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, 2000

                                       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, 2000,  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.



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     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"). The term "Holding" refers solely to AKI Holding Corp.

                                     PART I

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

ITEM 1.  BUSINESS

General

     Our company is a leading global marketer and manufacturer of multi-sensory,
interactive  advertising  utilizing  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  advertising  media  which is  designed to reach the
consumer  at home  or  in-store,  such as  magazine  inserts,  catalog  inserts,
remittance envelopes, statement enclosures, blow-ins and point-of-sale displays.

     Our  company  is a  fully  integrated  multi-sensory  advertising  company,
conducting its business  under the Arcade  Marketing Inc. name and is positioned
to  provide  complete,   interactive  advertising  programs  to  our  customers,
including creative content and product sample systems 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 sampling system advertising.

     In recent years,  our company has expanded our sampling  system business by
developing new  technologies  specifically  for the skincare,  makeup,  food and
beverage 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



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quality  renditions  of skincare  products,  foundation,  lipstick  and cosmetic
powders.  Management  believes that our innovative 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
("AHC"),  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, 2000, DLJMBII owned  approximately 98.8% of the outstanding common
stock of AHC.  See "Item 7.  Management's  Discussion  and Analysis of Financial
Condition  and  Results  of  Operations--Acquisition"  and  "Item  12.  Security
Ownership of Certain Beneficial Owners and Management."

     On September 15, 1999, we acquired all of the issued and outstanding shares
of capital stock of RetCom Holdings Ltd. ("RetCom"), a Delaware corporation, and
refinanced  working  capital  indebtedness of RetCom and its  subsidiaries.  See
"Item 7. 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 focused  presently at  merchandising  at point-of-sale  and through the
Internet. The acquired businesses offer proprietary, patented and patent-pending
sampling  systems that  include  MicroSilk(TM),  MicroDot(TM),  Snap and Powder,
ColorDot(TM) and Ascent(TM).

Products

     Our  company  offers  a broad  and  diversified  portfolio  of  innovative,
interactive   sampling  systems  and  advertising  formats  for  the  fragrance,
cosmetics and consumer  products markets.  Our major  technologies are described
below,  including  a  description  of the  patent  protection  of  each  product
technology.  Each of our products is a cosmetic,  fragrance or consumer  product
sample  system  generally  sold to the same  category  of  manufacturers  of the
product being advertised.

--------------------------------------------------------------------------------
                      Year of                      Patent
     Product        Introduction    Origin       Protection      Target Market
--------------------------------------------------------------------------------
ScentStrip(R)          1979       Internally     Proprietary   Fragrance,
                                  developed      secret        consumer products
--------------------------------------------------------------------------------
ScentStrip(R)Plus    mid 1980's   Internally     Proprietary   Fragrance
                                  developed      secret
--------------------------------------------------------------------------------
DiscCover(R)           1994       Licensed       Patented      Fragrance,
                                                               consumer products
--------------------------------------------------------------------------------
Scent Seal(R)          1995       Acquired       Patented      Fragrance
--------------------------------------------------------------------------------
LiquaTouch(R)          1997       Internally     Patent        Fragrance,
                                  developed      pending       skin care
--------------------------------------------------------------------------------

                                       2

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--------------------------------------------------------------------------------
MicroDot(TM)           1993       Acquired       Proprietary   Fragrance
                                                 secret
--------------------------------------------------------------------------------
Aromalacquer           1997       Acquired       Proprietary   Fragrance,
                                                 secret        consumer product
--------------------------------------------------------------------------------
Fragrance Burst and    1989       Acquired       Patented      Fragrance
Pearls
--------------------------------------------------------------------------------
Fragrance Burst        1984       Acquired       Patented      Fragrance
--------------------------------------------------------------------------------
Microfragrance Scratch            Acquired       Proprietary   Fragrance,
`n Sniff               1978                      secret        consumer product
--------------------------------------------------------------------------------
BeautiSeal(R)          1997       Internally     Patented      Cosmetics, skin
                                  developed                    care and personal
                                                               care
--------------------------------------------------------------------------------
PowdaTouch(R)          1997       Internally     Patented      Cosmetics
                                  developed
--------------------------------------------------------------------------------
LipSeal(TM)            1998       Internally     Patented      Cosmetics
                                  developed
--------------------------------------------------------------------------------
TouchDown(TM)          1999       Internally     Patent        Cosmetics
Nail Color Sampler                developed      application
                                                 pending
--------------------------------------------------------------------------------
BeautiTouch(R)         1999       Internally     Patent        Cosmetics, skin
Multi-well Sampler                developed      pending       care and personal
                                                               care
--------------------------------------------------------------------------------
ColorDot(TM)           1999       Acquired       Patented      Cosmetics
--------------------------------------------------------------------------------


Olfactory Sampling Systems

     Our diverse portfolio of fragrance  sampling systems,  which uses a variety
of  proprietary  chemistries  and  processes,  historically  has  represented  a
significant portion of our utilized sales. While ScentStrip  continues to be the
most widely used  technology for sampling  products for the fragrance  industry,
management  believes that our new and recently  acquired  sampling  systems have
helped us maintain a  competitive  advantage and our position as an innovator in
the sampling  industry.  Our products have been used in substantially  all major
new fragrance launches in recent years that have utilized sampling systems.

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

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

o    DiscCover(R):  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.

                                       3

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o    Scent Seal(R): 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.

o    LiquaTouch(R):  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(R) 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(R) was shown to be preferred among sampling
     systems  and was  also a  finalist  for  the  Fragrance  Foundation's  1997
     "Innovation of The Year" award.

o    MicroDot(TM):   A  peel  away  resealable  label,  which  reveals  pressure
     sensitive  microencapsulated  fragrance  oil  delivered in a  Microsilk(TM)
     powder.  When  applied to the skin,  the  Microsilk(TM)  powder  delivers a
     superior fragrance rendition.

o    Aramalacquer:  Scented  varnish that delivers a superior aroma rendition of
     nearly  any  fragrance,   personal   care,   household,   food,   beverage,
     pharmaceutical,  or novelty product. When rubbed or scratched, Aromalacquer
     releases the aroma rendition.

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

o    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.

o    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.

Other Sampling Systems

     Our  company  also  has  in its  portfolio  non-fragrance  sampling  system
products which  represent a growing  percentage of our company's  sales.  All of
these sampling  systems except  ColorDot(TM)  have been designed for U.S. Postal
Service approval for subscription magazine periodical rates.

o    BeautiSeal(R): A heat-sealed,  pouch-like,  pressure-sensitive format peels
     open to  deliver  quality  renditions  of cream and lotion  treatments  and
     liquid  foundations.  BeautiSeal(R)  is hygienic  and  spillproof  and less
     expensive and more  versatile  than existing  skincare/foundation  sampling
     alternatives.  For example,  a two-sided,  printed

                                       4

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     insert  incorporating a BeautiSeal(R)  sampling system generally costs less
     than  half  that  of  the  manufacture  and  magazine  distribution  of  an
     equivalent  sample packet.  BeautiSeal(R)  was a finalist for the Fragrance
     Foundation's 1998 "Marketing Innovation of The Year" award.

o    PowdaTouch(R): 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(R)  sampling systems can be produced
     approximately ten times faster than currently  competing  products and at a
     reduced production rate.

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

o    TouchDown(TM)  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.

o    BeautiTouch(R)   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.

o    ColorDot(TM):  A  pressure  sensitive  label  which  peels away to reveal a
     microencapsulated  color  cosmetic  sampling  system  containing up to four
     cosmetic colors laid down in parallel rows.

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 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 39% of fiscal 2000 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.

                                       5

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     Remittance Envelopes:  Remittance envelopes,  which are inserted into store
statement mailings, can be customized with a store logo and can accommodate many
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  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(R)  sampling
system,  as an alternative to vials, and expects increases for the BeautiSeal(R)
and PowdaTouch(R) 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  eight 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:

o    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,

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

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

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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,  home shopping  retailers 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,  Colgate,  Victoria
Secret Beauty and The Procter & Gamble Company.  Our company's top ten customers
accounted for  approximately  58% of sales in fiscal 2000. None of our company's
customers,  other than Estee  Lauder,  accounted for 10% or more of net sales in
fiscal 2000. 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.

Sales and Marketing

     Our company's sales and marketing efforts are organized geographically. Our
company currently has a total of twelve sales  executives.  The U.S. sales group
consists  of seven  sales  executives  who are  supervised  by the  Senior  Vice
President of Sales. 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
eighteen 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,  tradeshows 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:

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

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

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o    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 divided into three phases:

o    formulating  cosmetic and  fragrance  product  renditions  in our company's
     slurry laboratories for use in sampling systems;

o    manufacturing   the  sampler,   which   consists  of  either   applying  an
     encapsulated  slurry onto paper or producing  sampling  labels that contain
     fragrance  or other  cosmetic  product  renditions  as well as printing the
     advertising page; and

o    labeling   technologies   (DiscCover(R),   Scent  Seal(R),   BeautiSeal(R),
     LiquaTouch(R)),  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  pre-approved.  Formulation  is conducted in our
company's specially designed formulation laboratories by trained specialists.

     The  artwork  for  substantially  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.

                                       8

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     Our company has two different sampling component  manufacturing  processes:
(1) for its formulated offset paper samplers (ScentStrip(R), ScentStrip(R) Plus,
PowdaTouch(R))  and (2) for its  formulated  letterpress or flexo label samplers
(DiscCover(R),  Scent Seal(R), BeautiSeal(R),  LiquaTouch(R)).  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 system quality.

     All sampling systems in label form are 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
sample  systems  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  is  protected  by
non-competition agreements.

     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 also  registered with the Food and Drug  Administration  for the packaging of
regulated cosmetic products.

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.

                                       9

<PAGE>


In addition, certain cosmetics companies produce sampling products for their own
cosmetic  products.  Our company also competes with numerous other marketing and
advertising venues for marketing dollars our customers allocate to various types
of advertising,  marketing and promotional efforts such as print, television and
in-store promotions.

Environmental and Safety Regulation

     Our  company's  operations  are subject to extensive  laws and  regulations
relating to the storage,  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, 2000, our company employed 403 persons, which included 237
hourly and 166  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.

                                       10

<PAGE>


                                  RISK FACTORS

Our substantial  indebtedness and restrictive  covenants imposed by the terms of
our  indebtedness  could  adversely  affect  our cash flow 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,  2000,  Holding  and AKI had  total  consolidated  indebtedness  of
approximately  $145.7  million and $117.9  million,  respectively.  In addition,
Holding's  deficiency  of earnings  available to cover fixed  charges for fiscal
2000,  was $0.8  million.  As of September  20, 2000,  AKI had letters of credit
outstanding  in the amount of $0.6 million and  outstanding  borrowings  of $9.5
million under its revolving  credit  agreement with Heller  Financial,  Inc. and
$4.8  million  under  promissory  note with AHC. In  addition,  as of such date,
borrowings of up to  approximately  $9.9 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 negative consequences to
holders of the notes and the  debentures,  including,  but not  limited  to, the
following:

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

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

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

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

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

o    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:

o    pay dividends or make certain restricted payments;

                                       11

<PAGE>


o    incur additional indebtedness and issue preferred stock;

o    create liens;

o    incur dividend and other payment restrictions affecting subsidiaries;

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

o    enter into certain transactions with affiliates; and

o    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.

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. If the company is unable to maintain
the specified  financial  ratios or generate  sufficient  cash flow or otherwise
obtain funds necessary to make required  payments,  we would be in default under
the  terms  of  our  indebtedness,  which  would  permit  the  holders  of  such
indebtedness to accelerate the maturity of the indebtedness.

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 are 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, 2000,  Holding's  subsidiaries had $117.8 million of
indebtedness and $21.4 million of other outstanding liabilities (including trade
payables, accrued liabilities and deferred taxes). As of September 20, 2000, AKI
had letters of credit  outstanding in the amount of $0.6 million and outstanding
borrowings

                                       12

<PAGE>


of $9.5 million  under the credit  agreement and $4.8 million under a promissory
note with  AHC.  In  addition,  as of  September  20,2000,  borrowings  of up to
approximately $9.9 million were available under the credit agreement, subject to
specified  conditions.  All such  indebtedness  effectively  ranks senior to the
debentures.  At June 30, 2000,  Holding had $0.4 million of accrued  liabilities
and 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.

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.

Your  right to receive  payments  on the notes and  debentures  is junior to our
existing and future secured indebtedness.

     Under the terms of our 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  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, 2000,
AKI had  letters  of  credit  outstanding  in the  amount  of $0.6  million  and
outstanding  borrowings  of $9.5  million  under the credit  agreement  and $4.8
million under promissory note with AHC. In addition, as of such date, borrowings
of up to approximately  $9.9 million were available under the credit  agreement,
subject to specified conditions.

                                       13

<PAGE>


Our results of operations could be adversely affected if the U.S. Postal Service
reclassifies 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 32% of our company's
net sales in fiscal 2000. 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.

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  58% of our  company's  net  sales  in  fiscal  2000.  None of our
company's  customers  other than Estee Lauder  accounted  for 10% or more of net
sales in fiscal 2000.  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.

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
financial  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 primarily 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
basis.  There can be no  assurance  that  capital  will be  available  for these
purposes, that investments in

                                       14

<PAGE>


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.

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. These 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 and third fiscal
quarters  ended  September 30 and March 31,  respectively,  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.

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 28% of our company's
cost of goods sold in each of fiscal 1998, 1999 and 2000.  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
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.

                                       15

<PAGE>


     All of our company's  encapsulated  sampling  systems,  which accounted for
approximately  51% of our company's net sales in fiscal 2000,  utilize  specific
grades of paper that are subject to comprehensive  evaluation and  certification
by our company  for  quality,  consistency  and fit.  These  grades of paper are
produced exclusively for us by one domestic supplier.  We do not have a purchase
agreement  with the supplier  and are not aware of any other  suppliers of these
specific grades of paper.  Although our products can be manufactured using other
grades of paper, we believe that the specific  grades  currently used provide us
with an  advantage  over our  competitors.  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  and the  resulting  competitive  advantage  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.

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  14% of our company's net sales in fiscal 2000 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.

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 AHC and
generally exercises significant control over the business,  policies and affairs
of AHC, Holding,  AKI and its subsidiaries through its ownership of AHC. DLJMBII
currently owns approximately 98.8% of our outstanding common stock.  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.

Our company's business may be adversely affected by a labor dispute.

     As of August 31, 2000,  approximately 59% 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.


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

                                       16

<PAGE>


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.

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

     None.

                                       17

<PAGE>



                                     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, 2000, AHC 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 "Item 7.
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, 2000,  1999 and 1998 and the years ended June 30, 2000 and 1999 and for
the period from  December  16, 1997 to June 30, 1998 have been  derived from the
historical  consolidated  financial  statements  of our  company.  The  selected
historical  consolidated financial data presented below as of December 15, 1997,
June 30, 1997 and 1996,  and for the period  from July 1, 1997 to  December  15,
1997 and the fiscal  years  ended June 30,  1997 and 1996 and have been  derived
from  the  historical   consolidated  financial  statements  of  Arcade  Holding
Corporation,  the predecessor to our company. The information  contained in this
table should be read in conjunction  with "Item 7.  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.

                                       18

<PAGE>


<TABLE>
<CAPTION>
                                                 Holding                             Predecessor
                                                 -------                             -----------
                                                         December 16,  July 1, 1997
                                                           1997 to          to
                                 June 30,     June 30,     June 30,     December 15,   June 30,     June 30,
                                   2000         1999        1998           1997          1997        1996
                                ---------    ---------    ---------      ---------    ---------    ---------
<S>                             <C>          <C>          <C>            <C>          <C>          <C>
Statement of Operations
Data:
Net sales                       $  98,563    $  85,967    $  36,066      $  35,186    $  77,723    $  73,486
Cost of goods sold                 60,304       55,199       24,518         22,809       49,467       49,862
                                ---------    ---------    ---------      ---------    ---------    ---------
Gross profit                       38,259       30,768       11,548         12,377       28,256       23,624
Selling, general and
administrative expenses            16,980       14,500        5,587          5,703       13,333       10,635
Amortization of goodwill            5,336        4,606        2,101            568        1,234        1,234
Gain from settlement, net            (858)        --           --             --           --           --
                                ---------    ---------    ---------      ---------    ---------    ---------
Income from operations             16,801       11,662        3,860          6,106       13,689       11,755
Interest expense, net              17,401       16,740       11,327          2,646        6,203        6,762
Management fees                       250          250          125            215          470          470
Other, net                           --            128          (47)            11         (101)         244
Income tax expense (benefit)        1,596         (340)      (2,052)         1,441        3,135        2,101
                                ---------    ---------    ---------      ---------    ---------    ---------
Income (loss)                      (2,446)      (5,116)      (5,493)         1,793        3,982        2,178
Early retirement of debt, net       1,089         --           --             --           --           --
                                ---------    ---------    ---------      ---------    ---------    ---------
  Net income (loss)             $  (1,357)   $  (5,116)   $  (5,493)     $   1,793    $   3,982    $   2,178
                                =========    =========    =========      =========    =========    =========

Balance Sheet Data (at end
of period):
Cash and cash equivalents       $   1,158    $   7,015    $   3,842      $   4,481    $     303    $     626
Working capital (deficit)          13,759       14,853       15,046         (4,959)     (36,957)      (4,685)
Total Assets                      223,937      210,386      214,521         77,399       77,142       82,395
Total debt and redeemable
preferred stock                   145,722      146,688      144,448         55,408       54,964       60,736
Total stockholder's equity         58,834       49,797       57,084         12,716       11,225        7,932

Other Data:
Capital expenditures                2,782        2,856          514            807        2,462        2,051
Ratio of earnings to fixed
charges                              --           --           --             2.2x         2.1x         1.6x
---------
</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 $850,  $5,456 and $7,545 for the years  ended June 30,  2000 and
     1999 and the period from December 16, 1997 to June 30, 1998, respectively.


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

General

     The sales of our company are  primarily  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 recent  introduction  of a number of our company's  products,  such as
BeautiSeal(R),

                                       19

<PAGE>


PowdaTouch(R),   and  LiquaTouch(R),  has  affected  our  company's  results  of
operations for certain of the periods discussed below.

The Acquisition

     DLJMBII and certain members of our company's prior 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 AHC.

     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) AHC
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. AHC
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.  These borrowings were
subsequently repaid.

                                       20

<PAGE>


RetCom Acquisition

     On September 15, 1999, we acquired all of the issued and outstanding shares
of capital stock of RetCom at a purchase  price of  approximately  $12.5 million
and refinanced  working capital  indebtedness of  approximately  $4.5 million of
RetCom 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, 2000 Compared to Fiscal Year Ended June 30, 1999

     Net Sales.  Net sales for the fiscal  year  ended June 30,  2000  increased
$12.6 million,  or 14.7%,  to $98.6 million as compared to $86.0 million for the
fiscal year ended June 30,  1999.  The increase was  primarily  attributable  to
increases  in  domestic  sales of  sampling  technologies  for  advertising  and
marketing of cosmetics  and consumer  products,  due  partially to the timing of
completion and delivery of certain  substantial orders which remained in process
at June 30, 1999, increases in international sales of sampling  technologies for
advertising  and  marketing  of  fragrances  and sales from the RetCom  acquired
business, offset by changes in foreign exchange rates.

     Gross  Profit.  Gross  profit  for the  fiscal  year  ended  June 30,  2000
increased $7.5 million,  or 24.4%, to $38.3 million as compared to $30.8 million
for fiscal year ended June 30, 1999.  Gross profit as a percentage  of net sales
increased  to 38.8% in the fiscal  year ended June 30,  2000,  from 35.8% in the
fiscal year ended June 30,  1999.  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,  changes in product mix and more  efficient  production
levels, offset partially by changes in foreign exchange rates.

     Selling,  General  and  Administrative   Expenses.   Selling,  general  and
administrative  expenses for the fiscal year ended June 30, 2000  increased $2.5
million,  or 17.2% to $17.0  million as compared to $14.5 million for the fiscal
year ended June 30, 1999.  The increase in selling,  general and  administrative
expenses was primarily due to an increase  staffing levels and  compensation and
additional  expenses associated with the acquisition and operation of RetCom. As
a result of these factors,  selling,  general and  administrative  expenses as a
percent of net sales  increased  to 17.2% in the fiscal year ended June 30, 2000
from 16.9% in the fiscal year ended June 30, 1999.

                                       21

<PAGE>


     Income from  Operations.  Income from  operations for the fiscal year ended
June 30, 2000 increased $5.1 million,  or 43.6%, to $16.8 million as compared to
$11.7 million for the fiscal year ended June 30, 1999. Income from operations as
a percentage  of net sales  increased to 17.0% in the fiscal year ended June 30,
2000 from 13.6% in the fiscal year ended June 30, 1999,  principally as a result
of the factors  described  above and an $0.8 million net gain from settlement of
litigation involving the Acquisition purchase price.

     Interest Expense.  Interest expense for the fiscal year ended June 30, 2000
increased $0.7 million,  or 4.2% to $17.4 million,  as compared to $16.7 million
for the fiscal year ended June 30, 1999. Interest expense as a percentage of net
sales  decreased  to 17.7% in the fiscal  year ended June 30, 2000 from 19.4% in
the fiscal year ended June 30, 1999. The increase in interest expense, including
the  amortization  of deferred  financing  costs, is primarily due to use of the
credit line for working capital and the RetCom acquisition,  offset partially by
a decrease in interest  expense  related to the  repurchased  and retired Senior
Discount Debentures and Senior Notes.

     Interest  expense for AKI for the fiscal year ended June 30, 2000 increased
$0.7 million,  or 5.4%, to $13.7  million,  as compared to $13.0 million for the
fiscal year ended June 30, 1999.  Interest  expense as a percentage of net sales
decreased  to 13.9% in the fiscal  year  ended  June 30,  2000 from 15.1% in the
fiscal year ended June 30, 1999. The increase in interest expense, including the
amortization of deferred  financing costs, is primarily due to use of the credit
line for  working  capital and the RetCom  acquisition,  offset  partially  by a
decrease in  interest  expense  related to the  repurchased  and retired  Senior
Notes.

     Income Tax  Expense.  The income tax expense for the fiscal year ended June
30, 2000 increased $1.9 million to $1.6 million as compared to a benefit of $0.3
million  for the fiscal  year ended June 30,  1999.  The  increase is due to the
increase in income before income taxes and extraordinary gain as a result of the
factors described above.

     Income  tax  expense  for AKI for the  fiscal  year  ended  June  30,  2000
increased  $2.0  million to $2.8  million as  compared  to $0.8  million for the
fiscal year ended June 30,  1999.  The increase is due to the increase in income
before income taxes and extraordinary  gain as a result of the factors described
above.

     Extraordinary  gain from early  retirement of debt. An  extraordinary  gain
from early retirement of debt of $1.1 million for the fiscal year ended June 30,
2000 resulted from the purchase and subsequent  contribution of Senior Notes and
Senior  Discount  Debentures by AHC I Acquisition  Corporation.  The contributed
securities were subsequently retired.

     An extraordinary gain from early retirement of debt for AKI of $0.4 million
for the fiscal year ended June 30,  2000  resulted  from the  purchase of Senior
Notes  by AHC I  Acquisition  Corporation  and  subsequent  contribution  by AKI
Holding Corp. The contributed securities were subsequently retired.


                                       22
<PAGE>

     EBITDA.  EBITDA for the fiscal  year ended June 30,  2000,  increased  $5.6
million,  or 27.9%, to $25.7 million as compared to $20.1 million for the fiscal
year ended June 30,  1999.  The  increase  principally  reflects the increase in
income from operations  discussed above. EBITDA as a percentage of net sales was
26.1% and 23.4% for the fiscal year ended June 30, 2000 and 1999,  respectively.
EBITDA is income from operations plus  depreciation and amortization of goodwill
and other intangibles less net gain from settlement of litigation.

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.

     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


                                       23
<PAGE>

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.

     Income Tax  Expense.  The income tax benefit for the fiscal year ended June
30, 1999  decreased  $0.3  million to a benefit of $0.3 million as compared to a
benefit of $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 a benefit of $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.

Liquidity and Capital Resources

     Our company has  substantial  indebtedness  and  significant  debt  service
obligations.  As of June 30, 2000, our company had consolidated  indebtedness in
an  aggregate  amount of  $145.7  million  (excluding  trade  payables,  accrued
liabilities and deferred taxes), of which (1) approximately  $27.9 million was a
direct  obligation of Holding  relating to its debentures and (2)  approximately
$117.8 million was a direct  obligation of AKI relating to its notes,  revolving
credit line and capital  leases.  At June 30, 2000,  Holding had $0.4 million of
accrued  liabilities  and AKI also had $21.4 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, 2000, AKI had letters of credit outstanding in
the amount of $0.6 million and outstanding  borrowings of $9.5 million under the
credit agreement.


                                       24
<PAGE>

     Borrowings under the credit agreement are limited to a maximum amount equal
to $20.0 million. At June 30, 2000 and September 20, 2000, AKI had borrowings of
approximately $10.4 million and $9.9 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 limitations.
In addition,  the indentures  contains  restrictive  covenants that, among other
things, limit the ability of Holding and its Restricted Subsidiaries to:

     o    pay dividends or make certain restricted payments;

     o    incur additional indebtedness and issue preferred stock;

     o    create liens;

     o    incur dividend and other payment restrictions affecting subsidiaries;

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

     o    enter into certain transactions with affiliates; and

     o    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 "Item 1. Business-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 $4.9 million and $9.8 million for fiscal 2000 and 1999,  respectively,
together with borrowings under revolving credit facilities. Net cash provided by
operating  activities  during  fiscal  2000  resulted  from  net  income  before
depreciation and amortization, partially offset by increased accounts receivable
and inventory levels and a decrease in accounts payable and accrued expenses.

     In fiscal 2000 and fiscal  1999,  our company had capital  expenditures  of
approximately  $2.8  million  and  $2.9  million,  respectively.  These  capital
expenditures consisted primarily of the


                                       25
<PAGE>

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 at a purchase  price of  approximately  $12.5 million
and refinanced  working capital  indebtedness of  approximately  $4.5 million of
RetCom and its subsidiaries.  The 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.

     At June 30, 2000,  AHC had  outstanding  $35.5  million of Notes which bear
interest at  approximately  16% per annum and mature on December 15,  2009,  and
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 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 AHC and are not obligations of, or guaranteed by Holding,  AKI or
any of its subsidiaries. AHC is a holding company and is dependent 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 AHC

     In  September  1999,  AHC  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  were  used  in  fiscal  2000  to  reduce  outstanding
indebtedness  of  Holding  and AKI.  The  balance  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 AHC. to make any of these funds available.

     Capital  expenditures for the fiscal year ending June 30, 2001 are budgeted
to be approximately  $3.5 million.  Based on borrowings  outstanding (other than
pursuant to the credit agreement) as of June 30, 2000 and borrowings outstanding
under the credit  agreement as of September 20, 2000, our company  expects total
cash payments for debt service in fiscal 2001 to be approximately $13.2 million,
consisting of $11.3 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 2001.

     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 2001. In the event our company


                                       26
<PAGE>

consummates  any additional  acquisitions  it may seek additional debt or equity
financings subject to compliance with the terms of the indentures.

     At June 30,  2000,  Holding's  cash and cash  equivalents  and net  working
capital  were $1.2  million  and $13.8  million,  respectively,  representing  a
decrease  in cash and cash  equivalents  of $5.8  million  and a decrease in net
working capital of $1.1 million from June 30, 1999. Account receivables, net, at
June 30, 2000  increased  32.1% or $5.2  million  over the June 30, 1999 amount,
primarily due to increased sales.

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 and third fiscal
quarters  ended  September  30 and March 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.

     In December  1999,  the  Securities  and Exchange  Commission  issued Staff
Accounting Bulletin No. 101 "Revenue Recognition in Financial  Statements" ("SAB
101"),   which  provides  the  Staff's  views  on  applying  generally  accepted
accounting  principles  to revenue  recognition  issues.  The  Company  does not
anticipate  that the  adoption  of SAB 101 will  have a  material  impact on the
consolidated financial statements and will continue to analyze the impact of SAB
101.

     FASB  Interpretation  44,  Interpretation of APB Opinion 25 ("FIN 44"), was
issued in March 2000.  FIN 44 provides  an  interpretation  of APB Opinion 25 on
accounting  for employee  stock  compensation  and describes its  application to
certain transactions. FIN 44 is effective on


                                       27
<PAGE>

July 1, 2000. It applies on a prospective  basis to events  occurring after that
date,   except  for   certain   transactions   involving   options   granted  to
non-employees,  repriced fixed options,  and  modifications to add reload option
features,  which apply to awards granted after December 31, 1998. The provisions
of FIN 44 are not  expected to have a material  effect on  transactions  entered
into through June 30, 2000.

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;

     o    changes in prevailing interest rates;

     o    inflation;

     o    changes in cost of goods and services;

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

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

     o    liability and other claims asserted against our company;

     o    changes in operating strategy or development plans;

     o    the ability to attract and retain qualified personnel;

     o    the significant indebtedness of our company;

     o    labor disturbances;

     o    changes in our company's capital expenditure plans;

     o    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


                                       28
<PAGE>

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 14% 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, 2000, our company's forward
exchange  contracts  consisted of forward contracts to sell Euros at an exchange
rate of .8853 per U.S.  dollar and to buy British pound  sterling at an exchange
rate of 1.497 per U.S.  dollar.  The  notional  principal  amounts  under  these
foreign exchange contracts were $0.7 million and $0.2 million, respectively.

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 as of September 1, 2000.

Name                       Age   Position
----                       ---   --------
Thompson Dean              42    Chairman of the Board and Director
William J. Fox             44    President, Chief Executive Officer and Director
Kenneth A. Budde           51    Chief Financial Officer
Hugh R. Kirkpatrick        63    Director
David M. Wittels           36    Director

     Thompson Dean has served as Chairman of the Board and a Director of Holding
since  December  1997.  Mr.  Dean has been a Managing  Partner  of DLJ  Merchant
Banking, Inc. ("DLJ Merchant Banking") since November 1996. Previously, Mr. Dean
was a Managing  Director  of DLJ  Merchant  Banking  and its  predecessor  since
January  1992.  Mr. Dean also serves as a director of Von Hoffman  Press,  Inc.,
Manufacturers'  Services  Limited,  Phase Metrics,  Inc.,  Amatek Ltd.,  DeCrane
Aircraft  Holdings  Inc.,  Insilco  Holding  Corporation,  Formica  Corporation,
Mueller Group, Inc. and Charles River Laboratories International, 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")  (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.

     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>

     David M. Wittels has served as a director of Holding since  December  1997.
Mr. Wittels has been a Principal of DLJ Merchant Banking since January 1997. For
the past five  years,  Mr.  Wittels  has served in various  capacities  with DLJ
Merchant  Banking.  Mr.  Wittels  also serves as a director of Mueller  Holdings
(N.A.), Inc., Ziff Davis Holdings, Inc. and Wilson Greatbatch Technologies, Inc.

     On September 8, 2000,  Mr. James A. Quella was elected as a director of our
company.  Mr. Quella is a Managing  Director and Senior Operating Partner of DLJ
Merchant Banking since July,  2000. From January,  2000 to July, 2000 Mr. Quella
served as the Managing Director of GH Venture Partners. Mr. Quella served as the
Vice-Chairman:  Market  Development  and Director of the Executive  Committee of
Mercer  Management  Consulting from 1996 to 2000.  Prior to that, Mr. Quella had
founded and managed the Financial Services Practice Group for four years.

Compensation of Directors

     Except  for  Mr.  Kirkpatrick,  who  receives  an  annual  fee of  $20,000,
directors of Holding  will not receive  compensation  for services  rendered 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.  Mr.  Kirkpatrick  also received a grant of 5,000 stock options in fiscal
2000.


                                       31
<PAGE>

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 our
President  and Chief  Executive  Officer and our other most  highly  compensated
executive officer whose total annual compensation exceeded $100,000. We refer to
these individuals as our named executive officers.

                           Summary Compensation Table

<TABLE>
<CAPTION>
                                                                                     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                          2000   $  650,000   $1,214,000      888,000(2)        5,462
   President, Chief Executive Officer   1999      242,308      250,000         --              --
   And Director                         1998         --           --           --              --

Kenneth A. Budde                        2000      175,000      102,500      160,000           7,090
   Chief Financial Officer              1999      154,327       80,625         --             9,077
                                        1998      120,000       75,000         --              --
</TABLE>

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

(2)  Pursuant to the terms of his employment  agreement,  Mr. Fox is entitled to
     receive options to acquire 5% of AHC's issued and outstanding  common stock
     on a fully diluted  basis.  As of June 30, 2000,  888,000  shares of common
     stock  represented  5% of AHC's  issued and  outstanding  common stock on a
     fully  diluted  basis.  See  "---Equity  Based  Compensation"  and  "---Fox
     Employment Agreement."


                                       32
<PAGE>

Option Grants in Last Fiscal Year

     The following table sets forth information  regarding stock options granted
during  fiscal  2000 to each of the  executive  officers  named in the  "Summary
Compensation  Table" above,  including the potential  realizable  value over the
term of the options, based on assumed rates of stock appreciation of 5% and 10%,
compounded  annually.  These  assumed  rates  are  mandated  by the rules of the
Securities  and Exchange  Commission and do not represent our estimate of future
stock price performance.  Actual gains, if any, on stock option exercises,  will
be dependent on the future performance of our common stock.

<TABLE>
<CAPTION>
                                                                                                         Potential Realizable
                                                                                                           Value at Assumed
                                                                                                        Annual Rates of Stock
                                                                                                        Price Appreciation for
                                                              Individual Grants                               Option Term
                                        --------------------------------------------------------------------------------------------
                                                        Percent of
                                          Number of       Total
                                          Securities   Options/SARs
                                          Underlying    Granted to    Exercise
                                        Options/SARs   Employees in     Price
                    Name                 Granted (#)   Fiscal Year    ($/Share)   Expiration Date        5% ($)         10% ($)
                    ----                 -----------   -----------    ---------   ---------------        ------         -------

<S>                                        <C>             <C>         <C>       <C>                 <C>            <C>
William J. Fox                             888,000         100%        $ 1.00    December 15, 2009   $  558,458     $  1,415,243
   President, Chief Executive Officer
   And Director

Kenneth A. Budde                           160,000         100%          1.00    December 15, 2009      100,623          254,999
   Chief Financial Officer
</TABLE>

Fiscal Year End Option Values

     The following  table sets forth  information  about the number and value of
options held by the executive officers named in the "Summary Compensation Table"
above as of June 30, 2000. In the absence of a regular, active public market for
our common stock, and based in part on  consideration  of comparable  companies,
our management  estimated the fair value of the stock options  granted in fiscal
2000 to have been $0.27 per share as  determined  by the  Minimum  Value  option
pricing model.  The values of the  in-the-money  options have been calculated on
the basis of $1.00 per share fair  market  value of our common  stock as of that
date less the applicable exercise price.

<TABLE>
<CAPTION>
                                              Year End Option Values

                                                Number of securities
                                            underlying unexercised options    Value of unexercised in-the-money
                                                 at June 30, 2000                 options at June 30, 2000

            Name                            Exercisable      Unexercisable      Exercisable    Unexercisable
            ----                            -----------      -------------      -----------    -------------
<S>                                           <C>               <C>                  <C>            <C>
William J. Fox                                222,000           666,000              --             --
   President, Chief Executive Officer
   And Director

Kenneth A. Budde                               50,001           109,999              --             --
   Chief Financial Officer
</TABLE>

Equity-Based Compensation

     AHC adopted the 1998 Stock Option Plan for certain  employees and directors
of AHC and any parent or subsidiary  corporation  of AHC. The  objectives of the
option plan are (1) to


                                       33
<PAGE>

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 AHC 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
1,650,000 shares of common stock of AHC. 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,  AHC may grant  options,  including
options that become  exercisable  as  performance  standards  determined  by the
committee  are met,  to key  employees  and  directors  of AHC and any parent or
subsidiary  corporation.  The  terms  of any  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 AHC 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 AHC,  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 AHC 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 AHC common stock over the per share  exercise
price.

     AHC granted  1,519,917  options for shares of capital  stock in fiscal 2000
and no options for shares of capital stock of AHC were exercised in fiscal 2000.
These  options  vest over periods  ranging  from three to eight  years.  Certain
options are eligible for accelerated vesting based on targeted EBITDA.

Employment Agreements

Fox Agreement

     On January 27, 1999,  William J. Fox entered into an  employment  agreement
with our company effective  February 1, 1999. The agreement will end on February
1, 2002, the third  anniversary of the effective date,  subject to extension for
one additional day each day after February 1, 2000, unless either party provides
notice not to extend.

     Mr.  Fox's  base  salary  is  $700,000  and he is  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 AHC's issued and outstanding  common stock on a
fully diluted basis, subject to anti-dilution  protection.  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.


                                       34
<PAGE>

     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 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.

Budde Agreement

     Mr. Budde is presently  retained as Chief Financial  Officer pursuant to an
employment  agreement  that  provides  for an annual base salary of $190,000 and
participation  in our company's  Salaried  Employees Bonus Plan. The term of the
employment   agreement  with  Mr.  Budde,   which  expires  on  June  30,  2001,
automatically  renews for  additional  twelve-month  terms,  unless either party
elects otherwise.  If Mr. Budde is terminated by our company without cause or if
our company elects not to renew Mr. Budde's employment, our company will pay Mr.
Budde one times his base salary over a twelve-month period following the date of
termination.

Compensation Committee Interlocks and Insider Participation

     None of AHC,  Holding or AKI had a  compensation  committee  during  fiscal
2000.  Certain  members  of  our  board  of  directors,   other  than  Mr.  Fox,
participated in deliberations regarding compensation to be paid to Mr. Fox.. Mr.
Fox determined the compensation to be paid to other executive officers.

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 AHC. The following
table sets forth  certain  information  as of September 27, 2000 with respect to
the  beneficial  ownership  of AHC common stock by (1) owners of more than 5% of
such AHC. common stock, (2) each director and named executive officer of Holding
and (3) all directors and executive officers of Holding, as a group.


                                       35
<PAGE>

                                                                Percentage of
                                                     Shares    Outstanding AHC
                                                  Beneficially  Common Stock
         Beneficial Owner                            Owned      ------------
         ----------------                            -----

DLJ Merchant Banking Partners, II, L.P.           15,921,111        98.8%
  and affiliated entities (1)
William J. Fox                                          --          --
Thompson Dean (2)                                       --          --
Hugh R. Kirpatrick                                      --          --
James Quella (2)                                        --          --
David M. Wittels (2)                                    --          --
Kenneth A. Budde                                        --          --
All directors and executive officers
  as a group (2)                                        --          --

----------

*    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"); DLJ
     First ESC L.P ("First ESC"); and Scratch & Sniff Funding,  Inc. ("Scratch &
     Sniff"). 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,  Scratch & Sniff, 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 AHC Common Stock held  directly by the Scratch &
     Sniff Funding, Inc., an affiliate of DLJMBII.

(2)  Messrs.  Dean, Quella 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, Quella 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  and  Wittels,  who are  directors  of AKI and  officers  and
directors of Holding and AHC, 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 AHC.


                                       36
<PAGE>

     Pursuant to an agreement between  Donaldson,  Lufkin & Jenrette  Securities
Corporation  ("DLJ") and AHC,  DLJ receives an annual fee of $250,000 for acting
as the exclusive  financial and  investment  banking  advisor until 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,  AHC, DLJMBII and certain  investors in
our company  prior to the  Acquisition  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 AHC  (including  securities
exercisable  for or convertible or  exchangeable  into capital stock of AHC) and
agreements  among  the  parties  thereto  as  to  the  governance  of  AHC  and,
indirectly, Holding and AKI.

     Pursuant  to the  stockholders  agreement,  the board of  directors  of AHC
consists of six  members,  of which four may  currently be nominated by DLJMBII.
The Chief Executive Officer of our company is also to be a member of the board.

     The stockholders agreement contains (1) certain restrictions on the ability
of each holder of capital stock of AHC to transfer any capital stock of AHC, (2)
certain  preemptive  rights to the  holders of capital  stock of AHC,  (3) "drag
along"  rights to DLJMBII to require the  remaining  holders of capital stock of
AHC to sell a percentage  of their  ownership  and (4) "tag along" rights to the
holders of capital stock of AHC,  other than  DLJMBII,  with respect to sales of
capital stock of AHC 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 AHC
common stock (or if AHC is eligible to use Form S-3, the number of demand rights
is  unlimited)  and all  holders of capital  stock of AHC were  granted  certain
customary "piggyback"  registration rights to register their common stock in any
registration statement filed by AHC.

Employment Arrangements

     On February 1, 1999,  Roger L.  Barnett  resigned  as  President  and Chief
Executive Officer of our company.  Under the terms of his employment  agreement,
Mr.  Barnett was  entitled  to receive  payments  aggregating  $500,000 of which
$353,275  was paid in fiscal 1999 and the  remainder of which was paid in fiscal
2000.


                                       37
<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.+

10.20   Employment  Agreement  dated as of July 1,  2000,  between  Holding  and
        Kenneth A. Budde .+

12.1    Computation of Ratio of Earnings to Fixed Charges.+

21.1    Subsidiaries of Holding.+


                                       39
<PAGE>

23.1    Consent of PricewaterhouseCoopers LLP.+

23.2    Consent of PricewaterhouseCoopers LLP.+

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,
2000.


                                       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, 2000.

                                  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, 2000.

               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/ Hugh Kirkpatrick              Director
---------------------------
Hugh Kirkpatrick



/S/ James A. Quella               Director
---------------------------
James A. Quella


<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, 2000.

                                  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, 2000.


               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/ Hugh Kirkpatrick              Director
---------------------------
Hugh Kirkpatrick



/S/ James A. Quella               Director
---------------------------
James A. Quella


<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.


<PAGE>

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED FINANCIAL STATEMENTS OF AKI HOLDING CORP.:

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

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

     Consolidated Balance Sheets at June 30, 2000 and 1999.................  F-4

     Consolidated Statements of Operations for the year ended
         June 30, 2000, for the year ended June 30, 1999, for the
         period from December 16, 1997 through June 30, 1998 and
         for the period from July 1, 1997 through December 15, 1997........  F-5

     Consolidated Statements of Changes in Stockholder(s) Equity
         for the year ended June 30, 2000, for the year ended
         June 30, 1999, for the period from December 16, 1997
         through June 30, 1998 and for the period from July 1, 1997
         through December 15, 1997.........................................  F-6

     Consolidated Statements of Cash Flows for the year ended
         June 30, 2000, for the year ended June 30, 1999, for the
         period from December 16, 1997 through June 30, 1998 and
         for the period from July 1, 1997 through December 15, 1997........  F-7

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

 CONSOLIDATED FINANCIAL STATEMENTS OF AKI, INC.:

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

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

     Consolidated Balance Sheets at June 30, 2000 and 1999................. F-33

     Consolidated Statements of Operations for the year ended
         June 30, 2000, for the year ended June 30, 1999, for the
         period from December 16, 1997 through June 30, 1998 and
         for the period from July 1, 1997 through December 15, 1997........ F-34

     Consolidated Statements of Changes in Stockholder(s) Equity
         for the year ended June 30, 2000, for the year ended
         June 30, 1999, for the period from December 16, 1997
         through June 30, 1998 and for the period from July 1, 1997
         through December 15, 1997......................................... F-35

     Consolidated Statements of Cash Flows for the year ended
         June 30, 2000, for the year ended June 30, 1999, for the
         period from December 16, 1997 through June 30, 1998 and
         for the period from July 1, 1997 through December 15, 1997........ 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, 2000 and 1999, and the
results of their  operations  and their cash flows for the years  ended June 30,
2000 and 1999 and for the period from December 16, 1997 through June 30, 1998 in
conformity with generally accepted  accounting  principles in the United States.
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 in the United States 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
Knoxville, Tennessee
August 3, 2000


                                      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 period from July 1,
1997 through December 15, 1997 in conformity with generally accepted  accounting
principles  in  the  United   States.   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 in the
United  States  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
Knoxville, Tennessee
July 31, 1998


                                      F-3
<PAGE>

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

<TABLE>
<CAPTION>
                                                                        Successor
                                                                        ---------
                                                             June 30, 2000    June 30, 1999
                                                             -------------    -------------
<S>                                                            <C>               <C>
ASSETS
Current assets
Cash and cash equivalents .............................        $   1,158         $   7,015
Accounts receivable, net ..............................           21,522            16,287
Inventory .............................................            7,757             5,109
Income tax refund receivable ..........................               --                32
Prepaid expenses ......................................               92               452
Deferred income taxes .................................              396               400
                                                               ---------         ---------
      Total current assets ............................           30,925            29,295

Property, plant and equipment, net ....................           17,097            18,511
Goodwill, net .........................................          162,472           147,990
Other intangible assets, net ..........................            7,174             6,577
Deferred charges, net .................................            5,461             6,822
Deferred income taxes .................................              720             1,145
Other assets ..........................................               88                46
                                                               ---------         ---------
      Total assets ....................................        $ 223,937         $ 210,386
                                                               =========         =========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of capital lease obligations ..........        $     847         $     688
Accounts payable, trade ...............................            3,565             3,400
Accrued income taxes ..................................              724               497
Accrued compensation ..................................            3,965             2,527
Accrued interest ......................................            5,695             6,047
Accrued expenses ......................................            2,370             1,283
                                                               ---------         ---------
      Total current liabilities .......................           17,166            14,442

Long-term portion of capital lease obligations ........              502             1,349
Revolving credit line .................................            9,000                --
Senior notes ..........................................          107,510           115,000
Senior discount debentures ............................           27,863            29,651
Deferred income taxes .................................              663               147
Other non-current liabilities .........................            2,399                --
                                                               ---------         ---------
      Total liabilities ...............................          165,103           160,589

Commitments and contingencies (see Note 14)

Stockholder's equity
Common stock, $0.01 par, 1,000 shares authorized; 1,000
    shares issued and outstanding .....................               --                --
Additional paid-in capital ............................           88,935            78,364
Accumulated deficit ...................................          (13,829)          (12,472)
Accumulated other comprehensive loss ..................             (542)             (365)
Carryover basis adjustment ............................          (15,730)          (15,730)
                                                               ---------         ---------
      Total stockholder's equity ......................           58,834            49,797
                                                               ---------         ---------
      Total liabilities and stockholder's equity ......        $ 223,937         $ 210,386
                                                               =========         =========
</TABLE>

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


                                      F-4
<PAGE>

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

<TABLE>
<CAPTION>
                                                                  Successor                       Predecessor
                                                 --------------------------------------------------------------
                                                                                   December 16,      July 1,
                                                                                      1997            1997
                                                 Year Ended      Year Ended          through         through
                                                  June 30,        June 30,          June 30,       December 15,
                                                    2000            1999              1998            1997
                                                    ----            ----              ----            ----
<S>                                              <C>              <C>              <C>              <C>
Net sales ...............................        $ 98,563         $ 85,967         $ 36,066         $ 35,186
Cost of goods sold ......................          60,304           55,199           24,518           22,809
                                                 --------         --------         --------         --------
     Gross profit .......................          38,259           30,768           11,548           12,377

Selling, general and
   administrative expenses ..............          16,980           14,500            5,587            5,703
Amortization of goodwill
   and other intangible assets ..........           5,336            4,606            2,101              568
Gain from settlement of
   litigation, net ......................            (858)              --               --               --
                                                 --------         --------         --------         --------
     Income from operations .............          16,801           11,662            3,860            6,106

Other expenses (income):
   Interest expense to stockholder(s) and
      affiliate .........................              22               --           10,785            2,143
   Interest expense, other ..............          17,379           16,740              542              503
   Management fees to stockholders
     and affiliate ......................             250              250              125              215
   Other, net ...........................              --              128              (47)              11
                                                 --------         --------         --------         --------
     Income (loss) before income taxes
       and extraordinary gain ...........            (850)          (5,456)          (7,545)           3,234

Income tax expense (benefit) ............           1,596             (340)          (2,052)           1,441
                                                 --------         --------         --------         --------
     Income (loss) before
       extraordinary gain ...............          (2,446)          (5,116)          (5,493)           1,793

Extraordinary gain from early
   retirement of debt, net of tax .......           1,089               --               --               --
                                                 --------         --------         --------         --------
   Net income (loss) ....................        $ (1,357)        $ (5,116)        $ (5,493)        $  1,793
                                                 ========         ========         ========         ========
</TABLE>

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


                                      F-5
<PAGE>

                       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 and per share information)

<TABLE>
<CAPTION>
                                                                                   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, 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
  (see Note 13) ...............        1,000      --      78,364          --         --            --             --        78,364

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
Equity contribution by AHC I
  Acquisition Corp. ...........         --        --      10,571          --         --            --             --        10,571
Net loss ......................         --        --        --            --       (1,357)         --             --        (1,357)
Other comprehensive loss, net
  of tax:
   Foreign currency
     translation adjustment ...         --        --        --            --         --            (177)          --          (177)
                                                                                                                          --------
Comprehensive loss ............                                                                                             (1,534)
                                    --------  --------  --------      --------   --------      --------       --------    --------

Balances, June 30, 2000 .......        1,000  $   --    $ 88,935      $   --     $(13,829)     $   (542)      $(15,730)   $ 58,834
                                    ========  ========  ========      ========   ========      ========       ========    ========
</TABLE>

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


                                      F-6
<PAGE>

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

<TABLE>
<CAPTION>
                                                                                    Successor                         Predecessor
                                                                 -------------------------------------------------------------------
                                                                                                    December 16,        July 1,
                                                                     Year             Year             1997              1997
                                                                     ended            ended           through          through
                                                                   June 30,          June 30,         June 30,        December 15,
                                                                     2000              1999             1998             1997
                                                                     ----              ----             ----             ----
<S>                                                              <C>               <C>               <C>               <C>
Cash flows from operating activities:
   Net income (loss) ....................................        $  (1,357)        $  (5,116)        $  (5,493)        $   1,793
   Adjustment to reconcile net income (loss) to
     net cash provided by (used in) operating activities:
     Depreciation and amortization of goodwill
       and other intangibles ............................            9,738             8,487             3,954             2,456
     Amortization of debt discount ......................            3,638             3,631               139               233
     Amortization of loan closing costs .................            1,309               727             3,808               101
     Deferred income taxes ..............................              945              (544)           (2,035)             (460)
     Gain on sale of equipment ..........................               --               (50)               --                --
     Gain from early retirement of debt .................           (2,345)               --                --                --
     Other ..............................................               (1)             (308)              (57)              (18)
     Changes in operating assets and liabilities:
       Accounts receivable ..............................           (2,576)           (2,737)           (4,562)            1,153
       Inventory ........................................           (2,496)           (3,031)              543                69
       Prepaid expenses, deferred charges and
         other assets ...................................              450              (975)             (453)              (62)
       Accounts payable and accrued expenses ............           (2,637)            4,511            (5,432)           (1,036)
       Income taxes .....................................              259             5,238               767               699
                                                                 ---------         ---------         ---------         ---------
       Net cash provided by (used in) operating
         activities .....................................            4,927             9,833            (8,821)            4,928
                                                                 ---------         ---------         ---------         ---------
Cash flows from investing activities:
   Purchases of equipment ...............................           (2,782)           (2,856)             (514)             (807)
   Proceeds from sale of equipment ......................               --                50                --                --
   Payments for acquisitions, net of cash acquired ......          (16,164)               --          (141,403)               --
   Patents ..............................................             (150)               --                --
                                                                 ---------         ---------         ---------         ---------
         Net cash used in investing activities ..........          (19,096)           (2,806)         (141,917)             (807)
                                                                 ---------         ---------         ---------         ---------
 Cash flows from financing activities:
   Payments under capital leases for equipment ..........             (688)             (661)             (308)             (249)
   Net proceeds (repayments) on line of credit ..........            9,000                --            (6,700)            2,362
   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 ............               --                --           (36,649)           (1,851)
   Repayment of other notes payable .....................               --            (1,330)              (50)              (50)
   Dividends paid on preferred stock ....................               --                --              (128)             (155)
   Dividend paid to AHC I Acquisition Corp. .............               --            (1,863)               --                --
                                                                 ---------         ---------         ---------         ---------
     Net cash provided by (used in)
       financing activities .............................            8,312            (3,854)          154,580                57
                                                                 ---------         ---------         ---------         ---------

Net increase (decrease) in cash and cash equivalents ....           (5,857)            3,173             3,842             4,178
Cash and cash equivalents, beginning of period ..........            7,015             3,842                --               303
                                                                 ---------         ---------         ---------         ---------
Cash and cash equivalents, end of period ................        $   1,158         $   7,015         $   3,842         $   4,481
                                                                 =========         =========         =========         =========
Supplemental information:
   Cash paid (received) during the period for:
     Interest to stockholder(s) and affiliate ...........        $      22         $      --         $  11,503         $   1,146
     Interest, other ....................................           13,188             6,512               214               459
     Income taxes .......................................            1,264            (5,123)             (784)            1,222

Significant non-cash activities:
   Assets acquired under capital lease ..................        $      --         $     600         $      --         $      --
   Contribution of equity and retirement of
     senior discount debentures and senior notes ........           10,571                --                --                --
</TABLE>

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


                                      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 and per 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.  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.  ("AHC") 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,
     AHC 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.  AKI 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.

          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 and per share information)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

          One  customer  accounted  for 15.3% of net sales during the year ended
     June 30, 2000.  Two  customers  accounted for 26.8% of net sales during the
     year ended June 30,  1999.  One customer  accounted  for 13.3% of net sales
     during the period  from  December  16,  1997  through  June 30,  1998.  Two
     customers  accounted  for 35.3% of the  Predecessor's  net sales during the
     period from July 1, 1997 through December 15, 1997.

     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 the specific grades of paper utilized
     by the Company 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  is accounted  for net of  allowances  for
     doubtful  accounts.  Under  arrangements  with  certain  customers,  custom
     product  which is stored for future  delivery is recognized as revenue when
     title has passed to the customer.

     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 and per 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 a period of up to forty  years  using the
     straight-line  method.  Accumulated  amortization was $10,546 and $5,939 at
     June 30, 2000 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 covenants not to compete,  patents and
     other intangible  assets and are being amortized over their estimated lives
     using the straight-line method.  Accumulated  amortization related to these
     intangibles  assets was $1,479 and $754 at June 30, 2000 and June 30, 1999,
     respectively.

     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  $85,470  and   $19,687,
     respectively, at June 30, 2000 compared to a carrying value of $107,510 and
     $27,863, respectively, as of the same date. 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 all  other  financial  instruments
     approximated fair value at June 30, 2000 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 and per 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 $51, $91,  ($52) and ($44) for the year ended June 30,
     2000,  the year ended June 30,  1999,  the period  from  December  16, 1997
     through June 30, 1998 and the period from July 1, 1997 through December 15,
     1997, respectively.

          At June 30, 2000,  short term forward  exchange  contracts  existed to
     sell Euros at an exchange rate of .8853 per U.S.  dollar and to buy British
     pound  sterling  at an  exchange  rate of  1.497  per  U.S.  dollar.  These
     contracts  have been entered into for the purpose of mitigating  short term
     foreign  exchange risk for customer orders and  receivables  denominated in
     foreign  currencies.  The notional  principle  amounts  under these foreign
     exchange  contracts  were $700 and $200,  respectively.  The fair  value of
     these foreign exchange contracts as of June 30, 2000 was not significant.

     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 $1,309,  $1,136,  $717 and $664 for the year
     ended June 30, 2000, the year ended June 30, 1999, the period from December
     16, 1997  through  June 30,  1998 and the period from July 1, 1997  through
     December 15, 1997, 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


                                      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 and per share information)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

     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.

3. SIGNIFICANT ACQUISITIONS

          DLJMBII  and  certain  members of the  Predecessor  organized  AHC and
     Merger Corp. for purposes of acquiring the Predecessor.  Merger Corp. was a
     wholly-owned subsidiary of AHC and was initially capitalized by AHC 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 AHC. (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 AHC.
     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 cost, $2,363 in non-cash  consideration in the form of
     an option to purchase  Senior  Preferred Stock of AHC (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 AHC.  Merger Corp.  then merged with and into
     the Predecessor and the combined entity assumed the name AKI. Subsequent to
     the  Acquisition,  AHC  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 AHC 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.


                                      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 and per share information)

3.   SIGNIFICANT ACQUISITIONS (Continued)

          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.

     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 AHC (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).


                                      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 and per share information)

3. SIGNIFICANT ACQUISITIONS (Continued)

          In December, 1999 the Company settled a dispute with the former owners
     of the Predecessor.  In connection with the settlement the Company received
     approximately  $1.2 million and has included the  settlement  amount net of
     related expenses in income from operations.

          On  September  15,  1999,  the  Company  acquired  all of  the  equity
     interests in RetCom  Holdings  Ltd.  and its  subsidiaries  ("RetCom")  for
     approximately  $12,500  and  refinanced  working  capital  indebtedness  of
     approximately $4,500 of RetCom. The acquisition was accounted for using the
     purchase method of accounting. The purchase price has been allocated to the
     assets and liabilities  acquired using estimated fair values at the date of
     acquisition   and  resulted  in  assigning   value  to  goodwill   totaling
     approximately  $19,100  which is being  amortized on a straight  line basis
     over a period of twenty years. The fair values assigned are preliminary and
     may be  revalued  at a later  date but the  change  is not  expected  to be
     material.  The  results of the  acquired  operations  are  included  in the
     financial  statements since the date of acquisition.  Pro forma results had
     RetCom  been  acquired  at the  beginning  of fiscal  1999 and 2000 are not
     determinable.

          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,
                                         2000             1999
                                         ----             ----

Trade accounts receivable .....        $ 22,314         $ 16,349
Allowance for doubtful accounts            (963)            (251)
                                       --------         --------
                                         21,351           16,098
Other accounts receivable .....             171              189
                                       --------         --------

                                       $ 21,522         $ 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 and per share information)

5. INVENTORY

     The following table details the components of inventory:

                                June 30,      June 30,
                                 2000          1999
                                 ----          ----
Raw materials
  Paper ................        $3,944        $1,088
  Other raw materials ..         2,541         2,328
                                ------        ------
     Total raw materials         6,485         3,416
Work in process ........         1,272         1,693
                                ------        ------

Total inventory ........        $7,757        $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,
     2000 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         2000             1999
                                 ------------         ----             ----

Land ......................                        $    258         $    258
Building ..................     7 - 15 years          1,719            1,648
Leasehold improvements ....      1 - 3 years            635              579
Machinery and equipment ...      5 - 7 years         21,348           19,483
Furniture and fixtures ....      3 - 5 years          3,081            2,084
Construction in progress...                             101              183
                                                   --------         --------
                                                     27,142           24,235
Accumulated depreciation...                         (10,045)          (5,724)
                                                   --------         --------
                                                   $ 17,097         $ 18,511
                                                   ========         ========

          Depreciation expense amounted to $4,381, $3,881, $1,853 and $1,888 for
     the year ended June 30, 2000, the year ended June 30, 1999, the period from
     December  16, 1997  through  June 30, 1998 and the period from July 1, 1997
     through December 15, 1997, 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 and per 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,
                                                  2000           1999
                                                  ----           ----

Machinery and equipment .................       $ 3,000         $ 3,000
Building ................................           600             600
                                                -------         -------
                                                  3,600           3,600
Less accumulated depreciation ...........        (1,390)           (790)
                                                -------         -------
                                                $ 2,210         $ 2,810
                                                =======         =======

          Depreciation  of assets under capital lease totaled $600,  $515,  $275
     and $232 for the year ended June 30,  2000,  the year ended June 30,  1999,
     the period from December 16, 1997 through June 30, 1998 and the period from
     July 1, 1997 through December 15, 1997, respectively.  Future minimum lease
     payments under the remaining lease are as follows:

                                                Payment        Interest

                  2001 ..................           948             100
                  2002 ..................           529              27
                                                -------         -------
                                                $ 1,477         $   127
                                                =======         =======

7. LINE OF CREDIT

          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,  2000,  the  Company's  borrowing  base  was  approximately
     $24,128.  Interest on amounts borrowed accrue at a floating rate based upon
     either prime or LIBOR (10.25% and 8.50% at June 30, 2000 and June 30, 1999,
     respectively).  The  weighted  average  interest  rate  on the  outstanding
     balance under the Credit  Agreement was 9.12%,  8.51%,  9.25% and 9.50% for
     the year ended June 30, 2000, the year ended June 30, 1999, the period from
     December  16, 1997  through  June 30, 1998 and the period from July 1, 1997
     through December 15, 1997, respectively.

          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, 2000 and June 30, 1999. These
     fees totaled $69, $111, $59 and $30 for the year ended


                                      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 and per share information)

7. LINE OF CREDIT (Continued)

     June 30, 2000,  the year ended June 30, 1999,  the period from December 16,
     1997  through  June 30,  1998 and the  period  from  July 1,  1997  through
     December 15, 1997,  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, 2000, the Company was in compliance with all debt covenants.

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.  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.  The amounts due under
     the  Subordinated  Loan  Agreements  were  subsequently  retired  upon  the
     acquisition of the Predecessor as discussed in Note 3.

          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.

          In May 2000, the Company signed a promissory note payable to AHC which
     allows the Company to borrow up to $10 million at such  interest  rates and
     due as agreed upon by the Company  and AHC.  At June 30,  2000,  no amounts
     were outstanding under the promissory note.

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


                                      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 and per share information)

9. SENIOR NOTES (Continued)

     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. During fiscal 2000, AHC purchased $7,490 of the Senior
     Notes  for  $6,486  and  recognized  a  gain,  net  of  income  taxes,   of
     approximately  $429.  The notes were  contributed  to Holding  and  Holding
     contributed the notes to AKI. The notes were subsequently retired.

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  $13,368 and
     $20,349 at June 30,  2000 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.  During
     fiscal 2000, AHC purchased Senior Discount Debentures with a carrying value
     of $5,426  for  $4,084  and  recognized  a gain,  net of income  taxes,  of
     approximately   $660.  The  debentures  were  contributed  to  Holding  and
     subsequently retired.


                                      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 and per 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.  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,  AHC issued $30,000 of Floating
     Rate Notes,  $50,279 of Mandatorily  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%.  Interest  was payable  quarterly  and could be settled
     through the issuance of additional Floating Rate Notes through December 15,
     2009, the maturity  date, at the  discretion of AHC. The original  issuance
     discount of $5,389 was being amortized using the effective  interest method
     over the life of the Floating Rate Notes.  The  unamortized  balance of the
     original issuance discount at June 30, 1999 was $4,740. On November 1, 1999
     AHC issued Amended and Restated Notes totaling  $35,500 in exchange for the
     Floating Rate Notes.  The Amended and Restated  Notes bear a fixed interest
     rate of  approximately  16% per annum and mature on  December  15, 2009 and
     provide  for the  payment  of  stipulated  early  redemption  premiums.  In
     connection  with the exchange the  unamortized  original issue discount was
     expensed by AHC. The Senior  Preferred  Stock  accretes in value at 15% per
     annum and must be redeemed by December 15,  2012.  The Amended and Restated
     Notes and Senior Preferred Stock are general unsecured obligations of AHC.


                                      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 and per 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 Mandatorily
     Redeemable  Senior  Preferred  Stock  Option of  $2,363  (see Note 17) were
     contributed  by AHC to AKI in  exchange  for 1,000  shares of AKI's  Common
     Stock.  Subsequent to the capitalization of AKI, AHC contributed $1 of cash
     and  all of  its  ownership  interest  in AKI  to  Holding  for  all of the
     outstanding equity of Holding.

          AHC has no other operations other than the Company.  Absent additional
     financing  by AHC,  the  Company's  operations  represent  the only current
     source  of  funds   available  to  service  the  Floating  Rate  Notes  and
     Mandatorily  Redeemable Senior Preferred Stock; however, the Company is not
     obligated  to pay or  otherwise  guarantee  the  Floating  Rate  Notes  and
     Mandatorily 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 $589, $338, $198 and $192
     for the year ended June 30, 2000,  the year ended June 30, 1999, the period
     from  December  16, 1997  through June 30, 1998 and the period from July 1,
     1997 through December 15, 1997, respectively. Future minimum lease payments
     under the leases total $256 in 2001 and none thereafter.

     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 $500, $500, $516 and
     $437 under this  agreement for the year ended June 30, 2000, the year ended
     June 30, 1999,  the period from December 16, 1997 through June 30, 1998 and
     the period from July 1, 1997 through December 15, 1997,  respectively.  The
     Company has paid $5,076 in cumulative royalty payments under this agreement
     through June 30, 2000.

          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 $625,  $575,  $284 and $241 under
     this  agreement  for the year ended June 30, 2000,  the year ended June 30,
     1999,  the period  from  December  16, 1997  through  June 30, 1998 and the
     period from July 1, 1997 through December 15, 1997, 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 and per share information)

14. COMMITMENTS AND CONTINGENCIES (Continued)

     Employment Agreements

          The Company has employment  agreements with certain executive officers
     with terms through June 30, 2001 and 2002. Such agreements provide for base
     salaries  totaling $890 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.  The  employment
     agreements  also  provide  severance  benefits  of up to two  years of base
     salary if the officers' services are terminated under certain conditions.

          During fiscal 1999, two executive officer's  employment was terminated
     with the  Company.  In  accordance  with the terms of the 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 and subsequently paid in fiscal 2000.

     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.

     Printing Services Agreement

          In  connection  with the RetCom  acquisition,  AKI entered into a five
     year Printing Services  Agreement with a former  shareholder of RetCom. The
     Printing Services  Agreement requires annual purchases of printing services
     totaling  $5,000  and a 15%  charge  on the  amount of any  shortfall.  The
     present value of the costs related to the estimated shortfall over the life
     of the  Printing  Services  Agreement  was  recorded as a liability  in the
     RetCom purchase accounting.

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  $251,  $201,  $113 and $95 for the year
     ended June 30, 2000, the year ended June 30, 1999, the period from December
     16, 1997  through  June 30,  1998 and the period from July 1, 1997  through
     December 15, 1997, 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 and per share information)

15. RETIREMENT PLANS (Continued)

          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 $215,
     $204, $81 and $80 for the year ended June 30, 2000, the year ended June 30,
     1999,  the period  from  December  16, 1997  through  June 30, 1998 and the
     period from July 1, 1997 through December 15, 1997, respectively.

16. INCOME TAXES

          The Company is included in the consolidated  federal income tax return
     filed by AHC for periods  subsequent  to December  15,  1997.  Income taxes
     related to the Company for the period from  December  16, 1997 through June
     30, 2000 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
     and extraordinary gain includes the following components:

<TABLE>
<CAPTION>
                                                                      December 16,       July 1,
                                                                          1997            1997
                                        Year Ended      Year Ended       through         through
                                         June 30,        June 30,       June 30,      December 15,
                                           2000            1999           1998            1997
                                           ----            ----           ----            ----
<S>                                      <C>             <C>             <C>             <C>
Income (loss) before income taxes
  and extraordinary gain:
   United States ................        $(1,305)        $(5,978)        $(8,227)        $ 3,298
   Foreign ......................            455             522             682             (64)
                                         -------         -------         -------         -------
                                         $  (850)        $(5,456)        $(7,545)        $ 3,234
                                         =======         =======         =======         =======
</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 and per share information)

16. INCOME TAXES (Continued)

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

<TABLE>
<CAPTION>
                                                                 December 16,      July 1,
                                                                     1997           1997
                                   Year Ended    Year Ended         through        through
                                    June 30,      June 30,         June 30,     December 15,
                                      2000          1999             1998           1997
                                      ----          ----             ----           ----
<S>                                <C>             <C>             <C>             <C>
Current expense (benefit):
  Federal .................        $   480         $    --         $    --         $ 1,623
  Foreign .................            171             204             104              --
  State ...................             --              --            (121)            278
                                   -------         -------         -------         -------
                                       651             204             (17)          1,901
                                   -------         -------         -------         -------

Deferred expense (benefit):

  Federal .................            519            (481)         (1,916)           (376)
  Foreign .................             --              --             162             (25)
  State ...................            426             (63)           (281)            (59)
                                   -------         -------         -------         -------
                                       945            (544)         (2,035)           (460)
                                   -------         -------         -------         -------

                                   $ 1,596         $  (340)        $(2,052)        $ 1,441
                                   =======         =======         =======         =======
</TABLE>

          The  significant  components  of deferred  tax assets and deferred tax
     liability at June 30, 2000 and 1999, were as follows:

<TABLE>
<CAPTION>
                                               June 30, 2000              June 30, 1999
                                               -------------              -------------
                                           Current   Noncurrent       Current     Noncurrent
                                           -------   ----------       -------     ----------
<S>                                       <C>           <C>           <C>           <C>
Deferred income tax assets:
  Accrued expenses ..................     $  215        $2,427        $  308        $1,206
  Allowance for doubtful accounts....        181            --            92            --
  Net operating loss carryforwards...         --           720            --         3,132
                                          ------        ------        ------        ------
                                             396         3,147           400         4,338

Deferred income tax liability:
    Property, plant and equipment....         --         3,090            --         3,340
                                          ------        ------        ------        ------

                                          $  396        $   57        $  400        $  998
                                          ======        ======        ======        ======
</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 and per share information)

16. INCOME TAXES (Continued)

          The income tax provision recognized by the Company for the years ended
     June 30, 2000 and 1999 and for the period from  December  16, 1997  through
     June 30,  1998 and by the  Predecessor  for the  period  from  July 1, 1997
     through  December 15, 1997 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>
                                                                           December 16,       July 1,
                                                                               1997            1997
                                            Year Ended      Year Ended        through         through
                                             June 30,        June 30,        June 30,      December 15,
                                               2000            1999            1998            1997
                                               ----            ----            ----            ----
<S>                                          <C>             <C>             <C>             <C>
Computed tax provision (benefit)
  at the statutory rate .............        $  (289)        $(1,855)        $(2,565)        $ 1,100
State income tax provision (benefit),
  net of federal effect .............            281             (42)           (265)            145
Nondeductible expenses ..............          1,588           1,530             723             193
Other, net ..........................             16              27              55               3
                                             -------         -------         -------         -------
                                             $ 1,596         $  (340)        $(2,052)        $ 1,441
                                             =======         =======         =======         =======
</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  losses in prior years the Company has recorded a
     long-term  deferred tax asset of $720  reflecting  cumulative net operating
     loss  carryforwards  available  to offset  future state  taxable  income of
     approximately $10,996 at June 30, 2000. These cumulative net operating loss
     carryforwards  expire in  varying  amounts  through  2019.  Realization  is
     dependent on generating sufficient state 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.


                                      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 and per share information)

17. STOCK OPTIONS (Continued)

          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.

          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 AHC  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 AHC 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 AHC 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 AHC the funds to redeem the 80,000
     shares of Senior Preferred  Stock,  Holding issued AHC a dividend of $1,863
     in cash on such date.

          Subsequent to the Acquisition,  AHC adopted the 1998 Stock Option Plan
     ("Option  Plan") for certain  employees and directors of AHC and any parent
     or subsidiary of AHC. The Option Plan authorizes the issuance of options to
     acquire up to 1,650,000  shares of AHC Common Stock. The Board of Directors
     determines the terms of each individual  options grant.  The exercise price
     for each  grant is  required  to be set at least  equal to the fair  market
     value per share of AHC provided  that the exercise  price shall not be less
     than $1.00 per share. Options vest over periods ranging from three to eight
     years.  Certain  options are  eligible  for  accelerated  vesting  based on
     targeted EBITDA. 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 and per share information)

17. STOCK OPTIONS (Continued)

          On June 17,  1998,  AHC granted an officer of the  Company  options to
     purchase  32,500  shares of AHC Common Stock at 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.

          A summary of AHC stock option activity and related information for the
     year ended June 30, 2000 follows:

                                                          Weighted
                                                           Average
                                                          Exercise
                                            Options         Price
                                            -------         -----

Outstanding, beginning of year...                --         $  --
     Granted ....................         1,519,917          1.00
     Exercised ..................                --            --
     Forfeited ..................           (10,467)         1.00
                                         ----------         -----

Outstanding, end of year ........         1,509,450         $1.00
                                         ==========         =====

Exercisable, end of year ........           273,668         $1.00
                                         ==========         =====

Weighted average remaining
     contractual life ...........                 9.5 years

          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
     years ended June 30, 2000 and 1999 would have been  $(1,408) 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
     ranging from 6.3% to 6.9%,  estimated  life of five years and dividend rate
     of 0.0%.  The  weighted  average  fair  value  at date of grant of  options
     granted during 2000 was approximately $0.27 per option.

18. RELATED PARTY TRANSACTIONS

          The Successor  made payments to an affiliate of DLJMBII for management
     fees of $250,  $250 and $125 for the year  ended  June 30,  2000,  the year
     ended June 30, 1999 and the period from  December 16, 1997 through June 30,
     1998, respectively.

          The Predecessor made payments to a company controlled by a stockholder
     of the  Predecessor  of $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 $55 for the period
     from July 1, 1997 through December 15, 1997 for management fees.


                                      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 and per share information)

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:

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
Year ended June 30, 2000 ..................    84,379       14,184       98,563

Long-lived assets:

June 30, 1999 .............................   180,984          107      181,091
June 30, 2000 .............................   192,925           87      193,012


                                      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 and per share information)

20.  CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS

         The  following  condensed  balance  sheet at June 30, 2000 and June 30,
     1999 and condensed statement of operations, changes in stockholder's equity
     and cash  flows for the years  ended  June 30,  2000 and 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,
                                                                  2000              1999
                                                                  ----              ----
<S>                                                            <C>               <C>
Assets
Investment in subsidiaries ............................        $  99,798         $  92,817
Deferred charges ......................................            1,167             1,520
Deferred income taxes .................................            2,427             1,206
                                                               ---------         ---------
  Total assets ........................................        $ 103,392         $  95,543
                                                               =========         =========
Liabilities
Accrued Income Taxes ..................................        $     423         $      --
Senior Discount Debentures ............................           27,863            29,651
                                                               ---------         ---------
  Total liabilities ...................................           28,286            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 ............................           88,935            78,364
Accumulated deficit ...................................          (13,829)          (12,472)
                                                               ---------         ---------
  Total stockholder's equity ..........................           75,106            65,892
                                                               ---------         ---------
  Total liabilities and stockholder's equity ..........        $ 103,392         $  95,543
                                                               =========         =========
</TABLE>

<TABLE>
<CAPTION>
                             STATEMENT OF OPERATIONS

                                                                   Year ended     Year ended
                                                                    June 30,       June 30,
                                                                      2000           1999
                                                                      ----           ----
<S>                                                                 <C>             <C>
Equity in net income (loss) of subsidiaries ................        $   495         $(2,591)
Interest expense, net ......................................         (3,733)         (3,712)
                                                                    -------         -------
  Loss before income taxes and extraordinary gain ..........         (3,238)         (6,303)

Income tax benefit .........................................         (1,221)         (1,187)
                                                                    -------         -------
  Loss before extraordinary gain ...........................         (2,017)         (5,116)

Extraordinary gain from early retirement of debt, net of tax            660              --
                                                                    -------         -------
  Net loss .................................................        $(1,357)        $(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 and per share information)

20. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS (Continued)

                  STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY

<TABLE>
<CAPTION>
                                     Common Stock      Additional
                                     ------------        Paid-in    Accumulated
                                   Shares    Amount      Capital       Deficit      Total
                                   ------    ------      -------       -------      -----
<S>                              <C>        <C>         <C>           <C>         <C>
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
Equity contribution by AHC I
  Acquisition Corp. ........           --         --      10,571            --      10,571
Net loss ...................           --         --          --        (1,357)     (1,357)
                                 --------   --------    --------      --------    --------

Balances, June 30, 2000 ....        1,000   $     --    $ 88,935      $(13,829)   $ 75,106
                                 ========   ========    ========      ========    ========
</TABLE>

<TABLE>
<CAPTION>
                             STATEMENT OF CASH FLOWS

                                                                              Year ended     Year ended
                                                                               June 30,       June 30,
                                                                                 2000           1999
                                                                                 ----           ----
<S>                                                                           <C>             <C>
Cash flows from operating activities:
  Net loss ...........................................................        $(1,357)        $(5,116)
  Adjustments to reconcile net loss to
    net cash provided by (used in) operating activities:
    Net change in investment in subsidiaries .........................           (495)          2,591
    Amortization of original issuance discount and loan closing costs           3,992           3,722
    Deferred income taxes ............................................         (1,221)         (1,187)
    Increase in deferred charges .....................................             --            (348)
    Gain from early retirement of debt ...............................         (1,342)             --
  Changes in operating assets and liabilities:
    Income taxes .....................................................            423              --
                                                                              -------         -------
      Net cash provided by (used in) operating activities ............             --            (338)
                                                                              -------         -------
 Cash flows from financing activities:
  Dividend paid to AHC I Acquisition Corp. ...........................             --          (1,863)
                                                                              -------         -------
      Net cash provided by (used in) financing activities ............             --          (1,863)
                                                                              -------         -------

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

21. UNAUDITED QUARTERLY RESULTS OF OPERATIONS

          The  following  is a summary  of the  unaudited  quarterly  results of
     operations for Fiscal 2000 and Fiscal 1999.

<TABLE>
<CAPTION>
                                                                Successor
                             -----------------------------------------------------------------------------
                             Quarter Ended    Quarter Ended    Quarter Ended   Quarter Ended
                             September 30,    December 31,       March 31,       June 30,           Full
Fiscal 2000                      1999             1999             2000            2000             Year
                                 ----             ----             ----            ----             ----
<S>                           <C>              <C>              <C>              <C>              <C>
Net sales ............        $ 28,379         $ 20,508         $ 25,433         $ 24,243         $ 98,563
Gross profit .........          12,587            7,220            9,941            8,511           38,259
Income from operations           7,265            2,202            4,926            2,408           16,801
Interest expense, net            4,372            4,295            4,382            4,352           17,401
Net loss .............           1,281             (664)            (230)          (1,744)          (1,357)


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

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,  2000  and  1999  and the  results  of their
operations  and their cash flows for the years  ended June 30, 2000 and 1999 and
the period from  December  16, 1997  through  June 30, 1998 in  conformity  with
generally accepted accounting  principles in the United States.  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 in the United  States 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
Knoxville, Tennessee
August 3, 2000


                                      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 (the  "Predecessor")present  fairly, in all material  respects,
the results of their operations and their cash flows for the period from July 1,
1997 through December 15, 1997 in conformity with generally accepted  accounting
principles  in  the  United   States.   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 in the
United  States  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
Knoxville, Tennessee
July 31, 1998


                                      F-32
<PAGE>

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

<TABLE>
<CAPTION>
                                                                              Successor
                                                                              ---------
                                                                   June 30, 2000     June 30, 1999
                                                                   -------------     -------------
<S>                                                                   <C>               <C>
ASSETS
Current assets
Cash and cash equivalents ....................................        $   1,158         $   7,015
Accounts receivable, net .....................................           21,522            16,287
Inventory ....................................................            7,757             5,109
Income tax refund receivable .................................               --                32
Prepaid expenses .............................................               92               452
Deferred income taxes ........................................              396               400
                                                                      ---------         ---------
      Total current assets ...................................           30,925            29,295

Property, plant and equipment, net ...........................           17,097            18,511
Goodwill, net ................................................          162,472           147,990
Other intangible assets, net .................................            7,174             6,577
Deferred charges, net ........................................            4,294             5,302
Deferred income taxes ........................................              720             1,145
Other assets .................................................               88                46
                                                                      ---------         ---------
      Total assets ...........................................        $ 222,770         $ 208,866
                                                                      =========         =========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of capital lease obligation ..................        $     847         $     688
Accounts payable, trade ......................................            3,565             3,400
Accrued income taxes .........................................              301               497
Accrued compensation .........................................            3,965             2,527
Accrued interest .............................................            5,695             6,047
Accrued expenses .............................................            2,370             1,283
                                                                      ---------         ---------
      Total current liabilities ..............................           16,743            14,442

Long-term portion of capital lease obligation ................              502             1,349
Revolving credit line ........................................            9,000                --
Senior notes .................................................          107,510           115,000
Deferred income taxes ........................................            3,090             1,353
Other non-current liabilities ................................            2,399                --
                                                                      ---------         ---------
      Total liabilities ......................................          139,244           132,144

Commitments and contingencies (see Note 13)

Stockholder's equity
Preferred stock, $0.01 par, 8,700 shares authorized; no shares
    issued or outstanding ....................................               --                --
Common stock, $0.01 par, 100,000 shares authorized; 1,000
    shares issued and outstanding ............................               --                --
Additional paid-in capital ...................................          107,348           100,862
Accumulated deficit ..........................................           (7,550)           (8,045)
Accumulated other comprehensive loss .........................             (542)             (365)
Carryover basis adjustment ...................................          (15,730)          (15,730)
                                                                      ---------         ---------
      Total stockholder's equity .............................           83,526            76,722
                                                                      ---------         ---------
      Total liabilities and stockholder's equity .............        $ 222,770         $ 208,866
                                                                      =========         =========
</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, except share and per share information)

<TABLE>
<CAPTION>
                                                                  Successor                       Predecessor
                                                --------------------------------------------------------------
                                                                                  December 16,       July 1,
                                                                                     1997             1997
                                                 Year Ended      Year Ended         through          through
                                                  June 30,        June 30,         June 30,        December 15,
                                                    2000            1999             1998             1997
                                                 --------         --------         --------         --------
<S>                                              <C>              <C>              <C>              <C>
Net sales ...............................        $ 98,563         $ 85,967         $ 36,066         $ 35,186
Cost of goods sold ......................          60,304           55,199           24,518           22,809
                                                 --------         --------         --------         --------
     Gross profit .......................          38,259           30,768           11,548           12,377

Selling, general and
   administrative expenses ..............          16,980           14,500            5,587            5,703
Amortization of goodwill
   and other intangible assets ..........           5,336            4,606            2,101              568
Gain from settlement of
   litigation, net ......................            (858)              --               --               --
                                                 --------         --------         --------         --------
     Income from operations .............          16,801           11,662            3,860            6,106

Other expenses (income):
   Interest expense to stockholder(s) and
      affiliate .........................              22               --           10,785            2,143
   Interest expense, other ..............          13,646           13,028              484              503
   Management fees to stockholders
     and affiliate ......................             250              250              125              215
   Other, net ...........................              --              128              (47)              11
                                                 --------         --------         --------         --------
     Income (loss) before income taxes
       and extraordinary gain ...........           2,883           (1,744)          (7,487)           3,234

Income tax expense (benefit) ............           2,817              847           (2,033)           1,441
                                                 --------         --------         --------         --------
     Income (loss) before
       extraordinary gain ...............              66           (2,591)          (5,454)           1,793

Extraordinary gain from early
   retirement of debt, net of tax .......             429               --               --               --
                                                 --------         --------         --------         --------

   Net income (loss) ....................        $    495         $ (2,591)        $ (5,454)        $  1,793
                                                 ========         ========         ========         ========
</TABLE>

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


                                      F-34
<PAGE>

                           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 and per share information)

<TABLE>
<CAPTION>
                                                                                      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, 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 (see Note 12) ..    1,000        --       78,363       --         --            --          --        78,363
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
Equity contribution by AKI
  Holding Corp. .......................     --          --        6,486       --         --            --          --         6,486
Net income ............................     --          --         --         --          495          --          --           495
Other comprehensive loss, net
  of tax:
   Foreign currency translation
     adjustment .......................     --          --         --         --         --            (177)       --          (177)
                                                                                                                           --------
Comprehensive income ..................                                                                                         318
                                         -------    --------   --------   --------   --------      --------    --------    --------

Balances, June 30, 2000 ...............    1,000    $   --     $107,348   $   --     $ (7,550)     $   (542)   $(15,730)   $ 83,526
                                         =======    ========   ========   ========   ========      ========    ========    ========
</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, except share and per share information)

<TABLE>
<CAPTION>
                                                                               Successor                     Predecessor
                                                            --------------------------------------------------------------
                                                                                               December 16,      July 1,
                                                                                                  1997           1997
                                                            Year Ended        Year Ended         through        through
                                                             June 30,          June 30,         June 30,     December 15,
                                                               2000              1999             1998           1997
                                                               ----              ----             ----           ----
<S>                                                        <C>               <C>               <C>           <C>
   Cash flows from operating activities:
     Net income (loss) ................................    $     495         $  (2,591)        $  (5,454)    $   1,793
     Adjustment to reconcile net income (loss) to
       net cash provided by (used in) operating
       activities:
       Depreciation and amortization of goodwill
         and other intangibles ........................        9,738             8,487             3,954         2,456
       Amortization of debt discount ..................           --                --                81           233
       Amortization of loan closing costs .............          956               636             3,808           101
       Deferred income taxes ..........................        2,166               643            (2,016)         (460)
       Gain on sale of equipment ......................           --               (50)               --            --
       Gain from early retirement of debt .............       (1,004)               --                --            --
       Other ..........................................           (1)             (308)              (57)          (18)
       Changes in operating assets and liabilities:
         Accounts receivable ..........................       (2,576)           (2,737)           (4,562)        1,153
         Inventory ....................................       (2,496)           (3,031)              543            69
         Prepaid expenses, deferred charges and
           other assets ...............................          450              (627)             (453)          (62)
         Accounts payable and accrued expenses ........       (2,637)            4,511            (5,432)       (1,036)
         Income taxes .................................         (164)            5,238               767           699
                                                           ---------         ---------         ---------     ---------
         Net cash provided by (used in) operating
           activities .................................        4,927            10,171            (8,821)        4,928
                                                           ---------         ---------         ---------     ---------
   Cash flows from investing activities:
     Purchases of equipment ...........................       (2,782)           (2,856)             (514)         (807)
     Proceeds from sale of equipment ..................           --                50                --            --
     Payments for acquisitions, net of cash acquired ..      (16,164)               --          (141,403)           --
     Patents ..........................................         (150)               --                --            --
                                                           ---------         ---------         ---------     ---------

         Net cash used in investing activities ........      (19,096)           (2,806)         (141,917)         (807)
                                                           ---------         ---------         ---------     ---------

   Cash flows from financing activities:
     Payments under capital leases for equipment ......         (688)             (661)             (308)         (249)
     Net proceeds (repayments) on line of credit ......        9,000                --            (6,700)        2,362
     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 ........           --                --           (36,649)       (1,851)
     Repayment of other notes payable .................           --            (1,330)              (50)          (50)
     Dividends paid on preferred stock ................           --                --              (128)         (155)
                                                           ---------         ---------         ---------     ---------

       Net cash provided by (used in)
         financing activities .........................        8,312            (1,991)          152,379            57
                                                           ---------         ---------         ---------     ---------

   Net increase (decrease) in cash and cash equivalents       (5,857)            5,374             1,641         4,178
   Cash and cash equivalents, beginning of period .....        7,015             1,641                --           303
                                                           ---------         ---------         ---------     ---------
   Cash and cash equivalents, end of period ...........    $   1,158         $   7,015         $   1,641     $   4,481
                                                           =========         =========         =========     =========
   Supplemental information:
     Cash paid (received) during the period for:
       Interest to stockholder(s) .....................    $      22         $      --         $  11,503     $   1,146
       Interest, other ................................       13,188             6,512               214           459
       Income taxes ...................................        1,264            (5,123)             (784)        1,222

   Significant non-cash activities:
     Assets acquired under capital lease ..............    $      --         $     600         $      --     $      --
     Contribution of equity and retirement
       of senior notes ................................        6,486                --                --            --
</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 and per 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.  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.  ("AHC") 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,"  the  "Successor"  or the
     "Company").  Subsequent to the Acquisition,  AHC 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. AKI 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.

          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 and per share information)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

          One  customer  accounted  for 15.3% of net sales during the year ended
     June 30, 2000.  Two  customers  accounted for 26.8% of net sales during the
     year ended June 30,  1999.  One customer  accounted  for 13.3% of net sales
     during the period  from  December  16,  1997  through  June 30,  1998.  Two
     customers  accounted  for 35.3% of the  Predecessor's  net sales during the
     period from July 1, 1997 through December 15, 1997.

     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 the specific grades of paper utilized
     by the Company 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  is accounted  for net of  allowances  for
     doubtful  accounts.  Under  arrangements  with  certain  customers,  custom
     product  which is stored for future  delivery is recognized as revenue when
     title has passed to the customer.

     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 and per 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 a period of up to forty  years  using the
     straight-line  method.  Accumulated  amortization was $10,546 and $5,939 at
     June 30, 2000 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 covenants not to compete,  patents and
     other intangible  assets and are being amortized over their estimated lives
     using the straight-line method.  Accumulated  amortization related to these
     intangible  assets was $1,479 and $754 at June 30, 2000 and June 30,  1999,
     respectively.

     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  $85,470  and  $112,000  at June 30,  2000 and June 30,  1999,
     respectively,  compared to a carrying  value of $107,510 and $115,000 as of
     the same dates  respectively.  The  carrying  value of all other  financial
     instruments approximates fair value at June 30, 2000 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 and per 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 $51, $91,  ($52) and ($44) for the year ended June 30,
     2000,  the year ended June 30,  1999,  the period  from  December  16, 1997
     through June 30, 1998 and the period from July 1, 1997 through December 15,
     1997, respectively.

          At June 30, 2000,  short term forward  exchange  contracts  existed to
     sell Euros at an exchange rate of .8853 per U.S.  dollar and to buy British
     pound  sterling  at an  exchange  rate of  1.497  per  U.S.  dollar.  These
     contracts  have been entered into for the purpose of mitigating  short term
     foreign  exchange risk for customer orders and  receivables  denominated in
     foreign  currencies.  The notional  principle  amounts  under these foreign
     exchange  contracts  were $700 and $200,  respectively.  The fair  value of
     these foreign exchange contracts as of June 30, 2000 was not significant.

     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 $1,309,  $1,136,  $717 and $664 for the year
     ended June 30, 2000, the year ended June 30, 1999, the period from December
     16, 1997  through  June 30,  1998 and the period from July 1, 1997  through
     December 15, 1997, 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.


                                      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 and per share information)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

     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.

3. SIGNIFICANT ACQUISITIONS

          DLJMBII  and  certain  members of the  Predecessor  organized  AHC and
     Merger Corp. for purposes of acquiring the Predecessor.  Merger Corp. was a
     wholly-owned subsidiary of AHC and was initially capitalized by AHC 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 AHC (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 AHC.
     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 cost, $2,363 in non-cash consideration in the form of an
     option  to  purchase  Senior  Preferred  Stock of AHC (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 AHC.  Merger Corp.  then merged with and into
     the Predecessor and the combined entity assumed the name AKI. Subsequent to
     the  Acquisition,  AHC  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 AHC 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


                                      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 and per share information)

3.   SIGNIFICANT ACQUISITIONS (Continued)

     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.

     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 AHC
               (see Note 16) ....................................      2,363
                                                                   ---------

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

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

          Summry 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 16).


                                      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 and per share information)

3. SIGNIFICANT ACQUISITIONS (Continued)

          In December, 1999 the Company settled a dispute with the former owners
     of the Predecessor.  In connection with the settlement the Company received
     approximately  $1.2 million and has included the  settlement  amount net of
     related expenses in income from operations.

          On  September  15,  1999,  the  Company  acquired  all of  the  equity
     interests in RetCom  Holdings  Ltd.  and its  subsidiaries  ("RetCom")  for
     approximately  $12,500  and  refinanced  working  captial  indebtedness  of
     approximately $4,500 of RetCom. The acquisition was accounted for using the
     purchase method of accounting. The purchase price has been allocated to the
     assets and liabilities  acquired using estimated fair values at the date of
     acquisition   and  resulted  in  assigning   value  to  goodwill   totaling
     approximately  $19,100  which is being  amortized on a straight  line basis
     over a period of twenty years. The fair values assigned are preliminary and
     may be  revalued  at a later  date but the  change  is not  expected  to be
     material.  The  results of the  acquired  operations  are  included  in the
     financial  statements since the date of acquisition.  Pro forma results had
     RetCom  been  acquired  at the  beginning  of fiscal  1999 and 2000 are not
     determinable.

          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,
                                                 2000            1999
                                                 ----            ----

       Trade accounts receivable .....        $ 22,314         $ 16,349
       Allowance for doubtful accounts            (963)            (251)
                                              --------         --------
                                                21,351           16,098
       Other accounts receivable .....             171              189
                                              --------         --------

                                              $ 21,522         $ 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 and per share information)

5. INVENTORY

     The following table details the components of inventory:

                                              June 30,      June 30,
                                                2000          1999
                                              ------        ------
              Raw materials
                Paper ................        $3,944        $1,088
                Other raw materials ..         2,541         2,328
                                              ------        ------
                   Total raw materials         6,485         3,416
              Work in process ........         1,272         1,693
                                              ------        ------

              Total inventory ........        $7,757        $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,
     2000 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     2000          1999
                                         ------------     ----          ----

           Land .....................                   $    258      $    258
           Buildings ................   7 - 15 years       1,719         1,648
           Leasehold improvements ...   1 -  3 years         635           579
           Machinery and equipment...   5 -  7 years      21,348        19,483
           Furniture and fixtures ...   3 -  5 years       3,081         2,084
           Construction in progress..                        101           183
                                                        --------      --------
                                                          27,142        24,235
           Accumulated depreciation..                    (10,045)       (5,724)
                                                        --------      --------
                                                        $ 17,097      $ 18,511
                                                        ========      ========

          Depreciation expense amounted to $4,381, $3,881, $1,853 and $1,888 for
     the year ended June 30, 2000, the year ended June 30, 1999, the period from
     December  16, 1997  through  June 30, 1998 and the period from July 1, 1997
     through December 15, 1997, 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 and per 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,
                                                   2000            1999
                                                 -------         -------

     Machinery and equipment .................   $ 3,000         $ 3,000
     Building ................................       600             600
                                                 -------         -------
                                                   3,600           3,600
     Less accumulated depreciation ...........    (1,390)           (790)
                                                 -------         -------
                                                 $ 2,210         $ 2,810
                                                 =======         =======

         Depreciation of the assets under capital lease totaled $600, $515, $275
     and $232 for the year ended June 30,  2000,  the year ended June 30,  1999,
     the period from December 16, 1997 through June 30, 1998 and the period from
     July 1, 1997 through December 15, 1997, respectively.  Future minimum lease
     payments under the remaining leases are as follows:

                                                 Payment         Interest
                                                 -------         -------

                    2001......................   $   948         $   100
                    2002......................       529              27
                                                 -------         -------
                                                 $ 1,477         $   127
                                                 =======         =======

7. LINE OF CREDIT

          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,  2000,  the  Company's  borrowing  base  was  approximately
     $24,128.  Interest on amounts borrowed accrue at a floating rate based upon
     either prime or LIBOR (10.25% and 8.50% at June 30, 2000 and June 30, 1999,
     respectively).  The  weighted  average  interest  rate  on the  outstanding
     balance under the Credit  Agreement was 9.12%,  8.51%,  9.25% and 9.50% for
     the year ended June 30, 2000, the year ended June 30, 1999, the period from
     December  16, 1997  through  June 30, 1998 and the period from July 1, 1997
     through December 15, 1997, 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 and per 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, 2000 and June 30, 1999. These
     fees totaled $69,  $111,  $59 and $30 for the year ended June 30, 2000, the
     year ended June 30,  1999,  the period from  December 16, 1997 through June
     30,  1998 and the  period  from July 1, 1997  through  December  15,  1997,
     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, 2000, the Company
     was in compliance with all debt covenants.

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.  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.  The amounts due under
     the  Subordinated  Loan  Agreements  were  subsequently  retired  upon  the
     acquisition of the Predecessor as discussed in Note 3.

          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 and per share information)

8. LOANS PAYABLE TO STOCKHOLDER (Continued)

          In May 2000, the Company signed a promissory note payable to AHC which
     allows the Company to borrow up to $10 million at such  interest  rates and
     due as agreed upon by the Company  and AHC.  At June 30,  2000,  no amounts
     were outstanding under the promissory note.

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.  During
     fiscal  2000,  AHC  purchased  $7,490 of the  Senior  Notes for  $6,486 and
     recognized a gain, net of income taxes,  of  approximately  $429. The notes
     were  contributed to Holding and Holding  contributed the notes to AKI. The
     notes were subsequently retired.

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 and per 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.  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,  AHC issued $30,000 of Floating
     Rate Notes,  $50,279 of Mandatorily  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%.  Interest  was payable  quarterly  and could be settled
     through the issuance of additional Floating Rate Notes through December 15,
     2009, the maturity  date, at the  discretion of AHC. The original  issuance
     discount of $5,389 was being amortized using the effective  interest method
     over the life of the Floating Rate Notes.  The  unamortized  balance of the
     original  issue  discount at June 30, 1999 was $4,740.  On November 1, 1999
     AHC issued Amended and Restated Notes totaling  $35,500 in exchange for the
     Floating Rate Notes.  The Amended and Restated  Notes bear a fixed interest
     rate of  approximately  16% per annum and mature on  December  15, 2009 and
     provide  for the  payment  of  stipulated  early  redemption  premiums.  In
     connection  with the exchange the  unamortized  original issue discount was
     expensed by AHC. The Senior  Preferred  Stock  accretes in value at 15% per
     annum and must be redeemed by December 15,  2012.  The Amended and Restated
     Notes and Senior Preferred Stock are general unsecured obligations of AHC.

          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 AHC to
     the Company in exchange for 1,000  shares of the  Company's  Common  Stock.
     Subsequent to the initial capitalization of the Company, AHC contributed $1
     and all of its ownership  interest in the Company to Holding for all of the
     outstanding equity of Holding.

          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  $13,368 and
     $20,349 at June 30,  2000 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


                                      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 and per share information)

12. INITIAL CAPITALIZATION (Continued)

     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 contain certain customary convenants  including  restrictions on
     the  declaration and payment of dividends and limitations on the incurrence
     of additional  indebtedness.  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.

          AHC and  Holding  have no other  operations  other  than the  Company.
     Absent  additional  financing by AHC 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 $589, $338, $198 and $192
     for the year ended June 30, 2000,  the year ended June 30, 1999, the period
     from  December  16, 1997  through June 30, 1998 and the period from July 1,
     1997 through December 15, 1997, respectively. Future minimum lease payments
     under the leases total $256 in 2001 and none thereafter.

     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 $500, $500, $516 and
     $437 under this  agreement for the year ended June 30, 2000, the year ended
     June 30, 1999,  the period from December 16, 1997 through June 30, 1998 and
     the period from July 1, 1997 through December 15, 1997,  respectively.  The
     Company has paid $5,076 in cumulative royalty payments under this agreement
     through June 30, 2000.


                                      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 and per share information)

13. COMMITMENTS AND CONTINGENCIES (Continued)

          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 $625, $575, $284
     and $241 under this  agreement  for the year ended June 30, 2000,  the year
     ended June 30,  1999,  the period from  December  16, 1997 through June 30,
     1998  and  the  period  from  July  1,  1997  through  December  15,  1997,
     respectively.

     Employment Agreements

          The Company has employment  agreements with certain executive officers
     with terms through June 30, 2001 and 2002. Such agreements provide for base
     salaries  totaling $890 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.  The  employment
     agreements  also  provide  severance  benefits  of up to two  years of base
     salary if the officers' services are terminated under certain conditions.

          During fiscal 1999, two executive officer's  employment was terminated
     with the  Company.  In  accordance  with the terms of the 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 and subsequently paid in fiscal 2000.

     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.

     Printing Services Agreement

          In  connection  with the RetCom  acquisition,  AKI entered into a five
     year Printing Services  Agreement with a former  shareholder of RetCom. The
     Printing Services  Agreement requires annual purchases of printing services
     totaling  $5,000  and a 15%  charge  on the  amount of any  shortfall.  The
     present value of the costs related to the estimated shortfall over the life
     of the  Printing  Services  Agreement  was  recorded as a liability  in the
     RetCom purchase accounting.


                                      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 and per 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  $251,  $201,  $113 and $95 for the year
     ended June 30, 2000, the year ended June 30, 1999, the period from December
     16, 1997  through  June 30,  1998 and the period from July 1, 1997  through
     December 15, 1997, 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 $215,
     $204, $81 and $80 for the year ended June 30, 2000, the year ended June 30,
     1999,  the period  from  December  16, 1997  through  June 30, 1998 and the
     period from July 1, 1997 through December 15, 1997, respectively.

15. INCOME TAXES

          The Company is included in the consolidated  federal income tax return
     filed by AHC for periods  subsequent  to December  15,  1997.  Income taxes
     related to the Company for the period from  December  16, 1997 through June
     30, 2000 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
     and extraordinary gain includes the following components:

<TABLE>
<CAPTION>
                                                                 December 16,    July 1,
                                                                     1997         1997
                                        Year Ended   Year Ended     through      through
                                         June 30,     June 30,     June 30,   December 15,
                                           2000         1999         1998         1997
                                           ----         ----         ----         ----
<S>                                      <C>          <C>           <C>          <C>
Income (loss) before income taxes
 and extraordinary gain:
  United States .................        $ 2,428      $(2,266)      $(8,169)     $ 3,298
  Foreign .......................            455          522           682          (64)
                                         -------      -------       -------      -------
                                         $ 2,883      $(1,744)      $(7,487)     $ 3,234
                                         =======      =======       =======      =======
</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 and per share information)

15.  INCOME TAXES (Continued)

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

<TABLE>
<CAPTION>
                                                                December 16,       July 1,
                                                                    1997            1997
                                  Year Ended    Year Ended         through         through
                                   June 30,      June 30,         June 30,      December 15,
                                     2000          1999             1998            1997
                                     ----          ----             ----            ----
Current expense (benefit):
<S>                                <C>            <C>             <C>             <C>
  Federal .................        $   480        $    --         $    --         $ 1,623
  Foreign .................            171            204             104              --
  State ...................             --             --            (121)            278
                                   -------        -------         -------         -------
                                       651            204             (17)          1,901
                                   -------        -------         -------         -------
Deferred expense (benefit):

  Federal .................          1,740            569          (1,900)           (376)
  Foreign .................             --             --             162             (25)
  State ...................            426             74            (278)            (59)
                                   -------        -------         -------         -------
                                     2,166            643          (2,016)           (460)
                                   -------        -------         -------         -------

                                   $ 2,817        $   847         $(2,033)        $ 1,441
                                   =======        =======         =======         =======
</TABLE>

          The  significant  components  of deferred  tax assets and deferred tax
     liability at June 30, 2000 and 1999, were as follows:

<TABLE>
<CAPTION>
                                                 June 30, 2000              June 30, 1999
                                                 -------------              -------------
                                            Current    Noncurrent        Current    Noncurrent
                                            -------    ----------        -------    ----------
<S>                                         <C>          <C>             <C>          <C>
Deferred income tax assets:
    Accrued expenses .................      $   215      $    --         $   308      $    --
    Allowance for doubtful accounts...          181           --              92           --
    Net operating loss carryforwards..           --          720              --        3,132
                                            -------      -------         -------      -------
                                                396          720             400        3,132
Deferred income tax liability:
    Property, plant and equipment ....           --        3,090              --        3,340
                                            -------      -------         -------      -------
                                            $   396      $(2,370)        $   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 and per share information)

15. INCOME TAXES (Continued)

          The income tax provision recognized by the Company for the years ended
     June 30, 2000 and 1999 and for the period from  December  16, 1997  through
     June 30,  1998 and by the  Predecessor  for the  period  from  July 1, 1997
     through  December 15, 1997 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>
                                                                           December 16,        July 1,
                                                                              1997              1997
                                            Year Ended      Year Ended       through           through
                                             June 30,        June 30,       June 30,        December 15,
                                               2000            1999           1998              1997
                                               ----            ----           ----              ----
<S>                                          <C>            <C>             <C>             <C>
Computed tax provision (benefit)
  at the statutory rate .............        $   980        $  (593)        $(2,546)        $ 1,100
State income tax provision (benefit),
  net of federal effect .............            281             49            (263)            145
Nondeductible expenses ..............          1,540          1,364             720             193
Other, net ..........................             16             27              56               3
                                             -------        -------         -------         -------

                                             $ 2,817        $   847         $(2,033)        $ 1,441
                                             =======        =======         =======         =======
</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  losses in prior years the Company has recorded a
     long-term  deferred tax asset of $720  reflecting  cumulative net operating
     loss  carryforwards  available  to offset  future state  taxable  income of
     approximately $10,996 at June 30, 2000. These cumulative net operating loss
     carryforwards  expire in  varying  amounts  through  2019.  Realization  is
     dependent on generating sufficient state 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.

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.


                                      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 and per share information)

16. STOCK OPTIONS (Continued)

     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.

     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 AHC 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).

     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 AHC
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  AHC 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 AHC the funds to redeem the
80,000 shares of Senior Preferred Stock, Holding issued AHC a dividend of $1,863
in cash on such date.

     Subsequent  to the  Acquisition,  AHC  adopted  the 1998 Stock  Option Plan
("Option  Plan") for certain  employees  and  directors of AHC and any parent or
subsidiary of AHC. The Option Plan authorizes the issuance of options to acquire
up to 1,650,000  shares of AHC Common Stock.  The Board of Directors  determines
the terms of each individual options grant. The exercise price for each grant is
required  to be set at least  equal to the fair  market  value  per share of AHC
provided that the exercise price shall not be less than $1.00 per share. Options
vest over  periods  ranging  from  three to eight  years.  Certain  options  are
eligible  for  accelerated  vesting  based on  targeted  EBITDA.  Options may be
exercisable for up to ten years.


                                      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 and per share information)

16. STOCK OPTIONS (Continued)

          On June 17,  1998,  AHC granted an officer of the  Company  options to
     purchase  32,500  shares of AHC Common Stock at 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.

         A summary of AHC stock option activity and related  information for the
year ended June 30, 2000 follows:

<TABLE>
<CAPTION>
                                                                                 Weighted
                                                                                  Average
                                                                                 Exercise
                                                                   Options         Price
                                                                   -------         -----
<S>                                                                <C>            <C>
         Outstanding, beginning of year.....................            -         $     -
              Granted.......................................     1,519,917           1.00
              Exercised.....................................            -               -
              Forfeited.....................................       (10,467)          1.00
                                                                -----------       -------
         Outstanding, end of year...........................     1,509,450        $  1.00
                                                                ==========        =======
         Exercisable, end of year...........................       273,668        $  1.00
                                                                ==========        =======
         Weighted average remaining
              contractual life..............................             9.5 years
</TABLE>

          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
     income  (loss) for the years  ended June 30,  2000 and 1999 would have been
     $444 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 ranging from 6.3% to 6.9%,  estimated life of five
     years and dividend rate of 0.0%. The weighted average fair value at date of
     grant of options granted during 2000 was approximately $0.27 per option.

17. RELATED PARTY TRANSACTIONS

          The Successor  made payments to an affiliate of DLJMBII for management
     fees of $250,  $250 and $125 for the year  ended  June 30,  2000,  the year
     ended June 30, 1999 and the period from  December 16, 1997 through June 30,
     1998, respectively.

          The Predecessor made payments to a company controlled by a stockholder
     of the  Predecessor  of $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 $55 for the period
     from July 1, 1997 through December 15, 1997 for management fees.


                                      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 and per share information)

18. 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:

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
Year ended June 30, 2000 .....................     84,379     14,184    98,563

Long-lived assets:

June 30, 1999 ................................    179,464        107   179,571
June 30, 2000 ................................    198,100         87   198,187


                                      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 and per share information)

19. UNAUDITED QUARTERLY RESULTS OF OPERATIONS

     The following is a summary of the unaudited quarterly results of operations
for Fiscal 2000 and Fiscal 1999.

<TABLE>
<CAPTION>
                                                             Successor
---------------------------------------------------------------------------------------------------------
                             Quarter Ended   Quarter Ended    Quarter Ended   Quarter Ended
                             September 30,   December 31,       March 31,       June 30,           Full
     Fiscal 2000                 1999            1999             2000            2000             Year
                                 ----            ----             ----            ----             ----
<S>                           <C>             <C>              <C>             <C>              <C>
Net sales ............        $ 28,379        $ 20,508         $ 25,433        $ 24,243         $ 98,563
Gross profit .........          12,587           7,220            9,941           8,511           38,259
Income from operations           7,265           2,202            4,925           2,409           16,801
Interest expense, net            3,348           3,393            3,479           3,448           13,668
Net income (loss) ....           1,969            (713)             376          (1,137)             495

</TABLE>
<TABLE>
<CAPTION>
                                                             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>


                                      F-57