                           --------
Comprehensive loss...........                                                                                (2,899)
                               -------  -------  ---------  ------     ---------    ---------   --------   --------

Balances, June 30, 1999......    1,000  $     -  $ 100,862  $    -     $  (8,045)   $    (365)  $(15,730)  $ 76,722
                               =======  =======  =========  ======     =========    =========   ========   ========



</TABLE>

        The accompanying notes are an integral part of these consolidated
                             financial statements.

                                                       F-35

<PAGE>
                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (dollars in thousands)
<TABLE>
<CAPTION>
                                                                    Predecessor                        Successor
                                                                               July 1,        December 16,
                                                                                1997              1997
                                                           Year Ended          through           through      Year Ended
                                                            June 30,        December 15,        June 30,       June 30,
                                                              1997              1997              1998           1999
                                                              ----              ----              ----           ----

   <S>                                                      <C>              <C>                <C>           <C>
   Cash flows from operating activities:
     Net income (loss)...........................           $   3,982        $   1,793          $ (5,454)     $  (2,591)
     Adjustment to reconcile net income (loss) to
       net cash provided by (used in) operating activities:
       Depreciation and amortization of goodwill
         and other intangibles...................               5,084            2,456             3,954          8,487
       Amortization of debt discount.............                 560              233                81              -
       Amortization of loan closing costs........                 258              101             3,808            636
       Deferred income taxes.....................                (297)            (460)           (2,016)           643
       Gain on sale of equipment.................                   -                -                 -            (50)
       Other.....................................                (138)             (18)              (57)          (308)
       Changes in operating assets and liabilities:
         Accounts receivable.....................               2,546            1,153            (4,562)        (2,737)
         Inventory...............................                (550)              69               543         (3,031)
         Prepaid expenses, deferred charges and
           other assets..........................                (101)             (62)             (453)          (627)
         Income taxes............................              (1,163)             699               767          5,238
         Accounts payable and accrued expenses...              (1,239)          (1,036)           (5,432)         4,511
                                                            ---------        ---------         ---------      ---------

         Net cash provided by (used in) operating
           activities............................               8,942            4,928            (8,821)        10,171
                                                            ---------        ---------         ---------      ---------
   Cash flows from investing activities:
     Purchases of equipment......................              (2,462)            (807)             (514)        (2,856)
     Proceeds from sale of equipment.............                  38                -                 -             50
     Payments for acquisitions, net of cash acquired                -                -          (141,403)             -
                                                            ---------        ---------        ----------     ----------


         Net cash used in investing activities...              (2,424)            (807)         (141,917)        (2,806)
                                                            ---------        ---------         ---------      ---------

   Cash flows from financing activities:
     Payments under capital leases for equipment.              (2,359)            (249)             (308)          (661)
     Net proceeds (repayments) on line of credit.               4,338            2,362            (6,700)             -
     Proceeds from issuance of senior increasing rate
        notes, net of offering costs.............                   -                -           119,735              -
     Payments on senior increasing rate notes....                   -                -          (123,500)             -
     Proceeds from issuance of senior notes, net
       of offering costs.........................                   -                -           110,158              -
     Proceeds from issuance of common stock......                   -                -            98,499              -
     Redemption of preferred stock...............                   -                -            (8,678)             -
     Repayment of loans payable to stockholder...              (7,004)          (1,851)          (36,649)             -
     Repayment of other notes payable............              (1,200)             (50)              (50)        (1,330)
     Dividends paid on preferred stock...........                (616)            (155)             (128)             -
                                                            ---------        ---------         ----------     ---------

       Net cash provided by (used in)
         financing activities....................              (6,841)              57           152,379         (1,991)
                                                            ---------        ---------         ---------      ---------

   Net increase (decrease) in cash and cash equivalents          (323)           4,178             1,641          5,374
   Cash and cash equivalents, beginning of period                 626              303                 -          1,641
                                                            ---------        ---------         ---------      ---------
   Cash and cash equivalents, end of period......           $     303        $   4,481         $   1,641      $   7,015
                                                            =========        =========         =========      =========


   Supplemental information: Cash paid (received) during the period for:
       Interest to stockholder(s)................           $   4,559        $   1,146          $ 11,503      $       -
       Interest, other...........................                 917              459               214          6,512
       Income taxes..............................               4,594            1,222              (784)        (5,123)

   Significant non-cash activities:
     Assets acquired under capital lease.........           $       -        $       -          $      -      $     600


</TABLE>
        The accompanying notes are an integral part of these consolidated
                             financial statements.
                                      F-36
<PAGE>


                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


1.       ORGANIZATION AND BUSINESS

         Arcade Holding  Corporation (the  "Predecessor")  was organized for the
     purpose  of  acquiring  all the  issued and  outstanding  capital  stock of
     Arcade,  Inc.  ("Arcade")  on  November  4,  1993.  Arcade  is  engaged  in
     interactive advertising for consumer products companies and has a specialty
     in the design,  production and  distribution  of sampling  systems from its
     Chattanooga,  Tennessee facilities,  and distributes its products in Europe
     through  its  French  subsidiary,  Arcade  Europe  S.A.R.L.  As more  fully
     described  in Note 3, DLJ  Merchant  Banking  Partners II, L.P. and certain
     related  investors  (collectively,  "DLJMBII")  and certain  members of the
     Predecessor organized AHC I Acquisition Corp. ("Acquisition Corp.") and AHC
     I Merger Corp.  ("Merger Corp.") for purposes of acquiring the Predecessor.
     On December 15, 1997, Merger Corp.  acquired all of the equity interests of
     the Predecessor  then merged with and into the Predecessor and the combined
     entity assumed the name AKI, Inc. and Subsidiaries  ("AKI," the "Successor"
     or  the  "Company").  Subsequent  to  the  Acquisition,  Acquisition  Corp.
     contributed  $1 of cash  and all of its  ownership  interest  in AKI to AKI
     Holding  Corporation  ("Holding")  for  all of the  outstanding  equity  of
     Holding.

         Unless  otherwise  indicated,  all  references  to  years  refer to the
     Predecessor's and AKI's fiscal year, June 30.


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Principles of Consolidation

         The accompanying consolidated financial statements include the accounts
     of  the  Company  and  its  wholly  owned  subsidiaries.   All  significant
     intercompany transactions have been eliminated.

     Reclassification

         Certain prior year amounts have been  reclassified  to conform with the
current year presentation.

     Cash and Cash Equivalents

         For purposes of the consolidated  statements of cash flows, the Company
     considers all highly liquid  investments with an original maturity of three
     months or less at the time of purchase to be cash equivalents.

     Concentration of Credit Risk

         The Company  maintains  its cash in bank  deposit  accounts  which,  at
     times, may exceed federally insured limits. The Company has not experienced
     any losses in such accounts;  in addition,  the Company  believes it is not
     exposed to any significant  credit risk on cash and cash  equivalents.  The
     Company  grants  credit  terms in the  normal  course  of  business  to its
     customers and as part of its ongoing  procedures,  the Company monitors the
     credit worthiness of its customers. The Company does not believe that it is
     subject to any unusual  credit risk beyond the normal credit risk attendant
     in its business.




                                      F-37

<PAGE>


                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)



2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         Two customers  accounted for 23.5% and 35.3% of the  Predecessor's  net
     sales  during the year ended June 30, 1997 and the period from July 1, 1997
     through December 15, 1997,  respectively.  One customer accounted for 13.3%
     of net sales  during the period from  December  16, 1997  through  June 30,
     1998. Two customers  accounted for 26.8% of net sales during the year ended
     June 30, 1999.

     Concentration of Purchasing

         Products  accounting  for a majority of the Company's net sales utilize
     specific  grades of paper that are produced  exclusively for the Company by
     one domestic supplier.  The Company does not have a purchase agreement with
     the  supplier  and is not aware of any other  suppliers  of these  specific
     grades of paper.  These products can be manufactured  using other grades of
     paper; however, the Company believes these specific grades of paper provide
     the  Company  with an  advantage  over  its  competitors.  The  Company  is
     currently  researching  methods  of  replicating  the  advantages  of these
     specific grades of paper with other grades of paper available from multiple
     suppliers.  Until such  methods  are  developed,  a loss of supply of these
     specific  grades of paper and the  resulting  competitive  advantage  could
     cause a possible  loss of sales  which  could  adversely  affect  operating
     results.

     Revenue Recognition and Accounts Receivable

         Product sales are recognized upon shipment, net of estimated discounts.
     Accounts  receivable  are  accounted  for net of  allowances  for  doubtful
     accounts.

     Inventory

         Paper  inventory  is stated  at the  lower of cost or market  using the
     last-in,  first-out (LIFO) method;  all other inventories are stated at the
     lower of cost or market using the first-in, first-out (FIFO) method.

     Property, Plant and Equipment

         Property,  plant and  equipment are stated at cost.  Expenditures  that
     extend the  economic  lives or improve  the  efficiency  of  equipment  are
     capitalized. The costs of maintenance and repairs are expensed as incurred.
     Upon retirement or disposal, the related cost and accumulated  depreciation
     are removed from the respective accounts and any gain or loss is recorded.

         Depreciation  is computed using the  straight-line  method based on the
     estimated  useful lives of the assets as indicated in Note 6 for  financial
     reporting  purposes and  accelerated  methods for tax  purposes.  Leasehold
     improvements  are depreciated  over the shorter of their  estimated  useful
     lives or the lease term.




                                      F-38
<PAGE>



                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

     Goodwill

         The aggregate purchase price of business  acquisitions was allocated to
     the  assets  and  liabilities  of the  acquired  companies  based  on their
     respective fair values as of the acquisition dates. Goodwill represents the
     excess purchase price paid over the fair value of net  identifiable  assets
     acquired and is amortized over forty years using the straight-line  method.
     Accumulated  amortization  was $2,087 and $5,939 at June 30,  1998 and June
     30, 1999, respectively.

         Management  periodically  reviews the value of its  goodwill  and other
     long-lived assets to determine if an impairment has occurred. The potential
     impairment of recorded  goodwill and other long-lived assets is measured by
     the undiscounted  value of expected future operating cash flows in relation
     to its net capital  investment.  Based on its review,  management  does not
     believe that an impairment of its goodwill or other  long-lived  assets has
     occurred.

     Deferred Charges

         Deferred  charges are primarily  comprised of debt issuance costs which
     are being amortized  using the effective  interest method over the terms of
     the related debt. Such costs are included in the accompanying  consolidated
     balance sheets, net of accumulated amortization.

     Other Intangible Assets

         Other  intangible  assets  include a covenant  not to compete and other
     intangible assets resulting from the acquisition of the fragrance  sampling
     business of Minnesota Mining and Manufacturing  Company ("3M") (see Note 3)
     in June 1998 and are being amortized over ten years using the straight-line
     method.  Accumulated  amortization  related to these intangible  assets was
     $729 at June 30, 1999.

     Fair Value of Financial Instruments

         SFAS No. 107, "Disclosures About Fair Values of Financial Instruments,"
     requires the  disclosure  of the fair value of financial  instruments,  for
     assets and liabilities  recognized and not recognized on the balance sheet,
     for which it is practicable  to estimate fair value.  The fair value of the
     Company's  Senior Notes,  as  determined  from quoted  market  prices,  was
     $112,000  at June 30, 1999  compared to a carrying  value of $115,000 as of
     the same date.  The carrying  value of the Senior Notes  approximated  fair
     value  at  June  30,  1998.  The  carrying  value  of all  other  financial
     instruments approximates fair value at June 30, 1998 and June 30, 1999.





                                      F-39
<PAGE>


                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

     Foreign Currency Transactions

         Gains and losses on foreign  currency  transactions  with third parties
     have been included in the  determination  of net income in accordance  with
     SFAS No. 52, "Foreign  Currency  Translation."  Foreign currency losses and
     (gains) amounted to $387, ($44),  ($52) and $91 for the year ended June 30,
     1997,  the period from July 1, 1997 through  December 15, 1997,  the period
     from  December  16, 1997  through June 30, 1998 and the year ended June 30,
     1999, respectively.

     Research and Development Expenses

         Research and development  expenditures are charged to selling,  general
     and   administrative   expenses  in  the  period  incurred.   Research  and
     development  expenses  totaled  $1,263,  $664, $717 and $1,136 for the year
     ended June 30,  1997,  the period from July 1, 1997  through  December  15,
     1997,  the period from December 16, 1997 through June 30, 1998 and the year
     ended June 30, 1999, respectively.

     Income Taxes

         Income taxes are  provided in  accordance  with  Statement of Financial
     Accounting  Standards No. 109,  "Accounting for Income Taxes." Accordingly,
     deferred tax assets and liabilities are recognized at the applicable income
     tax rates  based upon  future tax  consequences  of  temporary  differences
     between  the  tax  bases  and  financial  reporting  bases  of  assets  and
     liabilities  using  enacted  tax  rates in effect in the years in which the
     differences  are expected to reverse.  Deferred tax assets are reduced,  if
     necessary,  by the  amount of any tax  benefits  that,  based on  available
     evidence, are not expected to be realized.

     Use of Estimates

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

     Comprehensive Income (Loss)

         The Company adopted the provision of Statement of Financial  Accounting
     Standards  No.  130  ("SFAS  No.  130")  on July 1,  1998.  This  Statement
     establishes standards for reporting and displaying comprehensive income and
     its  components in the financial  statements.  This Statement also requires
     that comparative  information for earlier periods be  reclassified.  As the
     Company only has two items of comprehensive  income, net income and foreign
     currency  translations,  adoption of this statement did not have a material
     effect upon the Company's financial position or results of operations.




                                      F-40


<PAGE>


                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


3.   SIGNIFICANT ACQUISITIONS

         DLJMBII and certain  members of the Predecessor  organized  Acquisition
     Corp.  and Merger Corp. for purposes of acquiring the  Predecessor.  Merger
     Corp. was a wholly-owned  subsidiary of Acquisition Corp. and was initially
     capitalized by Acquisition  Corp.  with an equity  contribution of $78,363,
     comprised  of  $76,000  of cash  (see  Note  12)  and  $2,363  of  non-cash
     consideration  in the form of an option to purchase Senior  Preferred Stock
     of  Acquisition  Corp.  (see Note 16).  Immediately  following  this equity
     contribution,  Merger Corp. issued $123,500 of senior increasing rate notes
     (the "Bridge Loans") to an entity with an ownership interest in Acquisition
     Corp.  The Bridge Loans had a stated  maturity of December 15, 1998 and had
     an  interest  rate  equal to the  greater of (i) 10.0% per annum and (ii) a
     daily  floating  rate of prime  plus 2.25%  plus an  additional  percentage
     amount equal to (a) 1.0% from and  including  the interest  payment date on
     June 15, 1998 or (b) 1.5% from and including  the interest  payment date on
     September 15, 1998.  Merger Corp.  received cash proceeds from the issuance
     of the Bridge Loans of $119,735,  net of $3,765 of associated debt issuance
     costs.

         On December 15, 1997, Merger Corp. acquired all of the equity interests
     of the Predecessor (the  "Acquisition")  for a total cost of $197,730 which
     consisted of $138,634 cash paid for equity interests and direct acquisition
     costs,  $2,363  in  non-cash  consideration  in the  form of an  option  to
     purchase Senior Preferred Stock of Acquisition  Corp. (see Note 16) and the
     assumption  of $56,733 in debt,  preferred  stock and related  interest and
     dividends, including a capital lease obligation.  Included in the amount of
     direct  acquisition costs was  approximately  $2,022 paid to an entity that
     has an ownership  interest in Acquisition  Corp.  Merger Corp.  then merged
     with and into the Predecessor and the combined entity assumed the name AKI.
     Subsequent to the Acquisition, Acquisition Corp. contributed $1 of cash and
     all of its ownership  interest in AKI to Holding for all of the outstanding
     equity of Holding.  Since all companies are under common  control and since
     Holding and Acquisition  Corp. have no operations  other than those related
     to the Company,  the contribution was accounted for as if it were a pooling
     of interests.

         The  Acquisition  was  accounted  for  using  the  purchase  method  of
     accounting. In accordance with the consensus reached by the Emerging Issues
     Task Force of the  Financial  Accounting  Standards  Board in Issue  88-16,
     "Basis in Leveraged  Buyout  Transactions,"  the purchase price  allocation
     required  an  adjustment  for  the  continuing  interest   attributable  to
     management's   ownership  interest  in  the  Predecessor  carried  over  in
     connection with the Acquisition.  As a result, a reduction in stockholders'
     equity of $15,730 was recorded which represents the difference  between the
     fair value of the Company's assets and the related book value  attributable
     to  the  interest  of  the  continuing   shareholders'  investment  in  the
     Predecessor.  The remaining purchase price has been allocated to assets and
     liabilities  based  upon  estimates  of  their  respective  fair  value  as
     determined  by  management  and  third-party  appraisals  with  respect  to
     property, plant and equipment.

         In connection with the Acquisition,  the Company repaid the outstanding
     balance  and  related  interest  of the  Predecessor's  loans  payable to a
     shareholder of $37,374, the outstanding balance and related interest of the
     Predecessor's  line of credit of $6,278  and the  outstanding  balance  and
     related dividends on the Predecessor's preferred stock of $8,806.





                                      F-41

<PAGE>


                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


3.   SIGNIFICANT ACQUISITIONS (Continued)

     The  following  shows  the  acquisition  costs  and the  allocation  of the
purchase price:
<TABLE>
<CAPTION>

         <S>                                                                              <C>
         Acquisition costs
              Cash paid for stock.......................................................  $   134,403
              Direct acquisition costs..................................................        4,231
                                                                                          -----------
                                                                                              138,634
              Non-cash consideration for stock in the form of an
                option to purchase Senior Preferred Stock of
                Acquisition Corp. (see Note 16).........................................        2,363
                                                                                          -----------

              Total.....................................................................      140,997
              Less--Carryover basis adjustment...........................................     (15,730)
                                                                                          -----------

              Purchase price to be allocated............................................  $   125,267
                                                                                          ===========

         Summary allocation of purchase price
              Cash......................................................................  $     4,481
              Other current assets......................................................       17,782
              Property, plant and equipment.............................................       20,132
              Deferred income taxes.....................................................        2,953
              Other assets..............................................................          329
              Goodwill..................................................................      153,929
                                                                                          -----------

              Total allocation to assets................................................  $   199,606
                                                                                          ===========


              Current liabilities.......................................................  $    13,190
              Long-term debt (including current portion) and related interest...........       47,927
              Deferred income taxes.....................................................        4,416
              Preferred stock and related dividends.....................................        8,806
                                                                                          -----------

              Total liabilities assumed.................................................  $    74,339
                                                                                          ===========
</TABLE>


         Included in cash paid for stock of  $134,403 is $19,342  related to the
     purchase and retirement of 11,201 options of the Predecessor.  In addition,
     the non-cash  consideration for stock of $2,363 was incurred to acquire and
     retire the remaining 1,370 options of the Predecessor (see Note 16).

         On June 22,  1998,  the Company  acquired  (the "3M  Acquisition")  the
     fragrance  sampling  business  of  the  Industrial  and  Consumer  Products
     division  of 3M for  approximately  $7,250  in cash and the  assumption  of
     liabilities of  approximately  $182. The only tangible assets acquired were
     approximately  $143 of equipment.  The  acquisition was accounted for using
     the  purchase  method of  accounting  and  resulted in  assigning  value to
     certain  intangible assets,  including a covenant not to compete,  totaling
     approximately  $7,289 which are being  amortized  on a straight  line basis
     over a period of 10 years.





                                      F-42

<PAGE>



                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)



3.   SIGNIFICANT ACQUISITIONS (Continued)

         Unaudited pro forma results for the Company  assuming the  Acquisition,
     the 3M Acquisition  and the Refinancing had occurred as of the beginning of
     each applicable fiscal year are presented below:

                                       Unaudited Pro Forma Results
                                            for the Year Ended

                                          June 30,        June 30,
                                            1997           1998
                                            ----           ----

         Net sales.....................  $  87,771       $ 81,831
         Income from operations........      9,565          5,838
         Interest expense, net.........     12,961         13,049
         Net loss......................     (3,665)        (6,091)

         On June 25, 1998, the Bridge Loans were repaid,  without penalty,  with
     the  proceeds  from the Senior  Note  offering  (see Note 9) and the equity
     contribution from Holding (see Note 12) (collectively,  the "Refinancing").
     Contemporaneous  with  the  repayment  of the  Bridge  Loans,  the  Company
     wrote-off the  unamortized  balance of debt issuance costs  associated with
     the Bridge Loans of $1,795 to interest expense.

4.       ACCOUNTS RECEIVABLE

     The following table details the components of accounts receivable:

                                                 June 30,        June 30,
                                                   1998             1999
                                                   ----             ----

         Trade accounts receivable...........  $  13,782       $ 16,349
         Allowance for doubtful accounts.....       (277)          (251)
                                               ---------       --------
                                                  13,505         16,098
         Other accounts receivable...........         45            189
                                               ---------       --------

                                               $  13,550       $ 16,287
                                               =========       ========












                                      F-43

<PAGE>



                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)

5.   INVENTORY

     The following table details the components of inventory:

                                                      June 30,       June 30,
                                                        1998           1999
                                                        ----           ----
         Raw materials
           Paper.................................    $     556       $  1,088
           Other raw materials...................        1,024          2,328
                                                     ---------       --------
              Total raw materials................        1,580          3,416
         Work in process.........................          498          1,693
                                                     ---------       --------

         Total inventory.........................    $   2,078       $  5,109
                                                     =========       ========


         The difference  between the carrying value of paper inventory using the
     FIFO method as compared to the LIFO method was not  significant at June 30,
     1998 or June 30, 1999.

6.       PROPERTY, PLANT AND EQUIPMENT

         The  following  table  details the  components  of property,  plant and
     equipment as well as their estimated useful lives:

                                            Estimated      June 30,   June 30,
                                          Useful Lives       1998       1999
                                          ------------       ----       ----

         Land............................                $     256    $    258
         Buildings....................... 7 - 15 years       1,048       1,648
         Leasehold improvements.......... 1 -  3 years         153         579
         Machinery and equipment......... 5 -  7 years      17,146      19,483
         Furniture and fixtures.......... 3 -  5 years       1,634       2,084
         Construction in progress........                      552         193
                                                         ---------    --------
                                                            20,789      24,245
         Accumulated depreciation........                   (1,853)     (5,734)
                                                         ---------    --------
                                                         $  18,936  $   18,511
                                                         =========  ==========

         Depreciation expense amounted to $3,850,  $1,888, $1,853 and $3,881 for
     the year ended June 30, 1997, the period from July 1, 1997 through December
     15, 1997,  the period from  December 16, 1997 through June 30, 1998 and the
     year ended June 30, 1999, respectively.






                                      F-44
<PAGE>



                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)

6.   PROPERTY, PLANT AND EQUIPMENT (Continued)

         Property  held  under  capital  lease  is  included  in the  respective
     property, plant and equipment category as follows:

                                                      June 30,       June 30,
                                                        1998           1999
                                                        ----           ----

         Machinery and equipment..................   $   3,000       $  3,000
         Building.................................           -            600
                                                     ---------       --------
                                                         3,000          3,600
         Less accumulated depreciation............        (275)          (790)
                                                     ---------       --------
                                                     $   2,725       $  2,810
                                                     =========       ========

         Depreciation of the assets under capital lease totaled $633, $232, $275
     and $515 for the year ended  June 30,  1997,  the period  from July 1, 1997
     through  December 15, 1997,  the period from December 16, 1997 through June
     30, 1998 and the year ended June 30,  1999,  respectively.  Future  minimum
     lease payments under the remaining leases are as follows:

                                                     Payment       Interest

                2000............................   $     884       $    197
                2001............................         948            100
                2002............................         529             27
                                                   ---------       --------

                                                   $   2,361       $    324
                                                   =========       ========

7.       LINE OF CREDIT

         On April  30,  1996,  the  Predecessor  entered  into a line of  credit
     agreement (the "Credit Agreement"), which was amended on December 12, 1997,
     in  connection  with the  Acquisition,  and amended  again on September 30,
     1998. The Credit Agreement provides for a revolving loan commitment up to a
     maximum of $20,000 and expires on December 31, 2002. Borrowings are limited
     to a borrowing  base  consisting  of  accounts  receivable,  inventory  and
     property, plant and equipment which serve as collateral for the borrowings.
     As of June  30,  1999,  the  Company's  borrowing  base  was  approximately
     $17,500.  Interest on amounts borrowed accrue at a floating rate based upon
     either  prime or LIBOR (9.25% and 8.50% at June 30, 1998 and June 30, 1999,
     respectively).  The  weighted  average  interest  rate  on the  outstanding
     balance under the Credit  Agreement was 9.31%,  9.50%,  9.25% and 8.51% for
     the year ended June 30, 1997, the period from July 1, 1997 through December
     15, 1997,  the period from  December 16, 1997 through June 30, 1998 and the
     year ended June 30, 1999, respectively.







                                      F-45
<PAGE>



                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)

7.   LINE OF CREDIT (Continued)

         The Company is required to pay commitment fees on the unused portion of
     the revolving loan commitment at a rate of approximately 0.5% per annum. In
     addition,  the Company is required to pay fees equal to 2.5% of the average
     daily  outstanding  amount of lender  guarantees.  The  Company had $600 of
     lender  guarantees  outstanding  at June 30, 1998 and June 30, 1999.  These
     fees totaled $109,  $30, $59 and $111 for the year ended June 30, 1997, the
     period  from July 1, 1997  through  December  15,  1997,  the  period  from
     December  16, 1997  through June 30, 1998 and the year ended June 30, 1999,
     respectively. The Credit Agreement contains certain financial covenants and
     other restrictions  including  restrictions on additional  indebtedness and
     restrictions on the payment of dividends.

         As of June  30,  1999,  the  Company  was in  compliance  with all debt
     covenants.  However, the Company expects to be in violation of certain loan
     covenants  in Fiscal  2000.  Management  expects to obtain loan  amendments
     and/or waivers in Fiscal 2000 with respect to such covenants. If management
     is unable to obtain loan  amendments  and/or  waivers in Fiscal  2000,  the
     Company may need to seek additional sources of financing.

8.   LOANS PAYABLE TO STOCKHOLDER

         The   Predecessor   entered  into  a  Senior  Loan  Agreement  and  two
     Subordinated Loan Agreements  (collectively,  the "Loan Agreements") with a
     party that had owned the  Predecessor's  preferred  stock and a significant
     portion of its common stock.  The Loan  Agreements were  collateralized  by
     substantially  all the  assets  of the  Predecessor.  The  Loan  Agreements
     limited the  Predecessor's  ability to incur additional  indebtedness,  pay
     dividends and purchase  fixed  assets.  Additionally,  the Loan  Agreements
     required that certain  financial  covenants be maintained.  The Predecessor
     was not in compliance  with all such  covenants at June 30, 1997.  However,
     this debt was subsequently  retired upon the acquisition of the Predecessor
     as  discussed  in Note 3.  All  amounts  borrowed  under  the  Senior  Loan
     Agreement bore interest at prime plus 1.50%.

         The  Predecessor   borrowed   $30,000  under  the   Subordinated   Loan
     Agreements,  of which  $23,000  was  designated  as Loan I and  $7,000  was
     designated  as Loan II. Loan I bore  interest,  payable  quarterly,  at 12%
     until  November 4, 1998,  and then would have  converted  to prime plus 4%.
     Loan II bore interest,  payable quarterly, at 7%. The outstanding amount of
     the subordinated  loans was net of unamortized  debt discounts,  which were
     being amortized over the term of the related loan.

         In  connection  with  Loan II,  the  Predecessor  issued a  warrant  to
     purchase 19,233 shares of common stock at $0.05 per share.  The warrant was
     exercisable until November 4, 2003. The Predecessor  valued the warrants at
     $100  each  based on the  fair  market  value of a share of the  underlying
     common stock  resulting from a sale with a third party.  In connection with
     the warrant issued, the Predecessor  recorded a debt discount of $1,923. In
     connection  with the sale of the Predecessor on December 15, 1997 (see Note
     3), all outstanding warrants were purchased from the holder by the buyer of
     the Predecessor and retired.








                                      F-46

<PAGE>


                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


9.   SENIOR NOTES

         On June 25, 1998, the Company completed a private placement of $115,000
     of Senior  Notes  (the  "Senior  Notes").  The  Senior  Notes  are  general
     unsecured  obligations of the Company and bear interest at 10.5% per annum,
     payable  semi-annually  on January 1 and July 1. The Senior Notes mature on
     July 1, 2008 and may be redeemed at the option of the Company,  in whole or
     in part,  at any time on or after July 1, 2003 at a price  equal to 105.25%
     of the outstanding principal balance plus accrued and unpaid interest.  The
     placement of the Senior Notes  yielded the Company net proceeds of $110,158
     after  deducting   offering   expenses  of  $4,842,   including  $3,450  of
     underwriting fees paid to an affiliate of the stockholder. The Senior Notes
     are redeemable at the option of the Company,  in whole or part, at any time
     after July 1, 2003 at a price of up to 105.25% of the outstanding principal
     balance  plus  accrued  and unpaid  interest.  Prior to July 1,  2003,  the
     Company is  permitted  to  repurchase  up to 35% of the  Senior  Notes at a
     redemption  price of up to 110.5% of the  aggregate  principal  amount plus
     accrued  and unpaid  interest  with the net  proceeds of one or more public
     equity  offerings.  The Senior Notes contain  certain  customary  covenants
     including  restrictions  on the declaration and payment of dividends by the
     Company  to  Holding  and  limitations  on  the  incurrence  of  additional
     indebtedness.  On December 22, 1998, the Company completed the registration
     of its Senior Notes with the Securities and Exchange Commission.

10.  OTHER NOTES PAYABLE

         On June  9,  1995,  the  Predecessor  acquired  all of the  issued  and
     outstanding  stock of Scent Seal Inc.  ("Scent  Seal").  The acquisition of
     Scent  Seal did not have a material  impact on the  financial  position  or
     results  of  operations  of the  Predecessor  and  was  accounted  for as a
     purchase  transaction  whereby the purchase  cost was allocated to the fair
     value of the net assets  acquired.  In connection  with the  acquisition of
     Scent Seal, the Predecessor issued $3,627 in noninterest bearing promissory
     notes (the "Notes") to an employee of the  Predecessor who was previously a
     Scent Seal stockholder. The Predecessor recorded a debt discount of $649 in
     connection with the issuance of the Notes to reflect an effective  interest
     rate of 10%. The discount was being amortized over the term of the Notes.

         Under certain provisions of the Scent Seal acquisition  agreement,  the
     Company was permitted to reduce the  outstanding  principal  balance of the
     Notes based upon the ultimate realization of assets acquired and settlement
     of liabilities assumed. In June 1998, the Company reached a settlement with
     the  holder of the Notes  under  these  provisions  which  resulted  in the
     reduction of the  outstanding  principal  balance of the Notes of $120. The
     remaining  principal balance of the Notes of $1,330 was repaid in July 1998
     in accordance with the terms of the Notes.
















                                      F-47

<PAGE>


                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


11.  REDEEMABLE PREFERRED STOCK OF PREDECESSOR

         In connection  with the 1993  acquisition  of Arcade,  the  Predecessor
     authorized  and  issued  8,000  shares  of  7%  cumulative,  $1  par  value
     redeemable  preferred stock at $1,000 per share.  The redeemable  preferred
     stock prohibited the Predecessor from acquiring its common stock as long as
     the preferred  stock was  outstanding  and restricted the payment of common
     stock  dividends.  Accrued and unpaid  dividends  of $678  accrued  through
     December 31, 1994,  were added to the outstanding  balance.  The redeemable
     preferred  stock  would have been  redeemable  on  December  31,  2001,  at
     liquidation value of $1,000 per share plus accrued and unpaid dividends. In
     conjunction with the sale of Predecessor on December 15, 1997 (see Note 3),
     all outstanding redeemable preferred stock was redeemed at $1,000 per share
     plus accrued and unpaid dividends.

12.  INITIAL CAPITALIZATION

         In conjunction with the Acquisition,  Acquisition  Corp. issued $30,000
     of Floating Rate Notes, $50,279 of Manditorily  Redeemable Senior Preferred
     Stock (the "Senior  Preferred  Stock") and $1,111 of its Common Stock.  The
     Floating  Rate Notes were  issued  with an  original  issuance  discount of
     $5,389  and bear  interest  at a rate  equal to the rate in  effect  on the
     Bridge  Loans  (see  Note  3)  plus  2.50%.  After  the  completion  of the
     Refinancing  (see Note 3) on June 25, 1998,  the  Floating  Rate Notes bear
     interest at 15% per annum. Interest is payable quarterly and can be settled
     through the issuance of additional  Floating Rate Notes through maturity at
     the  discretion of  Acquisition  Corp.  The original  issuance  discount of
     $5,389 is being amortized using the effective interest method over the life
     of the Floating Rate Notes.  The unamortized  balance of the original issue
     discount  was  $5,152  and  $4,740  at June 30,  1998  and  June 30,  1999,
     respectively.  The Floating  Rate Notes mature on December 15, 2009 and are
     held by affiliates of the primary  shareholder  of  Acquisition  Corp.  The
     Senior  Preferred  Stock  accretes  in value at 15% per  annum  and must be
     redeemed by December 15, 2012. The Floating Rate Notes and Senior Preferred
     Stock are general unsecured obligations of Acquisition Corp.

         The cash proceeds from the issuance of the Floating Rate Notes,  Senior
     Preferred  Stock and Common  Stock of  approximately  $76,000  and a Senior
     Preferred  Stock  option  of  $2,363  (see  Note  16) were  contributed  by
     Acquisition  Corp.  to the  Company  in  exchange  for 1,000  shares of the
     Company's  Common Stock.  Subsequent to the initial  capitalization  of the
     Company, Acquisition Corp. contributed $1 and all of its ownership interest
     in the Company to Holding for all of the outstanding equity of Holding.












                                      F-48

<PAGE>


                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


12.  INITIAL CAPITALIZATION (Continued)

         On June 25,  1998,  Holding  completed  a private  offering  of $50,000
     Senior Discount Debentures (the "Debentures"). The Debentures do not accrue
     or pay  interest  until  July 1,  2003 and  were  issued  with an  original
     issuance  discount  of $24,038.  The  original  issuance  discount is being
     accreted from issuance  through July 1, 2003 at an effective  rate of 13.5%
     per annum. The unamortized  balance of the original  issuance  discount was
     $23,980 and $20,349 at June 30, 1998 and June 30, 1999, respectively. After
     July 1, 2003,  the Debentures  will accrue  interest at a rate of 13.5% per
     annum,  payable  semi-annually,  commencing January 1, 2004. The Debentures
     are  redeemable at the option of Holding,  in whole or in part, at any time
     on or after  July 1, 2003 at a price of up to  106.75%  of the  outstanding
     principal balance plus accrued and unpaid interest.  Prior to July 1, 2003,
     Holding is permitted to  repurchase  up to 35% of the  aggregate  principal
     amount at  maturity of the  Debentures  originally  issued at a  redemption
     price equal to 113.5% of the accreted value of the Debentures  with the net
     proceeds of one or more public equity offerings. The Debentures are general
     unsecured  obligations  of  Holding.  With the  proceeds  of the  Debenture
     offering, Holding contributed $22,499 of cash to the Company. No additional
     shares were issued to Holding as a result of this contribution. On December
     22,  1998,  Holding  completed  the  registration  of its  Senior  Discount
     Debentures with the Securities and Exchange Commission.

         Acquisition  Corp. and Holding have no other  operations other than the
     Company.  Absent additional  financing by Acquisition Corp. or Holding, the
     Company's  operations  represent the only current source of funds available
     to service the Floating Rate Notes,  Senior Preferred Stock and Debentures;
     however,  the Company is not  obligated to pay or otherwise  guarantee  the
     Floating Rate Notes, Senior Preferred Stock and Debentures.

13.  COMMITMENTS AND CONTINGENCIES

     Operating Leases

         Equipment and office,  warehouse and production  space under  operating
     leases expire at various dates.  Rent expense was $443, $192, $198 and $338
     for the year ended June 30,  1997,  the  period  from July 1, 1997  through
     December 15, 1997,  the period from December 16, 1997 through June 30, 1998
     and the year  ended  June 30,  1999,  respectively.  Future  minimum  lease
     payments under these leases are as follows:

                                         2000..............  $    162
                                         2001..............       138
                                                             --------

                                                             $    300
                                                             ========










                                      F-49
<PAGE>


                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


13.  COMMITMENTS AND CONTINGENCIES (Continued)

     Royalty Agreements

         Royalty agreements are maintained for certain  technologies used in the
     manufacture of certain products.  Under the terms of one royalty agreement,
     payments are required  based on a percentage of net sales of those products
     manufactured with the specific  technology,  or a minimum of $500 per year.
     This  agreement  expires in 2003 or when a total of  $12,500 in  cumulative
     royalty  payments has been paid. The Company  expensed $761, $437, $516 and
     $500 under this agreement for the year ended June 30, 1997, the period from
     July 1, 1997 through  December 15, 1997,  the period from December 16, 1997
     through June 30, 1998 and the year ended June 30, 1999,  respectively.  The
     Company has paid $4,576 in cumulative royalty payments under this agreement
     through June 30, 1999.

         Under the terms of another  agreement,  royalty  payments  are required
     based on the  number  of  products  sold that  were  manufactured  with the
     specific licensed technology,  or a minimum payment per year. These minimum
     payments  for  years  after  fiscal  1999 are $625  per  year  through  the
     expiration of the agreement in 2012. The Company  expensed $475, $241, $284
     and $575 under this  agreement for the year ended June 30, 1997, the period
     from July 1, 1997 through  December 15, 1997,  the period from December 16,
     1997 through June 30, 1998 and the year ended June 30, 1999, respectively.

     Employment Agreements

         The Company has employment  agreements with certain officers with terms
     through  February  1,  2002.  Such  agreements  provide  for base  salaries
     totaling $825 per year. One officer has an incentive bonus of up to 200% of
     base salary which is payable if certain  financial and management goals are
     attained  and  certain  other  incentive  payments.  One of the  employment
     agreements  also  provides  severance  benefits  of up to two years of base
     salary if the officer's services are terminated under certain conditions.

         During fiscal 1999,  two executive  officers  employment was terminated
     with the  Company.  In  accordance  with  the  terms  of  former  officers'
     employment agreements,  the Company was obligated for severance benefits of
     approximately  $610.  The  Company  had  paid  approximately  $457 of these
     benefits by June 30,  1999.  The  remaining  balance of $153 is included in
     accrued compensation at June 30, 1999.

     Litigation

         The Company is a party to litigation  arising in the ordinary course of
     business  which,  in the  opinion of  management,  will not have a material
     adverse effect on the Company's financial condition,  results of operations
     or cash flows.






                                      F-50

<PAGE>


                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


14.  RETIREMENT PLANS

         A 401(k)  defined  contribution  plan (the  "Plan") is  maintained  for
     substantially all full-time salaried  employees.  Applicable  employees who
     have six  months  of  service  and have  attained  age 21 are  eligible  to
     participate in the Plan.  Employees may elect to contribute a percentage of
     their  earnings to the Plan in  accordance  with limits  prescribed by law.
     Contributions  to the Plan  are  determined  annually  by the  Company  and
     generally  are a  matching  percentage  of  employee  contributions.  Costs
     associated  with the Plan  totaled  $180,  $95,  $113 and $201 for the year
     ended June 30,  1997,  the period from July 1, 1997  through  December  15,
     1997,  the period from December 16, 1997 through June 30, 1998 and the year
     ended June 30, 1999, respectively.

         Certain  hourly  employees  are covered under a  multiemployer  defined
     benefit plan administered under a collective  bargaining  agreement.  Costs
     (determined by union  contract)  under the defined  benefit plan were $143,
     $80, $81 and $204 for the year ended June 30, 1997, the period from July 1,
     1997 through  December 15,  1997,  from  December 16, 1997 through June 30,
     1998 and the year ended June 30, 1999, respectively.

15.  INCOME TAXES

         The Company is included in the  consolidated  federal income tax return
     filed by  Acquisition  Corp.  for periods  subsequent to December 15, 1997.
     Income taxes  related to the Company for the period from  December 16, 1997
     through  June 30, 1999 were  determined  on a separate  entity  basis.  The
     Company files  separate  state income tax returns and  calculates its state
     tax  provision on a separate  company  basis.  Any income taxes  payable or
     receivable  by the  consolidated  group  are  settled  or  received  by the
     Company. The Predecessor was not part of a consolidated group.

         For  financial  reporting  purposes,  income (loss) before income taxes
includes the following components:

<TABLE>
<CAPTION>

                                                                July 1,       December 16,
                                                                 1997             1997
                                               Year Ended       through          through      Year Ended
                                                June 30,     December 15,       June 30,       June 30,
                                                  1997           1997             1998           1999
                                                  ----           ----             ----           ----
         <S>                                    <C>          <C>              <C>              <C>
         Income (loss) before income taxes:
             United States.................     $  7,609       $  3,298       $   (8,169)      $  (2,266)
             Foreign.......................         (492)           (64)             682             522
                                                ---------      ---------      ----------       ---------

                                                $  7,117       $  3,234       $   (7,487)      $  (1,744)
                                                ========       ========        =========       =========

</TABLE>




                                      F-51


<PAGE>


                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)



15.  INCOME TAXES (Continued)

         Significant  components of the provision (benefit) for income taxes are
as follows:
<TABLE>
<CAPTION>

                                                                July 1,       December 16,
                                                                 1997             1997
                                               Year Ended       through          through      Year Ended
                                                June 30,     December 15,       June 30,       June 30,
                                                  1997           1997             1998           1999
                                                  ----           ----             ----           ----
         <S>                                    <C>          <C>                <C>           <C>
         Current expense (benefit):
             Federal.......................     $  2,880       $    1,623     $        -       $       -
             Foreign.......................            -                -            104             204
             State.........................          552              278           (121)              -
                                                --------       ----------     ----------       ---------
                                                   3,432            1,901            (17)            204
                                                --------       ----------     ----------       ---------


         Deferred expense (benefit):
             Federal.......................          (90)           (376)         (1,900)            569
             Foreign.......................         (165)            (25)            162               -
             State.........................          (42)            (59)           (278)             74
                                                --------       ---------      ----------       ---------
                                                    (297)           (460)         (2,016)            643
                                                --------       ---------      ----------       ---------

                                                $  3,135       $    1,441     $   (2,033)      $     847
                                                ========       ==========     ==========       =========

</TABLE>



         The  significant  components  of deferred  tax assets and  deferred tax
     liability at June 30, 1998 and 1999, were as follows:
<TABLE>
<CAPTION>

                                                          June 30, 1998                      June 30, 1999
                                                    ------------------------           ------------------------
                                                    Current       Noncurrent           Current       Noncurrent
                                                    ------------------------           ------------------------
         <S>                                       <C>           <C>                  <C>            <C>
         Deferred income tax assets:
             Accrued expenses...................   $     719      $       -           $     308      $       -
             Allowance for doubtful accounts....         108              -                  92              -
             Net operating loss carryforwards...           -          2,947                   -          3,132
             Preferred stock option.............           -            922                   -              -
                                                   ---------      ---------           ---------      ---------
                                                         827          3,869                 400          3,132
         Deferred income tax liability:
             Property, plant and equipment......           -          4,143                   -          3,340
                                                   ---------      ---------           ---------      ---------

                                                   $     827      $    (274)          $     400      $    (208)
                                                   =========      =========           =========      =========


</TABLE>







                                      F-52

<PAGE>



                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


15.  INCOME TAXES (Continued)

         The income tax  provision  recognized by the  Predecessor  for the year
     ended June 30, 1997, the period from July 1, 1997 through December 15, 1997
     and by the Company for the period from  December  16, 1997 through June 30,
     1998 and the year ended June 30, 1999,  differs from the amount  determined
     by applying the applicable U.S. statutory federal income tax rate to pretax
     income as a result of the following:

<TABLE>
<CAPTION>
                                                                    July 1,         December 16,
                                                                     1997               1997
                                                  Year Ended        through            through       Year Ended
                                                   June 30,      December 15,         June 30,        June 30,
                                                     1997            1997               1998            1999
                                                     ----            ----               ----            ----
         <S>                                       <C>            <C>               <C>               <C>
         Computed tax provision (benefit)
           at statutory rate....................   $   2,420      $   1,100         $ (2,546)         $   (593)
         State income tax provision (benefit),..
           net of federal effect................         335            145             (263)              (49)
         Nondeductible expenses.................         455            193              720             1,477
         Other, net.............................         (75)             3               56                12
                                                   ---------      ---------        ---------         ---------

                                                   $   3,135      $   1,441        $  (2,033)        $     847
                                                   =========      =========        ==========        =========


</TABLE>

         In conjunction with the Acquisition,  the Company  recognized an income
     tax benefit of $7,327  related to the excess of the  redemption  price over
     the  strike  price of  certain  non-qualified  options  of the  Predecessor
     redeemed  and  retired by the  Company.  This  benefit  was  recorded  as a
     reduction to goodwill.

         Due to the Company's current year losses and certain  transactions made
     in conjunction with the  Acquisition,  the Company has recorded a long-term
     deferred  tax asset of $3,132  reflecting  cumulative  net  operating  loss
     carryforwards   available  to  offset  future  federal  taxable  income  of
     approximately  $6,900  and future  state  taxable  income of  approximately
     $15,600 at June 30, 1999. These cumulative net operating loss carryforwards
     expire in  varying  amounts  through  2019.  Realization  is  dependent  on
     generating  sufficient  taxable  income  prior  to  expiration  of the loss
     carryforwards.  Although  realization is not assured,  management  believes
     that it is more likely than not that all of the  deferred tax asset will be
     realized.  The  amount of the  deferred  tax asset  considered  realizable,
     however,  could be reduced in the near term if estimates of future  taxable
     income during the carryforward period are reduced.



















                                      F-53

<PAGE>




                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)

16.  STOCK OPTIONS

         The Predecessor  sponsored a key employee stock option plan under which
     a maximum  of 12,571  shares of the  Predecessor's  common  stock  could be
     reserved for nonqualified  options;  all stock options were granted with an
     exercise  price  equal to the fair  market  value  of $100 per  share.  All
     options  vested  ratably  over five years and would have  expired ten years
     from the grant date.

         The  Predecessor   accounted  for  its  employee  stock  options  under
     Accounting  Principles Board Opinion No. 25, Accounting for Stock Issued to
     Employees  ("APB  25").  Under APB 25,  because the  exercise  price of the
     Predecessor's  employee  stock  options  equaled  the  market  value of the
     underlying  stock  on the  date  of  grant,  no  compensation  expense  was
     recognized.

         A summary  of the  Predecessor's  stock  option  activity  and  related
information follows:

                                                       June 30, 1997
                                                              Weighted
                                                               Average
                                                              Exercise
                                                    Options     Price

         Outstanding, beginning of year.........    12,571    $   100
              Granted...........................         -          -
              Exercised.........................         -          -
              Forfeited.........................         -          -
                                                  --------    -------

         Outstanding, end of year...............    12,571    $   100
                                                  ========    =======

         Exercisable, end of year...............     5,866    $   100
                                                  ========    =======

         Weighted average remaining
              contractual life..................         7.3 years

         Statement of Financial  Accounting  Standards No. 123,  Accounting  for
     Stock-Based  Compensation  ("SFAS 123"),  requires  disclosure of pro forma
     information  regarding net income for option grants  subsequent to December
     15, 1995.  Because all of the  Predecessor's  options were granted prior to
     that  date,  no pro  forma  adjustments  to net  income  or  disclosure  of
     information would apply under SFAS 123.

          As a result of the sale of the  Predecessor  on December 15, 1997 (see
     Note 3), all outstanding  options became immediately vested and exercisable
     under the terms of the  original  individual  stock option  agreements.  In
     connection with the Acquisition,  the Company  purchased and retired 11,201
     options of the Predecessor for $19,342.  The remaining 1,370 options of the
     Predecessor  held by an officer,  which had a cumulative  exercise price of
     $137, were exchanged at fair value for an option to purchase 100,000 shares
     of Acquisition  Corp.'s  Senior  Preferred  Stock with a cumulative  stated
     value of $2,500 (the  "Preferred  Stock  Option").  The 1,370  options were
     subsequently  retired.  The Preferred Stock Option had an exercise price of
     $137.  The total  consideration  of $21,705 used to purchase and retire the
     outstanding  options of the  Predecessor  was  included  in the cost of the
     Acquisition (see Note 3).











                                      F-54


<PAGE>




                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)

16.  STOCK OPTIONS (Continued)

         The  Preferred  Stock Option was issued with a Put and Call Option (the
     "Put and Call  Option")  which  granted  the  officer  the  right to compel
     DLJMBII to purchase the 100,000 shares of Senior Preferred Stock obtainable
     under the  Preferred  Stock  Option,  together  with certain  common equity
     interests in Acquisition Corp. held by the officer, for $2,590. The Put and
     Call  Option  also  granted  DLJMBII  the  right  to  purchase  the  equity
     interests,  both common and preferred,  of the officer for the same amount.
     The Put and Call  Option had a stated  termination  on June 30,  1998.  The
     officer  agreed to  terminate  the Put and Call Option and enter into a new
     put option (the "Put Option")  dated June 17, 1998.  The Put Option granted
     the officer an irrevocable option to require  Acquisition Corp. to purchase
     80,000 shares of the Senior  Preferred Stock obtainable under the Preferred
     Stock  Option  for  $2,000  in cash.  As the terms of the Put  Option  were
     generally more  restrictive  than the Put and Call Option,  no compensation
     expense was  recognized as a result of the  transaction.  On July 30, 1998,
     the officer exercised the Preferred Stock Option and Put Option. To provide
     Acquisition Corp. the funds to redeem the 80,000 shares of Senior Preferred
     Stock,  Holding  issued  Acquisition  Corp. a dividend of $1,863 in cash on
     such date.

         Subsequent to the Acquisition, Acquisition Corp. adopted the 1998 Stock
     Option Plan  ("Option  Plan") for certain key  employees  and  directors of
     Acquisition  Corp.  and any parent or subsidiary of  Acquisition  Corp. The
     Option  Plan  authorizes  the  issuance of options to acquire up to 100,000
     shares of  Acquisition  Corp.  Common Stock.  The terms of each  individual
     options grant are determined by the Board of Directors.  The exercise price
     for each  grant is  required  to be set at least  equal to the fair  market
     value per share of Acquisition Corp. provided that the exercise price shall
     not be less than $1.00 per share.  Options may be exercisable for up to ten
     years.

         On June 17, 1998,  Acquisition Corp.  granted an officer of the Company
     options to purchase 32,500 shares of Acquisition  Corp.  Common Stock.  All
     options  had an  exercise  price of $1.00 per share and a term of 10 years.
     These  options  were  forfeited  during  1999 upon the  resignation  of the
     officer.

         The Company  has  elected to account  for its stock based  compensation
     with  employees  under the intrinsic  value method as permitted  under SFAS
     123.  Under the  intrinsic  value  method,  because  the stock price of the
     Company's  employee stock options  equaled the fair value of the underlying
     stock on the date of grant, no compensation expense was recognized.  If the
     Company had elected to  recognize  compensation  expense  based on the fair
     value of the options at grant date as  prescribed by SFAS 123, the net loss
     for the period from  December  16, 1997  through June 30, 1998 and the year
     ended June 30, 1999 would have been $(5,455) and $(2,593), respectively. In
     making this  determination,  fair value was  estimated on the date of grant
     using the minimum value method and a risk-free  interest rate of 5.4%.  The
     weighted average fair value at date of grant of options granted during 1998
     was approximately $0.41 per option.










                                      F-55


<PAGE>




                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)



17.  RELATED PARTY TRANSACTIONS

         The Predecessor made payments to a company  controlled by a stockholder
     of the  Predecessor  of $612 for the year ended June 30,  1997 and $160 for
     the period from July 1, 1997  through  December 15,  1997,  for  management
     fees, bonuses and expense reimbursements.


         The  Predecessor  made payments to another  stockholder of $120 for the
     year ended June 30, 1997 and $55 for the period  from July 1, 1997  through
     December 15, 1997, for management fees.

         The Successor made payments to an affiliate of DLJMBII of $125 and $250
     for the period from  December  16, 1997  through June 30, 1998 and the year
     ended  June  30,  1999,  respectively,  for  financial  advisory  fees.  In
     addition,  the Successor had  approximately  $200 of cash on deposit with a
     financial institution affiliated with DLJMBII as of June 30, 1998.

18.  SUBSEQUENT EVENT

          On  September  15, 1999,  AKI acquired all of the equity  interests in
     RetCom Holdings Ltd. and its subsidiaries for a total cost of approximately
     $12,000 and refinanced working capital indebtedness of approximately $4,500
     of RetCom  Holdings  Ltd.  and its  subsidiaries.  The  purchase  price and
     refinancing of indebtedness were initially financed by borrowings under the
     credit agreement.

19.  GEOGRAPHIC INFORMATION

         The following table illustrates geographic information for revenues and
     long-lived  assets.  Revenues  are  attributed  to  countries  based on the
     receipt of sales orders,  and long-lived  assets are based upon the country
     of domicile.
                                        United
                                        States           France         Total

                                                       Predecessor
                                                       -----------

     Net sales:

     Year ended June 30, 1997......  $    70,660    $     7,063    $    77,723
     Period from July 1, 1997
       through December 15, 1997...       32,600          2,586         35,186

      ________________________________________________________________________

                                                       Successor
                                                       ---------
     Net sales:

     Period from December 16, 1997
       through June 30, 1998.......  $    29,162    $     6,904    $    36,066
     Year ended June 30, 1999......       71,056         14,911         85,967

     Long-lived assets:

     June 30, 1998.................      187,250            158        187,408
     June 30, 1999.................      181,451            107        181,558





                                      F-56


<PAGE>



                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (dollars in thousands, except share information)


20.  UNAUDITED QUARTERLY RESULTS OF OPERATIONS

     The following is a summary of the unaudited quarterly results of operations
for Fiscal 1998 and Fiscal 1999.

<TABLE>
<CAPTION>


                                       Predecessor                                    Successor
                                            October 1,    December 16,
                                               1997           1997
                           Quarter Ended      through        through      Quarter Ended  Quarter Ended
                           September 30,   December 15,   December 31,      March 31,      June 30,         Full
     Fiscal 1998               1997            1997           1997             1998          1998           Year
                               ----            ----           ----             ----          ----           ----

     <S>                     <C>            <C>           <C>             <C>             <C>             <C>
     Net sales.............  $  21,928      $  13,258     $     2,791     $   19,191      $  14,084       $  71,252
     Gross profit..........      8,306          4,071             813          7,256          3,479          23,925
     Income from operations      4,680          1,426             153          3,603            104           9,966
     Interest expense, net.      1,451          1,195             759          4,404          6,106          13,915
     Net income (loss).....      1,796             (3)           (443)          (887)        (4,124)         (3,661)







                                                                      Successor
                                  Quarter Ended     Quarter Ended    Quarter Ended     Quarter Ended
                                  September 30,     December 31,       March 31,         June 30,           Full
     Fiscal 1999                      1998              1998             1999              1999             Year
                                      ----              ----             ----              ----             ----

     <S>                            <C>              <C>               <C>              <C>               <C>
     Net sales.............         $ 24,024         $  20,437         $  24,518        $  16,988         $  85,967
     Gross profit..........            8,603             6,777             9,691            5,697            30,768
     Income from operations            4,337             2,331             4,616              378            11,662
     Interest expense, net.            3,210             3,244             3,298            3,276            13,028
     Net income (loss).....              273              (970)              281           (2,175)           (2,591)


</TABLE>