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, 2001

                                       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(g) 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  17, 2001,  1,000 shares of common stock of AKI Holding  Corp.,
$0.01 par value, were outstanding and 1,000 shares of common stock of AKI, Inc.,
$0.01 par value, were outstanding.

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

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

                      DOCUMENTS INCORPORATED BY REFERENCE:

                                      None.




<PAGE>




     As used within this report, the term "company" refers to AKI Holding Corp.,
a Delaware  corporation,  and its subsidiaries,  including AKI, Inc., a Delaware
corporation ("AKI"). 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 that utilizes 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,  using vehicles such as magazine inserts,  catalog
inserts, remittance envelopes,  statement enclosures,  blow-ins, direct mail and
point-of-sale handouts and displays.

     We are a fully integrated multi-sensory advertising company, conducting our
business  under the Arcade  Marketing  Inc.  name.  We believe  that we are well
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.  We believe
that  our  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,  we now have a
diverse  portfolio  of  alternative  scent  sampling  systems,  all designed for
cost-effective  mass distribution,  and we continue to be a leading innovator in
sampling system advertising.

     In  recent  years,  we  have  expanded  our  sampling  system  business  by
developing  new  technologies,   specifically  BeautiSeal(R),   LipSeal(TM)  and
BeautiTouch(R),  for the sampling of skincare products, foundation, lipstick and
PowdaTouch(R) for the sampling of cosmetic powders. 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

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cost-effective  means of reaching  consumers in their homes on a mass scale with
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 other related
investors (collectively,  "DLJMBII") and certain members of our 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 August 31, 2001, DLJMBII
owned approximately 98.8% of the outstanding common stock of AHC.

     On November 6, 2000,  Credit  Suisse Group  completed the merger of Diamond
Restructuring Corp., an indirect wholly owned subsidiary of Credit Suisse Group,
with and into Donaldson,  Lufkin & Jenrette,  Inc.  ("DLJ").  As a result of the
merger,  DLJ is now an indirect  subsidiary of Credit Suisse First Boston,  Inc.
("CSFB").  All  references  to DLJ in this  annual  report on Form 10-K refer to
entities now controlled by or affiliated with CSFB.

     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  $4.5  million  indebtedness  of  RetCom  and its  subsidiaries.  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) and Aromalacquer(TM).

Products

     We offer a broad  and  diversified  portfolio  of  innovative,  interactive
sampling  systems and  advertising  formats  for the  fragrance,  cosmetics  and
personal care markets as well as other  consumer  products  markets and the food
and beverage markets.  Our major  technologies are described below,  including a
description  of the patent  protection of each product  technology.  Each of our
sample  systems is 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, consumer
                                developed    secret       products
------------------ ------------ ------------ ------------ ---------------------
ScentStrip(R)Plus   mid 1980's  Internally   Proprietary  Fragrance, consumer
                                developed    secret       products
------------------ ------------ ------------ ------------ ---------------------
DiscCover(R)       1994         Licensed     Patented     Fragrance, consumer
                                                          products, personal
                                                          care, food & beverage
------------------ ------------ ------------ ------------ ---------------------

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------------------ ------------ ------------ ------------ ---------------------
ScentSeal(R)       1995         Acquired     Patented     Fragrance and
                                                          personal care
------------------ ------------ ------------ ------------ ---------------------
LiquaTouch(R)      1997         Internally   Patent       Fragrance, skin care
                                developed    pending
------------------ ------------ ------------ ------------ ---------------------
MicroDot(TM)       1993         Acquired     Proprietary  Fragrance
                                             secret
------------------ ------------ ------------ ------------ ---------------------
Aromalacquer(TM)   1997         Acquired     Proprietary  Fragrance, food &
                                             secret       beverage and
                                                          consumer products
------------------ ------------ ------------ ------------ ---------------------
Microfragrance(R)  1978         Acquired     Proprietary  Fragrance, food &
Scratch `n Sniff                             secret       beverage and
                                                          consumer products
------------------ ------------ ------------ ------------ ---------------------
BeautiSeal(R)      1997         Internally   Patented     Cosmetics, skin care
                                developed                 and personal care
------------------ ------------ ------------ ------------ ---------------------
PowdaTouch(R)      1997         Internally   Patented     Cosmetic powders
                                developed
------------------ ------------ ------------ ------------ ---------------------
LipSeal(TM)        1998         Internally   Patented     Lipsticks
                                developed
------------------ ------------ ------------ ------------ ---------------------
TouchDown(R)       1999         Internally   Proprietary  Nail Enamel
Nail Color                      developed    secret
Sampler
------------------ ------------ ------------ ------------ ---------------------
BeautiTouch(R)     1999         Internally   Patent       Cosmetics, skin care
Multi-well                      developed    pending      and personal care
Sampler
------------------ ------------ ------------ ------------ ---------------------


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 annual sales. While ScentStrip(R) 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
enabled us to maintain a  competitive  advantage  and affirm our  position as an
innovator in the sampling  industry.  Our products  have been used in most major
new fragrance launches in recent years that have utilized sampling systems.

     o  ScentStrip(R):  A  proprietary  technology  introduced by our Company in
     1979, is a microencapsulated  essential oil deposited between two layers of
     paper  which  "snap"  open  to  release  a  quality  fragrance   rendition.
     ScentStrip(R)  can deliver  quality  aroma  renditions  of fine  fragrance,
     personal care, sun care and consumer  products.  ScentStrip(R) is available
     in many  formats,  including  magazine  and  catalogue  inserts,  blow-ins,
     enclosures,  remittance  envelopes,  among  others,  all  of  which  can be
     customized to include multiple fragrances in ScentStrip(R) form.

     o ScentStrip(R)  Plus: Combines the traditional  ScentStrip(R)  format with
     perfume  "pearls" in a proprietary  technology  wherein powder is deposited
     between two layers of paper.


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<PAGE>

     o  DiscCover(R):  A  peel-and-reveal,  non-encapsulated  patented  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. This technology keeps fragrance  locked-in until "lift off"
     with no  pre-release  and can be utilized for not only fine  fragrances but
     can  deliver a quality  aroma for a variety of  personal  care  products in
     addition to food and beverage products.

     o ScentSeal(R):  A patented,  pouch-like,  pressure  sensitive  format that
     incorporates  a product  rendition  deposited  between  two  layers of foil
     laminate. When pulled open, ScentSeal(R) reveals a moist, alcohol-based gel
     applicable to skin for  wearable-trial.  ScentSeal(R)  can contain  quality
     fragrance,  fragrance  ancillary or personal care product  renditions.  The
     product offers  customers the  opportunity to deliver moist,  on-skin trial
     via its "wet  delivery  system" and is  available  in many shapes and sizes
     compatible with brand image and creative design.

     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.   LiquaTouch(R)  is
     hermetically sealed with no pre-release and delivers a spill proof trial of
     any alcohol  formulated  fragrance  product.  Available in a single or dual
     chamber 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.

     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.  MicroDot(TM) is available as a stand-alone
     handout or a pressure sensitive label affixable to virtually any media.

     o  Aromalacquer(TM):   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 Microfragrance(R)  Scratch `n Sniff:  Microfragrance capsules are applied
     to paper or  stickers  which  affix to nearly any  surface,  delivering  an
     accurate aroma  rendition of any product where scent is part of the message
     such as flowers,  shampoos,  etc.  When the sampling  system is  scratched,
     capsules  release  a  quality  aroma   rendition.   Through  a  proprietary
     relationship with the 3M Company,  the product is also available applied to
     the familiar 3M  Post-it(R)  Notes to deliver an aroma  rendition of almost
     any scent.


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<PAGE>



Other Sampling Systems

     Our portfolio also includes non-fragrance  sampling system products,  which
represent a growing percentage of our sales. These sampling systems are utilized
to sample cosmetics and beauty care products  including  foundation,  creams and
lotions,  lipstick,  powders and nail enamel. All of these sampling systems have
been designed to meet U.S.  Postal Service  approval for  subscription  magazine
periodical rates.

     o BeautiSeal(R):  A proprietary,  patented  technology is a sampling system
     for  quality  renditions  of  creams,  lotion  or gel  products  which  are
     deposited  between the foil  layers of a  heat-sealed,  pressure  sensitive
     well.  BeautiSeal(R)  is  hermetically  sealed and  designed  to  withstand
     significant  pressure  and is designed for US Postal  Service  approval for
     subscription   magazine   periodical   rates.   BeautiSeal(R)  can  contain
     renditions  of  liquid  foundation,  as well  as  creams,  lotions  and gel
     treatment and personal care products such as moisturizers,  eye treatments,
     body,  hand and foot lotions and hair gel, among others.  BeautiSeal(R)  is
     ideal for magazine and catalogue  inserts,  bind-in cards,  direct mailers,
     brochures and in-store handout and regimen cards.

     o PowdaTouch(R):  A proprietary,  patented  technology is a sampling system
     wherein cosmetic powder is deposited  between two layers of paper,  die-cut
     with a tab that lifts up to reveal the powder rendition area. PowdaTouch(R)
     can contain quality renditions of eye shadow,  powder blush, face powder or
     bronzer.  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.
     PowdaTouch(R) is ideal for magazine and catalogue  inserts,  blow-ins,  and
     bind-in cards among others and is designed for US Postal  Service  approval
     for  subscription  magazine  periodical  rates.  Management  estimates that
     PowdaTouch(R)  sampling  systems  can be produced  approximately  ten times
     faster than currently competing products.

     o LipSeal(TM):  A proprietary,  patented  technology,  is a sampling system
     wherein  a   lipstick   rendition   is   deposited   into  the  well  of  a
     pressure-sensitive  format that easily pulls apart to offer  user-friendly,
     hygienic trial.  LipSeal(TM) offers trial of any lipstick shade, finish and
     texture in any lipstick formula, including long-lasting formulas.

     o TouchDown(R) Nail Color Sampler: A proprietary technology,  is a die-cut,
     pressure-sensitive, nail-shaped "chip" printed to match nail enamel shades.
     TouchDown(R)  can deliver  trial of up to 2 nail enamel  shades on a single
     carrier.  TouchDown(R)  does not mare the  user's  manicure  and  leaves no
     residue when trialed by the consumer.

     o  BeautiTouch(R)   Multi-Well  Sampler:  A  proprietary,   patent  pending
     technology, is a sampling system for cream, lotion, lipstick or gel product
     renditions  which are  deposited  into  individually-sealed,  foil laminate
     "pouches."  Heat-sealed  "pouches" which share a common backing easily pull
     apart to  provide  trial of  multiple  shades or  formulas.  BeautiTouch(R)
     offers ideal, multiple shade demonstration by delivering trial


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     of 8,  10,  12 or  more  foundation  shades  on a  single  carrier  with no
     cross-contamination.

Other Products & Services

     o Arcade Direct:  Our Company  offers a full range of creative  services to
     our  customers in the cosmetic and fragrance  industry,  as well as a niche
     presence in various  industries  that include retail and specialty  stores,
     fashion catalogues, buying offices, direct marketers, hotels and spas. This
     dedicated  division offers complete turnkey marketing and creative services
     up to and including electronic production and final video production.

     o  Arcade  Product   Technologies:   This  division   employs   proprietary
     chemistries to manufacture and market microencapsulated ingredients used in
     the formulation of various  personal care products.  Fragrance oil, whether
     customer-supplied  or selected from our Company's  extensive aroma library,
     can be encapsulated using these proprietary  systems and supplied in powder
     form, resulting in a scent that can be renewed as the capsules are sheared.
     In addition,  the  technologies  can be used to encapsulate a wide range of
     cosmetic  formulation  materials which provide  consumers with  additional,
     longer-lasting  benefits due to ingredients  that  re-release over time and
     which enhance texture, application and overall product stability.

     o Arcade Consumer Communications:  This division specializes in electronic,
     multi-media, multi-sensory devices primarily for use at point-of-sale.

Formats

     We produce 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
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 sampling systems and
are the most commonly produced among our formats.

     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.  We have the ability to create
and produce  special  formats,  to custom imprint with store  information and to
incorporate most of our sampling systems.

     Remittance Envelopes:  Remittance envelopes,  which are inserted into store
statement mailings, can be customized with a store logo and can accommodate many
of our sampling systems. We believe that we are the only company in the sampling
industry that can produce remittance  envelopes in-house.  Remittance  envelopes
can be produced with or without our


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sampling systems.  Remittance envelope production,  which is a highly customized
service business, reinforces our 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 design and has become the leading industry format.

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

     Direct Mail:  Full color,  direct mail formats can be produced in a variety
of sizes,  weights and designs,  including  single,  double and triple folds, as
well as standard and oversized postcards.  Direct mailers can be customized with
store or  manufacturer  logo and can  accommodate  virtually all of our sampling
technologies.

     In-Store  Handouts:  We have 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 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 sampling systems and items such as postcards,  stickers,
wristbands,  bookmarks  and  CD  inserts.  Our  other  technologies,   including
LiquaTouch(R), BeautiSeal(R) and PowdaTouch(R) are becoming more widely accepted
for in-store handouts and an alternative to more traditional sampling methods.

Intellectual Property

     We  currently  hold  patents  covering the  proprietary  processes  used to
produce  many of our  products  in both the U.S.  and abroad and have  submitted
applications  for  many  of our  manufacturing  processes.  We  have  trademarks
registered in the United States and we have also filed and registered trademarks
in over 15  countries  around the world,  including  countries  in the  European
Union, Australia, Japan and Brazil.

     We have ongoing research  efforts and expect to seek additional  patents in
the future  covering  results  of our  research.  We cannot  assure you 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 or held to be invalid or unenforceable.


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

Customers

     We sell our 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  (French
Fragrances Inc.), Estee Lauder, Inc., Giorgio Beverly Hills,  Colgate-Palmolive,
Victoria Secret Beauty and The Procter & Gamble  Company.  Our top ten customers
accounted for  approximately  62% of sales in fiscal 2001.  Estee Lauder was the
only  customer  that  accounted  for 10% or more of net sales in fiscal 2001. We
believe that our technical  expertise,  manufacturing  reliability  and customer
support  capabilities have enabled us to develop strong  relationships  with our
customers.  We employ sales and  marketing  personnel  who possess the requisite
technical backgrounds to communicate effectively with both prospective customers
and  our   manufacturing   personnel.   Historically,   we  have  had  long-term
relationships with our major customers.

Sales and Marketing

     Our sales and  marketing  efforts are  organized  geographically.  The U.S.
sales group is supervised by our Senior Vice President of U.S. Sales,  while our
European sales executives are based in Paris, France and London, England and are
managed by an executive based in Paris,  France. We also have representatives in
Australia,  Brazil,  Canada and Japan.  Each sales  executive  is dedicated to a
certain  number of identified  customers.  In addition,  these sales efforts are
supported by 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 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.  We also
provide press coverage in industry trade publications, attend industry seminars,
advertise in trade publications and sponsor promotional pieces. In addition,  we
focus our sales efforts  toward three  principal  groups  within our  customers'
organizations  that  management  believes  influence our  customers'  purchasing
decisions:

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

     o product  development,  which approves our sampling  system  rendition and
     conducts stability testing; and

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


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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 to introduce a new
fragrance.  Our executives  routinely  introduce new sampling system formats and
ideas based on our  technologies to the marketing  departments of our customers.
Our in-house creative and marketing  expertise,  as well as our complete product
line  provides  customers  with maximum  flexibility  in  designing  promotional
programs.

Manufacturing

     Our manufacturing  processes are highly technical and largely  proprietary.
Our 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.   Our  manufacturing
processes are composed of one or more of the following:

     o  formulating  cosmetic and  fragrance  product  renditions  in our slurry
     laboratories;

     o printing advertising pages and other media;

     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; and

     o affixing our label products onto a preprinted advertising carrier.

     ISO 9001  Registration:  During  2001 the  International  Organization  for
Standardization   awarded  our  Company's  three  manufacturing   facilities  in
Chattanooga, Tennessee with ISO 9001 registration. These facilities produce many
of the Company's  proprietary,  patented and patent pending products, as well as
several of our other sampling systems. The registration was awarded following an
extensive  examination  incorporating  20 elements that outline the requirements
for documenting and implementing our Company's overall philosophy as it pertains
to quality,  its policies,  systems and  procedures.  The ISO standards serve as
guidelines for businesses  interested in assuring that their processes result in
products that reflect the highest level of quality.  The ISO 9001 section of the
series  applies to  organizations  that design,  develop,  produce,  install and
service products.

     Management  believes that our formulation  capabilities are the best in the
cosmetics and fragrance  sampling  industry.  The formulation  process is highly
complex  because  we try 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 our
customers.  We have more than 125 different,  proprietary  formulations  that we
utilize in  replicating  different  characteristics  of over 500  fragrances  to
obtain a  customer-approved  rendition.  A  number  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


                                       9

<PAGE>


formula  that the  customer has  pre-approved.  Formulation  is conducted in our
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  digital  prepress
department utilizes state-of-the-art  technology in receipt of customer-supplied
computer disks and produces this material directly on to our printing plates. We
have the  capability to produce high quality  printed  materials,  including the
covers  of major  fashion  magazines,  in  connection  with  fragrance  sampling
systems.

     Our formulated offset paper samplers  (ScentStrip(R),  ScentStrip(R)  Plus,
PowdaTouch(R))  are produced in our primary  facility  where we carefully  apply
microencapsulated  slurry onto the paper during the  printing  process and, in a
continuous  in-line  operation,  fold, cut and trim the samplers for packing.  A
24-hour quality control function and hourly  accountability  provide significant
value  to our  customers'  product  development  personnel,  who  are  typically
responsible for sample system quality. Our formulated letterpress or flexo label
samplers (DiscCover(R),  BeautiSeal(R), LipSeal(TM), LiquaTouch(R)) are produced
on specially modified label and finishing  equipment in our second facility.  In
addition to the patents pending on a number of our manufacturing  processes,  we
use 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 production.

     We also have  agreements  with  North  American,  European  and  Australian
printers and labelers,  which we contract with to produce some materials for our
customers.  These arrangements are typically utilized when foreign  distribution
is required or demand exceeds our internal capacity.  Each of these arrangements
is protected by non-competition agreements.

     We have  been  awarded  The  Procter  &  Gamble  Pinnacle  Award,  which is
presented  to  companies  as   recognition   for  having  met  certain   quality
requirements and having demonstrated  outstanding quality assurance. We are 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
our products have been readily  available from numerous  suppliers and have been
purchased  by our  Company  at  prices  that we  believe  are  competitive.  Our
encapsulated paper products utilize specific grades of paper that are subject to
comprehensive  evaluation and  certification by us for quality,  consistency and
fit. We have not experienced any material supply  shortages in the past, nor are
any anticipated.

Competition

     Our competitors,  some of whom have substantially greater capital resources
than us,  are  actively  engaged in  manufacturing  products  similar  to, or in
competition with, our products. Competition in our markets is based upon product
quality,  product  technologies,  customer  relationships,  price  and  customer
service. Our principal competitors in the printed fragrance and

                                       10

<PAGE>


cosmetic samplers market are Webcraft,  a subsidiary of Vertis,  Inc.,  Orlandi,
Inc., Delta Graphics,  Inc.,  Nord'est,  Marietta Corp.,  Klocke, Color Prelude,
Rotocon,  Ascent and Appliquesence.  We also compete with numerous manufacturers
of  miniatures,  vials,  packets,  sachets,  blister packs and scratch and sniff
products.  In addition,  some cosmetics  companies produce sampling products for
their own cosmetic  products.  We also compete 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 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
policy is to comply with all legal  requirements  of  applicable  environmental,
health  and  safety  laws and  regulations.  We  believe  that we are in general
compliance  with such  requirements  and have  adequate  professional  staff and
systems in place to remain in  compliance,  although  there can be no assurances
that this is the case. We consider  costs for  environmental  compliance to be a
normal cost of doing business and include such costs in pricing decisions.

Employees

     As of August 31, 2001, we employed 433 persons,  which  included 260 hourly
and 173  salaried  and  management  personnel.  Substantially  all of our hourly
employees are  represented by the Graphics  Communications  International  Union
(GCIU) local 197-M.  Management  considers  our  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.


                                       11

<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.

     We have substantial  indebtedness and debt service obligations.  As of June
30, 2001, Holding and AKI had total  consolidated  indebtedness of approximately
$127.9 million and $104.0 million,  respectively. As of August 31, 2001, AKI had
outstanding borrowings of $4.9 million under its revolving credit agreement with
Heller  Financial,  Inc. and $0.4 million  under a promissory  note with AHC. In
addition,  as of such date, borrowings of up to approximately $15.1 million were
available  under the credit  agreement,  subject to  specified  conditions.  The
indenture  governing  Holding's 13 1/2% Senior Discount  Debentures due 2009 and
the  indenture  governing  AKI's 10 1/2%  Senior  Notes due 2008 and the  credit
agreement permit our Company and its restricted subsidiaries,  as defined in the
indentures,  in each case, to incur additional indebtedness if we meet specified
requirements.

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

     o our  level  of  indebtedness  could  restrict  our  ability  to  increase
     manufacturing capacity;

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

     o a portion of our 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;

     o incur additional indebtedness and issue preferred stock;

     o create liens;

     o incur dividend and other payment restrictions affecting subsidiaries;


                                       12

<PAGE>


     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 us to maintain  specified  financial
ratios and satisfy  specified  financial  condition  tests.  Our ability to meet
those  financial  ratios and tests can be affected by events beyond our control,
and there can be no assurance that we will meet those tests.

To service our 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  our 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  control.  We
anticipate  that our operating  cash flow,  together with  available  borrowings
under the credit  agreement,  will be sufficient to meet our operating  expenses
and to service our debt  requirements  as they become  due.  However,  if we are
unable to service  our  indebtedness,  we may be required to take action such as
reducing or delaying  capital  expenditures,  selling assets,  restructuring  or
refinancing our 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 we are  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, 2001,  Holding's  subsidiaries had $104.0 million of
indebtedness and $23.7 million of other outstanding liabilities (including trade
payables,  accrued  liabilities and deferred taxes).  As of August 31, 2001, AKI
had outstanding  borrowings of $4.9 million under the credit  agreement and $0.4
million  under a promissory  note with AHC. In addition,  as of August 31, 2001,
borrowings of up to approximately  $15.1 million were available under the credit
agreement,  subject to specified conditions.  All such indebtedness  effectively
ranks senior to Holding's debentures. At June 30, 2001, Holding had $0.1 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.


                                       13

<PAGE>


     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 affect 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,  the 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  financial
condition  and the  value of the  debentures  and the notes  will be  materially
adversely  affected  and could be  eliminated.  As of August 31,  2001,  AKI had
outstanding  borrowings  of $4.9 million  under the credit  agreement  and could
borrow up to approximately $15.1 million under the credit agreement,  subject to
specified conditions.

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 sampling  systems are approved by the U.S. Postal Service for inclusion
in  subscription  magazines  mailed at periodical  postage  rates.  Our sampling
systems  have  a  significant  cost  advantage  over  other  competing  sampling
products,  such as  miniatures,  vials,  packettes,  sachets and blister  packs,
because these 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 28% of our net sales in fiscal 2001.
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

                                       14

<PAGE>


not  reclassify  our  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 results of operations and financial condition.

We rely on a small number of customers for a large portion of our revenues.

     Our top ten customers by sales revenue  accounted for  approximately 62% of
our net sales in fiscal 2001.  None of our  customers,  other than Estee Lauder,
accounted  for  10% or  more of net  sales  in  fiscal  2001.  Although  we have
long-established  relationships with most of our major customers, we do not have
long-term  contracts  with  any of our  customers.  We may be  required  by some
customers  to qualify our  manufacturing  operations  under  specified  supplier
standards.  There can be no assurance  that we will be able to qualify under any
supplier  standards or that our  customers  will  continue to purchase  sampling
systems from us if our manufacturing operations are not so qualified. An adverse
change in our relationship with significant  customers,  including Estee Lauder,
would have a material  adverse effect on our 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.

     Our  competitors,   some  of  whom  have  substantially  greater  financial
resources  than our Company,  are  actively  engaged in  manufacturing  products
similar to those of our  Company.  Our  principal  competitors  in the  cosmetic
sampling  market are  Webcraft,  a subsidiary  of Vertis,  Inc.,  Orlandi  Inc.,
Nord'est,   Marietta  Corp.,   Klocke,  Color  Prelude,   Rotocon,   Ascent  and
Appliquesence. We also compete with numerous manufacturers of miniatures, vials,
packettes,  sachets, blister packs, and scratch and sniff products. In addition,
certain  cosmetic  companies  produce  sampling  products for their own cosmetic
products.  Competition  in our market is primarily  based upon product  quality,
product technologies,  customer  relationships,  price and customer service. The
future  success of our  business  will  depend in large part upon our 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 new technology will result in
commercially  viable products or that we will be successful in generating  sales
on commercially favorable terms, if at all.

We must protect our intellectual property to be successful.

     Our success,  competitive  position and revenues will depend, in part, upon
our  ability to protect  our  proprietary  technologies  and to operate  without
infringing on the proprietary rights of others. Although we have certain patents
and have filed, and expect to continue to file, other patent applications, there
can be no assurance that our issued  patents are  enforceable or that our 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 manufacturing processes are not covered by any patent or patent
application.  As a result, our business may be adversely affected by competitors
who  independently  develop  technologies   substantially  equivalent  to  those
employed  by us.

                                       15

<PAGE>



Our  business is affected by the  advertising  budgets of our  customers  and is
seasonal in nature.

     The advertising budgets of our customers,  and therefore our revenues,  are
susceptible to prevailing economic and market conditions that affect advertising
expenditures,   the  performance  of  the  products  of  our  customers  in  the
marketplace  and  other  related  factors.  As  of  August  31,  2001,  we  have
experienced a 10% decline in sales in the first  quarter of fiscal 2002,  and we
cannot  predict if this trend will  continue or worsen in the  remainder  of the
quarter or fiscal year. There can be no assurance that reductions in advertising
spending  will not occur,  which  could have a  material  adverse  effect on our
results of operations and financial condition.

     In addition,  our sales and operating results have  historically  reflected
seasonal  variations.  These seasonal  variations are based on the timing of our
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 first and third fiscal quarters  ending  September
30 and March 31,  respectively,  when sales from such advertising  campaigns are
principally  recognized while our fourth fiscal quarter ending June 30 typically
reflects the lowest sales level of the fiscal year. These seasonal  fluctuations
require us to  accurately  allocate our  resources  to manage our  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 raw material prices or a decrease in raw material supply.

     Paper is the primary raw material  utilized by our Company in producing our
sampling systems. Paper costs represented approximately 28% of our cost of goods
sold in each of fiscal 1999, 2000 and 2001. Significant increases in paper costs
could have a material  adverse effect on our results of operations and financial
condition to the extent that we are unable to price our products to reflect such
increases.  There can be no assurance that our customers would accept such price
increases  or the  extent to which  such  price  increases  would  impact  their
decision to utilize our sampling systems.

     Substantially all of our encapsulated sampling systems, which accounted for
approximately  52% of our net sales in fiscal 2001,  utilize  specific grades of
paper that are subject to comprehensive  evaluation and  certification by us 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.  We  continue  to  research  methods of  replicating  the
advantages  of these  specific  grades of paper with other  available  grades of
paper. Until alternative  methods are developed,  a loss of such supply of paper
and the resulting  competitive advantage could have a material adverse effect on
our results of  operations  and  financial  condition  to the extent that we are
unable to obtain such paper elsewhere.


                                       16

<PAGE>


Certain of our label sampling systems,  which accounted for approximately 34% of
our net sales in fiscal 2001, utilize component  materials that are sourced from
one qualified vendor in Europe.  Although  alternative  sources are being sought
for  the  component  materials,  there  can be no  assurance  that  we  will  be
successful in locating  another vendor. A loss of supply of materials could have
a material  adverse effect on our results of operations and financial  condition
to the extent we are unable to obtain materials elsewhere.

We receive a portion of our revenue from foreign  countries  which is subject to
foreign laws and regulations and political and economic events.

     Approximately 21% of our net sales in fiscal 2001 was generated outside the
United  States.  Foreign  operations are subject to 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 control. We have
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.

We are 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 AHC's outstanding  common stock.  DLJMBII
may have  interests  that could be in conflict  with those of the holders of the
notes or the debentures and may take actions that adversely affect the interests
of the holders of the notes or debentures.

Our business may be adversely affected by a labor dispute.

     As of August 31, 2001,  approximately  60% of our employees  worked under a
collective bargaining agreement that expires on March 31, 2003. While we believe
that our relations  with our employees are good,  there can be no assurance that
our 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 business, financial condition and results of operations.

ITEM 2.  PROPERTIES

     We own land and  buildings  in  Chattanooga,  Tennessee,  that are used for
production,  administration  and warehousing.  Our executive offices and primary
facility  at 1815  East Main  Street  are  located  on 2.55  acres and  encloses
approximately  67,900 square feet. A second facility housing product development
and  additional  manufacturing  areas at 1600 East Main Street is located  three
blocks away on 2.49 acres and encloses approximately 36,700 square feet. We also
lease 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


                                       17

<PAGE>


approximately  29,500  square  feet.  The lease  for this  building  expires  in
November 2001, at which time we intend to exercise our purchase option.

     We  currently  have a  number  of web  printing  presses  with  multi-color
capability  as  well  as   envelope-converting   machines  and  other  ancillary
equipment.  We operate a fully equipped  production  lab for the  manufacture of
microcapsules and slurry and separate laboratories for the manufacture of Arcade
Product Technologies and our research and development  facility.  We also have 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 products and a complete label attaching operation.  We also lease
sales offices in New York, New York, Paris, France and London, England.

ITEM 3.  LEGAL PROCEEDINGS

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

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

     On June 18, 2001,  by unanimous  written  consent,  each of Holding and AKI
held its respective  annual meeting of stockholders to vote upon the election of
directors.  The stockholder in each case voted to elect the previously disclosed
directors to serve until the next annual  meeting or until their  successors are
elected and duly qualified.


                                       18


<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 August 31,  2001,  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.

ITEM 6.  SELECTED FINANCIAL DATA

     The selected historical  consolidated  financial data presented below as of
June 30, 2001,  2000,  1999 and 1998 and the years ended June 30, 2001, 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 and June 30,  1997 and for the  period  from July 1, 1997 to
December 15, 1997 and the fiscal year ended June 30, 1997 have been derived from
the historical  consolidated financial statements of Arcade Holding Corporation,
our  predecessor.  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 Consolidated  Financial Statements
and the notes thereto included elsewhere in this report.

                                       19


<PAGE>

<TABLE>
<CAPTION>


                                                         Holding                                     Predecessor
                                ---------------------------------------------------------    --------------------------
                                                                             December 16,    July 1, 1997
                                                                                1997 to           to
                                 June 30,        June 30,       June 30,       June 30,      December 15,     June 30,
(dollars in thousands)             2001            2000           1999           1998            1997           1997
                                   ----            ----           ----           ----            ----           ----
<S>                             <C>            <C>             <C>            <C>             <C>            <C>
Statement of Operations Data:
Net sales (1)                   $ 115,395      $  99,811       $  87,169      $  36,694       $  36,003      $  79,584
Cost of goods sold (1)             71,336         61,552          56,401         25,146          23,626         51,328
                                ---------      ---------       ---------      ---------       ---------      ---------
Gross profit                       44,059         38,259          30,768         11,548          12,377         28,256
Selling, general and
  administrative expenses          18,199         16,980          14,500          5,587           5,703         13,333
Amortization of goodwill            5,757          5,336           4,606          2,101             568          1,234
Gain from settlement, net               -           (858)              -              -               -              -
                                ---------      ---------       ---------      ---------       ---------     ----------
Income from operations             20,103         16,801          11,662          3,860           6,106         13,689
Interest expense, net              16,911         17,401          16,740         11,327           2,646          6,203
Management fees                       250            250             250            125             215            470
Other, net                              -              -             128            (47)             11           (101)
Income tax expense (benefit)        3,449          1,596            (340)        (2,052)          1,441          3,135
                                ---------      ---------       ---------      ---------       ---------     ----------
Income (loss) before
  extraordinary item                 (507)        (2,446)         (5,116)        (5,493)          1,793          3,982
Extraordinary gain, net             2,016          1,089               -              -               -              -
                                ---------      ---------       ---------      ---------       ---------     ----------
  Net income (loss)             $   1,509      $  (1,357)      $  (5,116)     $  (5,493)      $   1,793     $    3,982
                                =========      =========       =========      =========       =========     ==========

Balance Sheet Data (at end
of period):
Cash and cash equivalents       $   4,654      $   1,158       $   7,015      $   3,842       $   4,481      $     303
Working capital (deficit)          10,169         13,759          14,853         15,046          (4,959)       (36,957)
Total assets                      214,184        223,274         210,386        214,521          77,399         77,142
Total debt and redeemable
  preferred stock                 127,939        145,722         146,688        144,448          55,408         54,964
Total stockholder's equity         64,769         58,834          49,797         57,084          12,716         11,225

Other Data:
Capital expenditures            $   3,015      $   2,782       $   2,856      $     514       $     807      $   2,462
Ratio of earnings to fixed
charges (2)                          1.2x            ---             ---            ---            2.2x           2.1x

</TABLE>

------------
(1) Net sales and cost of goods sold have been restated to conform with current
    year presentation.
(2) 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 $851, $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

     Our  sales are  primarily  derived  from the sale of  sampling  systems  to
cosmetics,  fragrance and consumer products companies.  Substantially all of our
sales are made directly to our 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 our
customers  generally  do  not  enter  into  long-term  contracts,  we  have  had
long-standing  relationships  with  the  majority  of  our  customer  base.


                                       20

<PAGE>


The Acquisition

     DLJMBII and certain members of our 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. We financed the 3M acquisition
with borrowings under the credit  agreement.  These borrowings were subsequently
repaid.

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


                                       21

<PAGE>


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.

Results of Operations

Fiscal Year Ended June 30, 2001 Compared to Fiscal Year Ended June 30, 2000

     Net Sales.  Net sales for the fiscal  year  ended June 30,  2001  increased
$15.6 million,  or 15.6%, to $115.4 million as compared to $99.8 million for the
fiscal year ended June 30,  2000.  The increase was  primarily  attributable  to
volume  and  favorable  pricing  mix  in  sales  of  sampling  technologies  for
advertising and marketing of fragrance products, and domestic cosmetic products,
partially  offset  by a  decrease  in the  sales of  sampling  technologies  for
advertising and marketing of consumer  products and the unfavorable  effect of a
stronger U.S. dollar against foreign currencies, primarily the French Franc.

     Gross  Profit.  Gross  profit  for the  fiscal  year  ended  June 30,  2001
increased $5.8 million,  or 15.1%, to $44.1 million as compared to $38.3 million
for fiscal year ended June 30,  2000.  The increase in gross profit is primarily
attributable to the increase in net sales discussed above and changes in product
mix,  offset by increased raw material  costs,  additional  premium labor costs,
increased  overhead  costs  and  foreign  exchange  rates.  Gross  profit  as  a
percentage  of net sales  decreased  to 38.2% in the fiscal  year ended June 30,
2001, from 38.4% in the fiscal year ended June 30, 2000.

     Selling,  General  and  Administrative   Expenses.   Selling,  general  and
administrative  expenses for the fiscal year ended June 30, 2001  increased $1.2
million,  or 7.1% to $18.2  million as compared to $17.0  million for the fiscal
year ended June 30, 2000.  The increase in selling,  general and  administrative
expenses  was  primarily  due to  increased  staffing  levels and  compensation,
including  increased sales  commissions and incentive bonuses as a result of the
increase in sales volume and other  quantitative  incentive  measures.  Selling,
general and administrative expenses as a percent of net sales decreased to 15.8%
in the fiscal  year ended June 30, 2001 from 17.0% in the fiscal year ended June
30, 2000.

     Income from  Operations.  Income from  operations for the fiscal year ended
June 30, 2001 increased $3.3 million,  or 19.6%, to $20.1 million as compared to
$16.8  million for the fiscal year ended June 30, 2000.  Income from  operations
for  2000  included  a net  gain  of $0.9  million  resulting  from a  favorable
litigation  settlement  with the  sellers of Arcade  Holding  Corp.  Income from
operations  as a percentage  of net sales  increased to 17.4% in the fiscal year
ended  June 30,  2001  from  16.8%  in the  fiscal  year  ended  June 30,  2000,
principally as a result of the factors described above.

     Interest Expense.  Interest expense for the fiscal year ended June 30, 2001
decreased $0.5 million,  or 2.9% to $16.9 million,  as compared to $17.4 million
for the fiscal year ended June 30, 2000. Interest expense as a percentage of net
sales  decreased  to 14.6% in the fiscal  year ended June 30, 2001 from 17.4% in
the fiscal year ended June 30, 2000. The decrease in interest expense, including
the amortization of deferred financing costs, is primarily due to a decrease in

                                       22

<PAGE>


interest  expense  related  to  the  repurchased  and  retired  Senior  Discount
Debentures and Senior Notes, partially offset by an increase in interest expense
related to use of the credit  line and the  promissory  note to AHC for  working
capital and the RetCom acquisition.

     Interest  expense for AKI for the fiscal year ended June 30, 2001 decreased
$0.5 million,  or 3.7%, to $13.2  million,  as compared to $13.7 million for the
fiscal year ended June 30, 2000.  Interest  expense as a percentage of net sales
decreased  to 11.4% in the fiscal  year  ended  June 30,  2001 from 13.7% in the
fiscal year ended June 30, 2000. The decrease in interest expense, including the
amortization  of deferred  financing  costs,  is primarily  due to a decrease in
interest expense related to the repurchased and retired Senior Notes,  partially
offset by use of the revolving  credit line and the  promissory  note to AHC for
working capital and the RetCom acquisition.

     Income Tax  Expense.  The income tax expense for the fiscal year ended June
30, 2001  increased $1.8 million to $3.4 million as compared to $1.6 million for
the fiscal year ended June 30,  2000.  The  increase  is due to the  increase in
income before income taxes and extraordinary gain.

     Income  tax  expense  for AKI for the  fiscal  year  ended  June  30,  2001
increased  $1.9  million to $4.7  million as  compared  to $2.8  million for the
fiscal year ended June 30,  2000.  The increase is due to the increase in income
before income taxes and extraordinary gain.

     Extraordinary  gain from early  retirement of debt. An  extraordinary  gain
from early retirement of debt of $2.0 million for the fiscal year ended June 30,
2001 and $1.1 million for the fiscal year ended June 30, 2000  resulted from the
purchase  and  subsequent   contribution  in  fiscal  2001  of  Senior  Discount
Debentures  by AHC,  and the  purchase  of  Senior  Notes and the  purchase  and
subsequent  contribution in fiscal year 2000 of Senior Notes and Senior Discount
Debentures by AHC. The purchased and contributed  securities  were  subsequently
retired.

     An extraordinary gain from early retirement of debt for AKI of $0.5 million
for the fiscal  year ended June 30,  2001 and $0.4  million  for the fiscal year
ended June 30,  2000  resulted  from the  purchase in fiscal year 2001 of Senior
Notes and the purchase in fiscal year 2000 of Senior Notes by AHC and subsequent
contribution  by  Holding.   The  purchased  and  contributed   securities  were
subsequently retired.

     EBITDA.  EBITDA for the fiscal  year ended June 30,  2001,  increased  $4.5
million,  or 17.5%, to $30.2 million as compared to $25.7 million for the fiscal
year ended June 30,  2000.  The  increase  in EBITDA  principally  reflects  the
increase in gross profit  partially  offset by the increase in selling,  general
and administrative expenses discussed above. EBITDA as a percentage of net sales
was  26.2%  and  25.8%  for the  fiscal  year  ended  June 30,  2001  and  2000,
respectively.   EBITDA  is  income  from   operations  plus   depreciation   and
amortization of goodwill and other  intangibles less net gain from settlement of
litigation.


                                       23

<PAGE>


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 14.5%,  to $99.8 million as compared to $87.2 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 38.4% in the fiscal  year ended June 30,  2000,  from 35.3% in the
fiscal year ended June 30,  1999.  The increase in gross profit and gross profit
as a percentage of net sales was 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 increased  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 17.0% in the fiscal year ended June 30, 2000
from 16.6% in the fiscal year ended June 30, 1999.

     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 16.8% in the fiscal year ended June 30,
2000 from 13.4% 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 17.4% in the fiscal  year ended June 30, 2000 from 19.2% 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 draw
downs under the credit agreement 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.

                                       24

<PAGE>


Interest  expense as a percentage of net sales  decreased to 13.7% in the fiscal
year ended June 30, 2000 from 14.9% 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.

     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.

     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. 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 and subsequent  contribution by Holding. The contributed securities
were subsequently retired.

     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
25.8% and 23.1% 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.

Liquidity and Capital Resources

     We have substantial  indebtedness and significant debt service obligations.
As of June 30, 2001, we had consolidated  indebtedness in an aggregate amount of
$127.9 million  (excluding  trade  payables,  accrued  liabilities  and deferred
taxes),  of which (1)  approximately  $23.9  million is a direct  obligation  of
Holding  relating to its  debentures and (2)  approximately  $103.5 million is a
direct  obligation  of AKI  relating  to its notes,  revolving  credit  line and
capital  leases.  At June  30,  2001,  Holding  had  $21.5  million  of  accrued
liabilities and AKI had $23.7 million in accrued  liabilities  (including  trade
payables,  accrued  liabilities and deferred taxes).  As of August 31, 2001, AKI
had outstanding borrowings of $4.9 million under the credit agreement.

     Borrowings under the credit agreement are limited to a maximum amount equal
to $20.0  million.  At June 30,  2001 and August  31,  2001,  AKI had  borrowing
availability  of  approximately  $20.0 million and $15.1 million,  respectively,
subject  to a  borrowing  base  calculation  and the  achievement  of  specified
financial ratios and compliance with specified

                                       25

<PAGE>


conditions.  The interest  rate for  borrowings  under the credit  agreement are
determined from time to time based on our 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 subsidiaries
to incur additional indebtedness, subject to specified limitations. In addition,
the indentures contain restrictive covenants that, among other things, limit the
ability of Holding and its  subsidiaries  to: (i) pay  dividends or make certain
restricted  payments;  (ii) incur  additional  indebtedness  and issue preferred
stock;  (iii) create liens;  (iv) incur dividend and other payment  restrictions
affecting subsidiaries;  (v) enter into mergers,  consolidations or sales of all
or  substantially  all of the assets of our  company;  (vi)  enter into  certain
transactions with affiliates; and (vii) 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.

     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,   we  have  funded  our  capital,   debt  service  and   operating
requirements  with a combination  of net cash provided by operating  activities,
which was $19.6 million and $4.9 million for fiscal 2001 and 2000, respectively,
together with borrowings under revolving credit facilities. Net cash provided by
operating  activities  during  fiscal 2001  resulted  primarily  from net income
before  depreciation  and  amortization,  a decrease in accounts  receivable and
inventory levels and an increase in accounts payable and accrued expenses.

     In  fiscal  2001  and  fiscal  2000,   we  had  capital   expenditures   of
approximately  $3.0  million  and  $2.8  million,  respectively.  These  capital
expenditures   consisted   primarily  of  the  purchase   and   maintenance   of
manufacturing equipment and furniture and fixtures and maintaining and upgrading
our 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 financed by borrowings under the credit agreement.

     We may from time to time evaluate additional potential acquisitions.  There
can be no assurance that  additional  capital sources will be available to us to
fund additional acquisitions on terms that we find acceptable, or at all.

     At June 30, 2001,  AHC had  outstanding  $45.0  million of Notes which bear
interest at  approximately  16% per annum and mature on December 15,  2009,  and
approximately  $85.5 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

                                       26

<PAGE>


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 us 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, 2002 are budgeted
to be approximately  $3.0 million.  Based on borrowings  outstanding (other than
pursuant to the credit agreement) as of June 30, 2001 and borrowings outstanding
under the credit  agreement as of August 31, 2001, we expect total cash payments
for debt service in fiscal 2002 to be approximately $11.1 million, consisting of
$10.9 million in interest payments on the notes and $0.2 million in interest and
fees under the credit  agreement.  We also  expect to make  royalty  payments of
approximately $1.1 million during fiscal 2002.

     We believe  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 our indebtedness,  including the debentures and the notes for fiscal
2002.  In the  event we  consummate  any  additional  acquisitions,  we may seek
additional debt or equity financings subject to compliance with the terms of the
indentures.

     At June 30,  2001,  Holding's  cash and cash  equivalents  and net  working
capital  were $4.7  million and $10.2  million,  respectively,  representing  an
increase  in cash and cash  equivalents  of $3.5  million  and a decrease in net
working capital of $3.6 million from June 30, 2000. Account receivables, net, at
June 30, 2001  decreased  16.3% or $3.5  million  over the June 30, 2000 amount,
primarily  due to a reduction in the days sales  outstanding  and a  comparative
decrease in fourth quarter sales.

Seasonality

     Our  sales and  operating  results  have  historically  reflected  seasonal
variations.  Such seasonal  variations are based on the timing of our 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 first and third fiscal quarters ended September 30 and March 31
when sales from such  advertising  campaigns are principally  recognized.  These
seasonal  fluctuations  require  us to  allocate  our  resources  to manage  our
manufacturing  capacity,  which  often  operates  at full  capacity  during peak
seasonal demand periods.

                                       27

<PAGE>


Recently Issued Accounting Standards

     In September  2000,  the Emerging  Issues Task Force reached a consensus on
Issue 00-10,  "Accounting  for Shipping  and  Handling  Fees and Costs"  ("Issue
00-10").  Issue 00-10 requires that all amounts  billed to customers  related to
shipping  and  handling  should  be  classified  as  revenues.  Issue  00-10 was
effective  for the  Company no later than the fourth  quarter of the fiscal year
ending June 30, 2001, and,  accordingly,  amounts billed to customers related to
shipping  and  handling  have been  reclassified  from cost of goods sold to net
sales.

     FASB  Statement  of  Financial   Accounting  Standards  No.  141  "Business
Combinations"  ("SFAS  141)  was  issued  in June  2001.  SFAS 141  changes  the
accounting  and reporting for business  combinations.  SFAS 141 is effective for
all business combinations initiated after June 30, 2001.

     FASB  Statement of Financial  Accounting  Standards  No. 142  "Goodwill and
Other Intangible  Assets" ("SFAS 142") was issued in June 2001. SFAS 142 changes
the accounting and reporting for acquired goodwill and other intangible  assets.
SFAS 142 is effective  for fiscal years  beginning  after  December 15, 2001 and
must be applied at the  beginning  of an entity's  fiscal  year.  The Company is
currently  assessing  the  effect,  if  any,  on  its  financial  statements  of
implementing SFAS 142.

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: (i) the competitive  environment in the
sampling  industry in general and in our specific market areas;  (ii) changes in
prevailing  interest rates;  (iii) inflation;  (iv) changes in cost of goods and
services;  (v) economic  conditions in general and in our specific market areas;
(vi) changes in or failure to comply with postal  regulations  or other federal,
state and/or local  government  regulations;  (vii)  liability  and other claims
asserted against us; (viii) changes in operating  strategy or development plans;
(ix) the ability to attract and retain qualified personnel;  (x) the significant
indebtedness  of our  company;  (xi) labor  disturbances;  (xii)  changes in our
capital expenditure plans; (xiii) and other factors.

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

                                       28

<PAGE>



of the forward-looking  statements  contained in this document to reflect future
events or developments.


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

     In fiscal 2001, we generated  approximately 21% of our sales from customers
outside the United States,  principally in Europe.  International sales are made
mostly  from  our  foreign  subsidiary  located  in  France  and  are  primarily
denominated  in the local  currency.  Our  foreign  subsidiary  also  incurs the
majority of its expenses in the local  currency  and uses the local  currency as
its functional currency.

     Our 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.

     We periodically  enter 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,  2001,  there  were no  forward
exchange contracts outstanding.

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, 2001.

Name                 Age    Position
----                 ---    --------
Thompson Dean         43     Chairman of the Board and Director
William J. Fox        45     President, Chief Executive Officer and Director
Kenneth A. Budde      52     Senior Vice President, Chief Financial Officer and
                             Secretary
A. Bruce Prashker     39     Senior Vice President and Assistant Secretary
Hugh R. Kirkpatrick   64     Director
David M. Wittels      37     Director
James A. Quella       51     Director

     Thompson Dean has served as Chairman of the Board and a Director of Holding
since  December  1997.  Mr. Dean has been Head of  Leveraged  Corporate  Private
Equity for Credit  Suisse  First Boston since  November  2000.  He has also been
Investment  Committee  Co-Chairman and Managing  Partner of DLJ Merchant Banking
Partners  since  1995.  Previously,  Mr.  Dean was a  Managing  Director  of DLJ
Merchant  Banking  and its  predecessor  since  1991.  Mr.  Dean also  serves as
Chairman of the Board of DeCrane Aircraft Holdings, Inc. and Von Hoffmann Press,
Inc., and as a director of Charles River Laboratories, Inc. Formica Corporation,
Insilco  Holding  Company,  Manufactures'  Services  Ltd.  and Mueller  Holdings
(N.A.), 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.  Mr. Fox also serves as Director  and
Co-Chairman of the Board of Loehmann's Holdings, Inc.

         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.

                                       30

<PAGE>


     A. Bruce  Prashker  has served as Senior Vice  President  of Holding  since
April 2000. Prior to joining the Company, Mr. Prashker was Managing Principal of
the Capital  Markets  Company  N.V.  from April 1999  through  April  2000.  Mr.
Prashker served as Vice President & Controller of the International  Division of
RCPC from January 1996 through April 1999,  Vice  President and Chief  Financial
Officer of the Licensing  Division of RCPC from August 1994 through January 1996
and held various other  executive  positions at RCPC and  MacAndrews  and Forbes
Holding Inc. from April 1990 through August 1994.

     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.

     David M. Wittels has served as a director of Holding since  December  1997.
Mr. Wittels has been a Managing  Director of DLJ Merchant  Banking since January
2001. 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., Ziff Davis Media Inc., Advanstar, Inc.,
Advanstar Communications, Inc. and Wilson Greatbatch Technologies, Inc.

     James A. Quella has served as a director of Holding since  September  2000.
Mr. Quella has been a Managing  Director and  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.  Mr.  Quella  was a  Senior
Consultant for Mercer Management Consulting from 1990 to 1996. Mr. Quella serves
on the boards of directors of  Advanstar,  Inc.  Merrill  Corporation,  Formica,
Inc., and Von Hoffman Press, Inc.

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 chief
executive officer and our other most highly compensated executive officers 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                                 2001    $   700,000     $ 1,125,000                  --                6,800
   President, Chief Executive Officer          2000        650,000       1,214,000             888,000(2)             6,400
   And Director                                1999        242,308         250,000                  --                   --

Kenneth A. Budde                               2001        190,000         135,000                  --                6,800
   Chief Financial Officer                     2000        175,000         102,500             160,000                7,090
                                               1999        154,327          80,625                  --                9,077

A. Bruce Prashker                              2001        190,000          90,000                  --                4,787
  Senior Vice President                        2000         34,346              --              50,000                   --
                                               1999             -               --                  --                   --

</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.


                                       32

<PAGE>


Option Grants in Last Fiscal Year



     There were no stock options  granted during fiscal 2001 to any of the named
executive officers.



Fiscal Year End Option Values



     The following  table sets forth  information  about the number and value of
options held by the named executive  officers as of June 30, 2001. 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.


                                           Year End Option Values

<TABLE>
<CAPTION>

                                             Number of securities
                                            underlying unexercised          Value of unexercised in-the-
                                           options at June 30, 2001        money options at June 30, 2001
                                      ---------------------------------   ---------------------------------


                 Name                    Exercisable    Unexercisable      Exercisable    Unexercisable
                 ----                    -----------    -------------      -----------    -------------

<S>                                         <C>           <C>                   <C>               <C>
William J. Fox                              444,000       444,000               --                --
   President, Chief Executive Officer
   And Director

Kenneth A. Budde                             83,334        76,666               --                --
   Chief Financial Officer

A. Bruce Prashker                             8,333        41,667               --                --
  Senior Vice President

</TABLE>


Equity-Based Compensation

     AHC adopted the 1998 Stock Option Plan for  employees  and directors of AHC
and any parent or subsidiary  corporation  of AHC. The  objectives of the option
plan are (1) to retain the  services  of persons  holding key  positions  and to
secure the  services of persons  capable of filling  such  positions  and (2) to
provide  persons  responsible  for the future  growth of 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

                                       33

<PAGE>


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  35,500  options for shares of capital stock in fiscal 2001 and
no options for shares of capital  stock of AHC were  exercised  in fiscal  2001.
These options vest over periods ranging from one to five 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 and as amended  effective  July 1,
2001. The agreement  initially ended 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.
Accordingly, as of September 1, 2001 the agreement ends on September 1, 2003.

     Mr.  Fox's  base  salary  is  $775,000  and he is  eligible  to  receive  a
performance-based  bonus of between  50% to 100% or between  100% to 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.

     If Mr. Fox's employment is terminated by us without cause or by Mr. Fox for
good reason,  we 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
six-month  period following the date of termination.  However,  in the event Mr.
Fox's  employment  is  terminated  by us  without  cause or by Mr.  Fox for good
reason, within sixteen months following a Change of Control, Mr. Fox is entitled
to an  amount  equal  to  two  times  the  highest  aggregate  base  salary  and
performance-based  bonus amount paid to him in any of the three  calendar  years
prior to the  effective  date of any Change of  Control,  50% of such  amount on
termination  of  employment  and 50% paid in equal monthly  installments  over a
six-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.


                                       34

<PAGE>


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 us without cause or by us 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 $210,000 and he
is eligible to receive a performance-based  bonus of 60% of his base salary upon
achievement  of  targeted  goals and up to 100% of his base  salary  for  higher
performance.  The term of the employment agreement with Mr. Budde, which expires
on June 30, 2002, automatically renews for additional twelve-month terms, unless
either party elects otherwise. If Mr. Budde is terminated by us without cause or
if we elect not to renew Mr. Budde's employment, we will pay Mr. Budde an amount
equal  to 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
2001.  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.


                                       35


<PAGE>


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 August 31, 2001 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.



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

DLJ Merchant Banking Partners, II, L.P.        15,921,111            98.8%
  and affiliated entities  (1)
William J. Fox (2)                                666,000             4.0%
Thompson Dean (3)                                     ---              ---
Hugh R. Kirpatrick (2)                              2,778                *
James Quella (3)                                      ---              ---
David M. Wittels (3)                                  ---              ---
Kenneth A. Budde (2)                              126,667                *
A. Bruce Prashker (2)                              33,333                *
All directors and executive officers              828,778             4.9%
  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")."  The  address of each of  DLJMBII,  DLJMBII-A,
          Diversified Partners,  Diversified Partners-A, DLJ Funding II, Scratch
          & Sniff, Millennium Partners,  Millennium Partners-A, EAB Partners and
          First ESC is Eleven  Madison  Avenue,  New York,  New York 10010.  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)  Includes  shares of common stock  issuable  upon the exercise of stock
          options exercisable within 60 days of August 31, 2001.


                                       36

<PAGE>


     (3)  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 Eleven Madison Avenue, New York, New York 10010.


ITEM 13.  RELATED PARTY 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.

     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 actions as
our financial advisor.

Stockholders Agreement

     In connection with the acquisition of our Company, 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.

     DLJMBII  is  entitled  to demand and piggy back  registration  rights  with
regard to its shares of our common stock.

                                       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).

4.4    Form of  10 1/2%  Senior Discount Notes  due  July 1,  2008  (included in
       Exhibit 4.2).

10.1   Registration  Rights  Agreement of  Holding,  dated as of  June 25,  1998
       between Holding and DLJMBII.*

10.2   Registration Rights Agreement of AKI, dated as of June 25, 1998,  between
       AKI and DLJMBII.**

10.3   AHC Stock Option Plan.*

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

10.5   Amendment to Employment Agreement  dated as of September 17, 2001 between
       Holding and William J. Fox. +

10.6   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. (the "Credit Agreement").*

                                       38

<PAGE>


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

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

10.9   Amendment No. 5 to the Credit Agreement dated as of May 17, 2000, between
       the Company and Heller Financial, Inc. |_|

10.10  Amendment No. 6 to the Credit  Agreement  dated as of  December  1, 2000,
       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
       related investors.*

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

10.15  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.*****

10.16  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.+

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

*      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.

****   Incorporated by reference from  Registrant's  Annual  Report on Form 10-K
       filed with the Securities and Exchange Commission on September 28, 1999.

*****  Incorporated by reference from  Registrant's  Annual  Report on Form 10-K
       filed with the Securities and Exchange Commission on September 28, 2000.

|_|    Incorporated by reference from Registrant's Quarterly Report on Form 10-Q
       filed with the Securities and Exchange Commission on November 14, 2000.

+      Filed herewith.


                                       39

<PAGE>


          (b)     Reports on Form 8-K.

                  No  reports on  Form 8-K  were filed during the  three  months
                  ended June 30, 2001.


                                       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 18th day of
September, 2001.

                                  AKI HOLDING CORP.

                                     (Registrant)


                                  By: /S/ William J. Fox
                                          --------------------------------------
                                          William J. Fox
                                          President and Chief Executive Officer

     Each person whose signature  appears below hereby  appoints  William J. Fox
and  Kenneth  Budde,   or  any  of  them,  as  such  person's  true  and  lawful
attorney-in-fact,  with full power of  substitution or  resubstitution  for such
person and in such person's name, place and stead, in any and all capacities, to
sign on such person's  behalf,  individually  and in each capacity stated below,
any and all amendments to this Report on Form 10-K,  with all exhibits  thereto,
and other  documents in connection  therewith,  with the Securities and Exchange
Commission, granting unto said attorneys-in-fact, full power and authority to do
and perform  each and every act and thing  requisite  or necessary to be done in
and about the  premises,  as fully to all  intents  and  purposes as such person
might or could do in  person,  hereby  ratifying  and  confirming  all that said
attorneys-in-fact,  or their substitute or substitutes, may lawfully do or cause
to be done by virtue hereof.

     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 18th day of September, 2001.

     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                 Senior Vice President, Chief Financial Officer
---------------------------       and Secretary (Principal Financial and
Kenneth Budde                     Accounting Officer)


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


                                       41

<PAGE>



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


/S/ David Wittels                 Director
----------------------------
David Wittels


                                       42

<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  18th  day of
September, 2001.

                                  AKI, INC.

                                  (Registrant)


                                  By: /S/ William J. Fox
                                          --------------------------------------
                                          William J. Fox
                                          President, Chief Executive Officer and
                                          Chairman

     Each person whose signature  appears below hereby  appoints  William J. Fox
and  Kenneth  Budde,   or  any  of  them,  as  such  person's  true  and  lawful
attorney-in-fact,  with full power of  substitution or  resubstitution  for such
person and in such person's name, place and stead, in any and all capacities, to
sign on such person's  behalf,  individually  and in each capacity stated below,
any and all amendments to this Report on Form 10-K,  with all exhibits  thereto,
and other  documents in connection  therewith,  with the Securities and Exchange
Commission, granting unto said attorneys-in-fact, full power and authority to do
and perform  each and every act and thing  requisite  or necessary to be done in
and about the  premises,  as fully to all  intents  and  purposes as such person
might or could do in  person,  hereby  ratifying  and  confirming  all that said
attorneys-in-fact,  or their substitute or substitutes, may lawfully do or cause
to be done by virtue hereof.

     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 18th day of September, 2001.

     SIGNATURE                              TITLE

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


/S/ Kenneth Budde                 Senior Vice President, Chief Financial Officer
---------------------------       and Secretary (Principal Financial and
Kenneth Budde                     Accounting Officer)


/S/ Thompson Dean                 Director
---------------------------
Thompson Dean


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


                                       43

<PAGE>


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


/S/ David Wittels                 Director
---------------------------
David Wittels


                                       44

<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.


                                       45

<PAGE>
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED FINANCIAL STATEMENTS OF AKI HOLDING CORP.:

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

     Consolidated Balance Sheets at June 30, 2001 and 2000................   F-3

     Consolidated Statements of Operations for the years ended
         June 30, 2001, 2000 and 1999 ....................................   F-4

     Consolidated Statements of Stockholder's Equity
         for the years ended June 30, 2001, 2000 and 1999 ................   F-5

     Consolidated Statements of Cash Flows for the years ended
         June 30, 2001, 2000 and 1999 ....................................   F-6

     Notes to Consolidated Financial Statements...........................   F-7

CONSOLIDATED FINANCIAL STATEMENTS OF AKI, INC.:

     Report of Independent Accountants....................................  F-23

     Consolidated Balance Sheets at June 30, 2001 and 2000 ...............  F-24

     Consolidated Statements of Operations for the years ended
         June 30, 2001, 2000 and 1999 ....................................  F-25

     Consolidated Statements of Stockholder's Equity
         for the years ended June 30, 2001, 2000 and 1999 ................  F-26

     Consolidated Statements of Cash Flows for the years ended
         June 30, 2001, 2000 and 1999 ....................................  F-27

     Notes to Consolidated Financial Statements...........................  F-28


                                      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,  stockholder's  equity and cash
flows present fairly, in all material  respects,  the financial  position of AKI
Holding Corp.  and  Subsidiaries  at June 30, 2001 and 2000,  and the results of
their  operations and their cash flows for each of the three years in the period
ended June 30, 2001 in conformity with generally accepted accounting  principles
in  the  United  States  of  America.   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 auditing  standards  generally  accepted in the
United  States of America,  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 our opinion.






PricewaterhouseCoopers LLP
Knoxville, Tennessee
August 3, 2001




                                      F-2


<PAGE>


                       AKI HOLDING CORP. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
             (in thousands, except share and per share information)


<TABLE>
<CAPTION>


                                                                                              June 30,
                                                                                       ----------------------
                                                                                       2001              2000
                                                                                       ----              ----

<S>                                                                                 <C>              <C>
ASSETS
Current assets
Cash and cash equivalents..............................................             $     4,654      $     1,158
Accounts receivable, net...............................................                  18,020           21,522
Inventory..............................................................                   6,330            7,757
Prepaid expenses.......................................................                     492               92
Deferred income taxes..................................................                     770              396
                                                                                    -----------      -----------
      Total current assets.............................................                  30,266           30,925

Property, plant and equipment, net.....................................                  15,778           17,097
Goodwill, net .........................................................                 157,334          162,472
Other intangible assets, net...........................................                   6,337            7,174
Deferred charges, net..................................................                   4,381            5,461
Deferred income taxes..................................................                       -               57
Other assets...........................................................                      88               88
                                                                                    -----------      -----------
      Total assets.....................................................             $   214,184      $   223,274
                                                                                    ===========      ===========

LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of capital lease obligations...........................             $       503      $       847
Accounts payable, trade................................................                   3,886            3,565
Accrued income taxes...................................................                   1,642              724
Accrued compensation...................................................                   4,715            3,965
Accrued interest.......................................................                   5,443            5,695
Accrued expenses.......................................................                   3,908            2,370
                                                                                    -----------      -----------
      Total current liabilities........................................                  20,097           17,166

Long-term portion of capital lease obligations.........................                       -              502
Revolving credit line..................................................                       -            9,000
Senior notes...........................................................                 103,510          107,510
Senior discount debentures.............................................                  23,926           27,863
Deferred income taxes..................................................                      19                -
Other non-current liabilities..........................................                   1,863            2,399
                                                                                    -----------      -----------
      Total liabilities................................................                 149,415          164,440

Commitments and contingencies

Stockholder's equity
Common stock, $0.01 par, 1,000 shares authorized; 1,000
    shares issued and outstanding......................................                       -                -
Additional paid-in capital.............................................                  93,656           88,935
Accumulated deficit....................................................                 (12,320)         (13,829)
Accumulated other comprehensive loss...................................                    (837)            (542)
Carryover basis adjustment.............................................                 (15,730)         (15,730)
                                                                                    -----------      -----------
      Total stockholder's equity.......................................                  64,769           58,834
                                                                                    -----------      -----------

      Total liabilities and stockholder's equity.......................             $   214,184      $   223,274
                                                                                    ===========      ===========
</TABLE>



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


                                       F-3

<PAGE>


                       AKI HOLDING CORP. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                 (in thousands)

<TABLE>
<CAPTION>

                                                                                      Year Ended June 30,
                                                                              ----------------------------------
                                                                              2001           2000           1999
                                                                              ----           ----           ----

<S>                                                                       <C>             <C>             <C>
Net sales.....................................................            $  115,395      $  99,811       $  87,169
Cost of goods sold............................................                71,336         61,552          56,401
                                                                           ---------      ---------       ---------

     Gross profit.............................................                44,059         38,259          30,768

Selling, general and administrative expenses .................                18,199         16,980          14,500
Amortization of goodwill and other intangible assets..........                 5,757          5,336           4,606
Gain from settlement of litigation, net.......................                     -           (858)              -
                                                                           ---------      ---------       ---------

     Income from operations...................................                20,103         16,801          11,662

Other expenses (income):
   Interest expense to stockholder(s) and affiliate...........                   320             22               -
   Interest expense, other....................................                16,591         17,379          16,740
   Management fees to stockholders and affiliate..............                   250            250             250
   Other, net.................................................                     -              -             128
                                                                           ---------      ---------       ---------

     Income (loss) before income taxes and extraordinary gain.                 2,942           (850)         (5,456)

Income tax expense (benefit)..................................                 3,449          1,596            (340)
                                                                           ---------      ---------       ---------

     Loss before extraordinary gain...........................                  (507)        (2,446)         (5,116)

Extraordinary gain from early retirement of debt, net of tax..                 2,016          1,089               -
                                                                           ---------      ---------       ---------

   Net income (loss)..........................................             $   1,509      $  (1,357)      $  (5,116)
                                                                           =========      =========       =========
</TABLE>



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


                                       F-4



<PAGE>


                       AKI HOLDING CORP. AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
                    (in thousands, except share information)


<TABLE>
<CAPTION>
                                                                                                   Accumulated
                                                       Additional                     Other         Carryover
                                     Common Stock       Paid-in     Accumulated   Comprehensive       Basis
                                    Shares  Amount      Capital       Deficit         Loss          Adjustment     Total
                                    ------  ------      -------       -------         ----          ----------     -----

<S>                                 <C>    <C>         <C>           <C>           <C>             <C>           <C>
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
Equity contribution by AHC I
  Acquisition Corp..............        -        -         4,721             -             -               -        4,721
Net income......................        -        -             -         1,509             -               -        1,509
Other comprehensive loss, net
  of tax:
   Foreign currency translation
     adjustment.................        -        -             -             -          (295)              -         (295)
                                                                                                                 --------
Comprehensive income............                                                                                    1,214
                                    -----  -------     ---------    ----------     ---------       ---------     --------

Balances, June 30, 2001.........    1,000  $     -     $  93,656    $  (12,320)    $    (837)      $ (15,730)    $ 64,769
                                    =====  =======     =========    ==========     =========       =========     ========

</TABLE>


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


                                       F-5



<PAGE>


                       AKI HOLDING CORP. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)

<TABLE>
<CAPTION>

                                                                                      Year Ended June 30,
                                                                           ---------------------------------------
                                                                           2001              2000             1999
                                                                           ----              ----             ----

<S>                                                                     <C>              <C>              <C>
Cash flows from operating activities:
   Net income (loss)..........................................          $   1,509        $  (1,357)       $  (5,116)
   Adjustment to reconcile net income (loss) to net cash
     provided by operating activities:
     Depreciation and amortization of goodwill and other
       intangibles............................................             10,119            9,738            8,487
     Amortization of debt discount............................              3,610            3,638            3,631
     Amortization of loan closing costs.......................                664            1,309              727
     Deferred income taxes....................................             (1,597)             945             (544)
     Gain on sale of equipment................................                  -                -              (50)
     Gain from early retirement of debt.......................             (2,016)          (2,345)               -
     Other....................................................                (84)              (1)            (308)
     Changes in operating assets and liabilities:
       Accounts receivable....................................              3,502           (2,576)          (2,737)
       Inventory..............................................              1,427           (2,496)          (3,031)
       Prepaid expenses, deferred charges and other assets....               (400)             450             (975)
       Accounts payable and accrued expenses..................              1,939           (2,637)           4,511
       Income taxes...........................................                931              259            5,238
                                                                        ---------        ---------        ---------

       Net cash provided by operating activities..............             19,604            4,927            9,833
                                                                        ---------        ---------        ---------

Cash flows from investing activities:
   Purchases of equipment.....................................             (3,015)          (2,782)          (2,856)
   Proceeds from sale of equipment............................                  -                -               50
   Payments for acquisitions, net of cash acquired............                  -          (16,164)               -
   Patents....................................................               (137)            (150)               -
                                                                        ---------        ---------        ---------

       Net cash used in investing activities..................             (3,152)         (19,096)          (2,806)
                                                                        ---------        ---------        ---------

Cash flows from financing activities:
   Payments under capital leases for equipment................               (846)            (688)            (661)
   Repayments of long-term debt...............................             (3,110)               -                -
   Net proceeds (repayments) on line of credit................             (9,000)           9,000                -
   Repayment of other notes payable...........................                  -                -           (1,330)
   Dividend paid to AHC I Acquisition Corp....................                  -                -           (1,863)
                                                                        ---------        ---------        ---------

       Net cash provided by (used in) financing activities....            (12,956)           8,312           (3,854)
                                                                        ---------        ---------        ---------

Net increase (decrease) in cash and cash equivalents..........              3,496           (5,857)           3,173
Cash and cash equivalents, beginning of period................              1,158            7,015            3,842
                                                                        ---------        ---------        ---------
Cash and cash equivalents, end of period......................          $   4,654        $   1,158        $   7,015
                                                                        =========        =========        =========

Supplemental information:
   Cash paid (received) during the period for:
         Interest to stockholder(s) and affiliate.............          $     320        $      22        $       -
         Interest, other......................................             12,233           13,188            6,512
         Income taxes.........................................              4,115            1,264           (5,123)

Significant non-cash activities:
   Assets acquired under capital lease........................          $       -        $       -        $     600
   Contribution of equity and retirement of senior discount
     debentures and senior notes..............................              4,721           10,571                -


</TABLE>




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


                                       F-6




<PAGE>


                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (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 (the  "Acquisition").  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 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-7

<PAGE>
                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (in thousands, except share and per share information)


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

          One  customer  accounted  for 14.9% of net sales during the year ended
     June 30,  2001.  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.

     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 at the time ownership  transfers,  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-8

<PAGE>

                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (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 $15,353 and $10,546 at
     June 30, 2001 and June 30, 2000, 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  $2,442  and  $1,479 at June 30,  2001 and June 30,
     2000, 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 $99,370 and $12,110 at June 30,
     2001  compared to a carrying  value of $103,510 and $23,926,  respectively.
     The carrying value of all other  financial  instruments  approximated  fair
     value at June 30, 2001.

     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
     amounted to $403,  $51 and $91 for the years ended June 30, 2001,  2000 and
     1999, respectively.


                                      F-9

<PAGE>

                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (in thousands, except share and per share information)

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

     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 $1,591,  $1,309 and $1,136 for the years ended
     June 30, 2001, 2000 and 1999, respectively.

     Income Taxes

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

     Use of Estimates

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

     Recently Issued Accounting Standards

          In September  2000, the Emerging Issues Task Force reached a consensus
     on Issue 00-10,  "Accounting  for  Shipping  and  Handling  Fees and Costs"
     ("Issue 00-10").  Issue 00-10 requires that all amounts billed to customers
     related to shipping and handling  should be classified  as revenues.  Issue
     00-10 was effective for the Company no later than the fourth quarter of the
     fiscal year ending  June 30,  2001,  and,  accordingly,  amounts  billed to
     customers related to shipping and handling have been reclassified from cost
     of goods sold to net sales.

          FASB  Statement of Financial  Accounting  Standards  No. 141 "Business
     Combinations"  ("SFAS  141) was issued in June 2001.  SFAS 141  changes the
     accounting and reporting for business  combinations.  SFAS 141 is effective
     for all business combinations initiated after June 30, 2001.

          FASB Statement of Financial Accounting Standards No. 142 "Goodwill and
     Other  Intangible  Assets"  ("SFAS 142") was issued in June 2001.  SFAS 142
     changes the  accounting  and  reporting  for  acquired  goodwill  and other
     intangible  assets.  SFAS 142 is effective for fiscal years beginning after
     December  15,  2001 and must be applied  at the  beginning  of an  entity's
     fiscal year. The Company is currently  assessing the effect, if any, on its
     financial statements of implementing SFAS 142.


                                      F-10

<PAGE>
                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (in thousands, except share and per share information)


3.   SIGNIFICANT ACQUISITIONS

          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.

          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.

4.   ACCOUNTS RECEIVABLE

     The following table details the components of accounts receivable:

                                                              June 30,
                                                        --------------------
                                                        2001            2000
                                                        ----            ----

         Trade accounts receivable...............   $   18,487       $   22,314
         Allowance for doubtful accounts.........         (836)            (963)
                                                    ----------       ----------
                                                        17,651           21,351
         Other accounts receivable...............          369              171
                                                    ----------       ----------

                                                    $   18,020       $   21,522
                                                    ==========       ==========

5.   INVENTORY

     The following table details the components of inventory:

                                                              June 30,
                                                        --------------------
                                                        2001            2000
                                                        ----            ----
         Raw materials
           Paper.................................   $   1,796        $    3,944
           Other raw materials...................       2,697             2,541
                                                    ---------        ----------
              Total raw materials................       4,493             6,485
         Work in process.........................       1,837             1,272
                                                    ---------        ----------

         Total inventory.........................   $   6,330        $    7,757
                                                    =========        ==========

          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,
     2001 or June 30,  2000.  During  the year  ended  June  30,  2001,  certain
     inventory quantity reductions caused a liquidation of LIFO inventory values
     which were immaterial.


                                      F-11


<PAGE>
                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (in thousands, except share and per share information)


6.   PROPERTY, PLANT AND EQUIPMENT

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

                                                                  June 30,
                                         Estimated          ------------------
                                       Useful Lives         2001          2000
                                       ------------         ----          ----

         Land.......................                     $    258      $    258
         Building...................   7 - 15 years         1,851         1,719
         Leasehold improvements.....   1 -  3 years           651           635
         Machinery and equipment....   5 -  7 years        23,622        21,348
         Furniture and fixtures.....   3 -  5 years         3,370         3,081
         Construction in progress...                          405           101
                                                        ---------      --------
                                                           30,157        27,142
         Accumulated depreciation...                      (14,379)      (10,045)
                                                        ---------      --------
                                                         $ 15,778      $ 17,097
                                                        =========      ========

          Depreciation  expense  amounted  to $4,334,  $4,381 and $3,881 for the
     years ended June 30, 2001, 2000 and 1999, respectively.

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

                                                               June 30,
                                                          -------------------
                                                          2001           2000
                                                          ----           ----

         Machinery and equipment...................    $       -       $  3,000
         Building..................................          600            600
                                                       ---------       --------
                                                             600          3,600
         Less accumulated depreciation.............         (500)        (1,390)
                                                       ---------       --------
                                                       $     100       $  2,210
                                                       =========       ========


          Depreciation of assets under capital lease totaled $200, $600 and $515
     for the years  ended June 30,  2001,  2000 and 1999,  respectively.  Future
     minimum lease payments under the remaining lease are as follows:

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

                           2002.................      $     529       $     26

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,  2001,  the  Company's  borrowing  base  was  approximately
     $19,551.  Interest on amounts borrowed accrue at a floating rate based upon
     either  prime  or LIBOR  (7.75%  and  10.25%  at June  30,  2001 and  2000,
     respectively).  The  weighted  average  interest  rate  on the  outstanding
     balance under the Credit Agreement was 9.58%, 9.12% and 8.51% for the years
     ended June 30, 2001, 2000 and 1999, respectively.


                                      F-12


<PAGE>
                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (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 did not
     have any lender guarantees outstanding at June 30, 2001. These fees totaled
     $59,  $69 and $111  for the  years  ended  June 30,  2001,  2000 and  1999,
     respectively. The Credit Agreement contains certain financial covenants and
     other restrictions  including  restrictions on additional  indebtedness and
     restrictions on the payment of dividends.  As of June 30, 2001, the Company
     was in compliance with all debt covenants.

8.   LOANS PAYABLE TO STOCKHOLDER

          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, 2001 no amount was
     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") which mature on July 1, 2008. 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 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 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
     2001, AKI purchased  $4,000 of the Senior Notes for $3,110 and recognized a
     gain, net of income taxes, of approximately  $457.  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,  respectively.  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  $7,124 and
     $13,368 at June 30, 2001 and 2000, respectively. After July 1, 2003,


                                      F-13

<PAGE>
                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (in thousands, except share and per share information)


10.  SENIOR DISCOUNT DEBENTURES (Continued)

     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 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 2001, AHC purchased
     Senior  Discount  Debentures with a carrying value of $7,547 for $4,721 and
     recognized a gain, net of income taxes,  of  approximately  $1,559.  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.

11.  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.  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.  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 Mandatorily
     Redeemable  Senior Preferred Stock Option of $2,363 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.


                                      F-14

<PAGE>
                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (in thousands, except share and per share information)


12.  COMMITMENTS AND CONTINGENCIES

     Operating Leases

          Equipment and office,  warehouse and production  space under operating
     leases expire at various  dates.  Rent expense was $538,  $589 and $338 for
     the years ended June 30, 2001, 2000 and 1999, respectively.  Future minimum
     lease payments under the leases are as follows.

                                    2002       $    353
                                    2003            431
                                    2004            377
                                    2005            356
                                    2006            365
                                    2007            157
                                               --------
                                               $  2,039
                                               ========

     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 under this
     agreement for each of the three years ended June 30, 2001.  The Company has
     paid $5,576 in cumulative  royalty  payments under this  agreement  through
     June 30, 2001.

          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,  $625 and $575 under this
     agreement for the years ended June 30, 2001, 2000 and 1999, respectively.

     Employment Agreements

          The Company has employment  agreements with certain executive officers
     with terms through June 30, 2002 and 2003. Such agreements provide for base
     salaries  totaling $985 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.

     Litigation

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


                                      F-15


<PAGE>
                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (in thousands, except share and per share information)


12.  COMMITMENTS AND CONTINGENCIES (Continued)

     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.

13.  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. The
     Company  makes  contributions  to the  Plan by  matching  a  percentage  of
     employee  contributions.  Costs associated with the Plan totaled $294, $251
     and $201 for the years ended June 30, 2001, 2000 and 1999, respectively.

          Certain  hourly  employees are covered under a  multiemployer  defined
     benefit plan administered under a collective  bargaining  agreement.  Costs
     (determined by union  contract)  under the defined  benefit plan were $233,
     $215  and  $204  for  the  years  ended  June  30,  2001,  2000  and  1999,
     respectively.

14.  INCOME TAXES

          The Company is included in the consolidated  federal income tax return
     filed by AHC.  Income  taxes  related to the  Company are  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.

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

<TABLE>
<CAPTION>

                                                                               Year Ended June 30,
                                                                     ---------------------------------------
                                                                     2001             2000              1999
                                                                     ----             ----              ----

<S>                                                                <C>              <C>              <C>
         Income (loss) before income taxes and
          extraordinary gain:
            United States..................................        $   1,481        $  (1,305)       $  (5,978)
            Foreign........................................            1,461              455              522
                                                                   ---------        ---------        ---------
                                                                   $   2,942        $    (850)       $  (5,456)
                                                                   =========        =========        =========

</TABLE>



                                      F-16



<PAGE>
                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (in thousands, except share and per share information)

14.  INCOME TAXES (Continued)

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

<TABLE>
<CAPTION>
                                                                               Year Ended June 30,
                                                                     ---------------------------------------
                                                                     2001             2000              1999
                                                                     ----             ----              ----

<S>                                                               <C>               <C>              <C>
         Current expense (benefit):
           Federal........................................        $   4,288         $     480        $       -
           Foreign........................................              526               171              204
           State..........................................              232                 -                -
                                                                  ---------         ---------        ---------
                                                                      5,046               651              204
                                                                  ---------         ---------        ---------

         Deferred expense (benefit):

           Federal........................................           (1,931)              519             (481)
           Foreign........................................                -                 -                -
           State..........................................              334               426              (63)
                                                                  ---------         ---------        ---------
                                                                     (1,597)              945             (544)
                                                                  ---------         ---------        ---------

                                                                  $   3,449         $   1,596        $    (340)
                                                                  =========         =========        =========
</TABLE>

          The  significant  components of deferred tax assets  (liabilities)  at
     June 30, 2001 and 2000, were as follows:


<TABLE>
<CAPTION>
                                                                                June 30,
                                                       -------------------------------------------------------
                                                                2001                            2000
                                                       ----------------------           ----------------------
                                                       Current     Noncurrent           Current     Noncurrent
                                                       -------     ----------           -------     ----------
<S>                                                    <C>           <C>                <C>          <C>
         Deferred income tax assets:
           Accrued expenses........................    $     474     $  2,338           $     215    $   2,427
           Allowance for doubtful accounts.........          296            -                 181            -
           Net operating loss carryforwards........            -           78                   -          412
           Other non-current liabilities...........            -          343                   -          308
                                                       ---------     --------           ---------    ---------
                                                             770        2,759                 396        3,147

         Deferred income tax liability:
             Property, plant and equipment.........            -       (2,778)                  -       (3,090)
                                                       ---------     ---------          ---------    ----------

                Deferred tax assets (liabilities)..    $     770     $    (19)          $     396    $      57
                                                       =========     ========           =========    =========
</TABLE>

          The income tax provision recognized by the Company for the years ended
     June 30, 2001, 2000 and 1999 differs from the amount determined by applying
     the applicable U.S. statutory federal income tax rate to pretax income as a
     result of the following:

<TABLE>
<CAPTION>
                                                                               Year Ended June 30,
                                                                     ---------------------------------------
                                                                     2001             2000              1999
                                                                     ----             ----              ----

<S>                                                               <C>               <C>              <C>
         Computed tax provision (benefit) at the
           statutory rate.................................        $   1,030         $    (289)       $  (1,855)
         State income tax provision (benefit),
           net of federal effect..........................              368               281              (42)
         Nondeductible expenses...........................            2,036             1,588            1,530
         Other, net.......................................               15                16               27
                                                                  ---------         ---------        ---------

                                                                  $   3,449         $   1,596        $    (340)
                                                                  =========         =========        =========
</TABLE>

                                      F-17

<PAGE>
                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (in thousands, except share and per share information)


14.  INCOME TAXES (Continued)

          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 $78  reflecting  cumulative  net operating
     loss  carryforwards  available  to offset  future state  taxable  income of
     approximately  $1,297 at June 30, 2001. 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.

15.  STOCK OPTIONS

          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 one to eight
     years.  Certain  options are  eligible  for  accelerated  vesting  based on
     targeted EBITDA. Options may be exercisable for up to ten years.

          A summary of AHC stock option activity and related information for the
     years ended June 30, 2001 and 2000 follows:


<TABLE>
<CAPTION>

                                                               2001                            2000
                                                     ------------------------         ------------------------
                                                                     Weighted                         Weighted
                                                                      Average                          Average
                                                                     Exercise                         Exercise
                                                       Options         Price           Options          Price
                                                       -------         -----           -------          -----

<S>                                                  <C>             <C>              <C>            <C>
         Outstanding, beginning of year..........    1,509,450       $  1.00                  -      $      -
              Granted............................       35,500          1.00          1,519,917          1.00
              Exercised..........................            -             -                  -             -
              Forfeited..........................      (90,567)         1.00            (10,467)         1.00
                                                     ---------       -------          ---------      --------

         Outstanding, end of year................    1,454,383       $  1.00          1,509,450      $   1.00
                                                     =========       =======          =========      ========

         Exercisable, end of year................      640,793       $  1.00            273,668      $   1.00
                                                     =========       =======          =========      ========

         Weighted average remaining
              contractual life...................             8.5 years                        9.5 years

</TABLE>



                                      F-18
<PAGE>
                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (in thousands, except share and per share information)


15.  STOCK OPTIONS (Continued)

          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 income (loss)
     for the years  ended  June 30,  2001 and 2000  would  have been  $1,404 and
     $(1,408),  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 2001 and 2000 was  approximately  $0.27 per
     option.

16.  RELATED PARTY TRANSACTIONS

          The Company made  payments to an  affiliate of DLJMBII for  management
     fees of $250 for each of the three years ended June 30, 2001.

17.  GEOGRAPHIC INFORMATION

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


<TABLE>
<CAPTION>

                                                         United
     Net sales:                                          States              France              Total

<S>                                                  <C>                 <C>                 <C>
     Year ended June 30, 1999....................    $     72,016        $     15,153        $    87,169
     Year ended June 30, 2000....................          85,418              14,393             99,811
     Year ended June 30, 2001....................          96,845              18,550            115,395

     Long-lived assets:

     June 30, 1999...............................         180,984                 107            181,091
     June 30, 2000...............................         192,262                  87            192,349
     June 30, 2001...............................         183,848                  70            183,918


</TABLE>

                                      F-19

<PAGE>
                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (in thousands, except share and per share information)


18.  CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS

          The  following  condensed  balance sheet at June 30, 2001 and June 30,
     2000 and condensed statement of operations,  stockholder's  equity and cash
     flows for the  years  ended  June 30,  2001 and June 30,  2000 for  Holding
     should be read in conjunction  with the consolidated  financial  statements
     and notes thereto.

                                 BALANCE SHEETS
<TABLE>
<CAPTION>

                                                                                          June 30,
                                                                                    ---------------------
                                                                                    2001             2000
                                                                                    ----             ----
<S>                                                                             <C>              <C>
     Assets
     Investment in subsidiaries........................................         $  102,237       $    99,798
     Deferred charges..................................................                806             1,167
     Deferred income taxes.............................................              2,338             2,013
                                                                                ----------       -----------
       Total assets....................................................         $  105,381       $   102,978
                                                                                ==========       ===========

     Liabilities
     Accrued Income Taxes..............................................         $      119       $         9
     Senior Discount Debentures........................................             23,926            27,863
                                                                                ----------       -----------
       Total liabilities...............................................             24,045            27,872
                                                                                ----------       -----------

     Stockholder's equity
     Common Stock, $0.01 par value, 1,000 shares authorized;
       1,000 shares issued and outstanding.............................                  -                 -
     Additional paid-in capital........................................             93,656            88,935
     Accumulated deficit...............................................            (12,320)          (13,829)
                                                                                ----------       -----------
       Total stockholder's equity......................................             81,336            75,106
                                                                                ----------       -----------

       Total liabilities and stockholder's equity......................         $  105,381       $   102,978
                                                                                ==========       ===========

</TABLE>

                             STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>

                                                                                     Year Ended June 30,
                                                                                   ----------------------
                                                                                   2001              2000
                                                                                   ----              ----

<S>                                                                             <C>              <C>
     Equity in net income of subsidiaries..............................         $    2,439       $       495
     Interest expense, net.............................................             (3,699)           (3,733)
                                                                                ----------       -----------

       Loss before income taxes and extraordinary gain.................             (1,260)           (3,238)

     Income tax benefit................................................             (1,210)           (1,221)
                                                                                ----------       -----------

       Loss before extraordinary gain..................................                (50)           (2,017)

     Extraordinary gain from early retirement of debt, net of tax......              1,559               660
                                                                                ----------       -----------

       Net income (loss)...............................................         $    1,509       $    (1,357)
                                                                                ==========       ===========
</TABLE>

                                      F-20


<PAGE>
                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (in thousands, except share and per share information)


18.  CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS (Continued)

                        STATEMENT OF STOCKHOLDER'S EQUITY

<TABLE>
<CAPTION>
                                                                 Additional
                                             Common Stock          Paid-in      Accumulated
                                          Shares     Amount        Capital        Deficit         Total
                                          ------     ------        -------        -------         -----
<S>                                         <C>      <C>        <C>             <C>            <C>
     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
     Equity contribution by AHC I
       Acquisition Corp...............          -          -          4,721              -           4,721
     Net income.......................          -          -              -          1,509           1,509
                                          -------    -------    -----------     ----------     -----------

     Balances, June 30, 2001..........      1,000    $     -    $    93,656     $  (12,320)    $    81,336
                                          =======    =======    ===========     ==========     ===========

</TABLE>


                             STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>

                                                                                    Year Ended June 30,
                                                                                    -------------------
                                                                                    2001           2000
                                                                                    ----           ----
<S>                                                                             <C>            <C>
     Cash flows from operating activities:
       Net income (loss)...................................................     $    1,509     $    (1,357)
       Adjustments to reconcile net income (loss) to net cash provided
        by (used in) operating activities:
         Net change in investment in subsidiaries..........................         (2,439)           (495)
         Amortization of original issuance discount and loan closing costs.          3,699           3,733
         Deferred income taxes.............................................         (1,210)         (1,221)
         Gain from early retirement of debt................................         (1,559)           (660)
                                                                                ----------     -----------
           Net cash provided by (used in) operating activities.............              -               -
                                                                                ----------     -----------

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

</TABLE>


                                      F-21


<PAGE>
                       AKI HOLDING CORP. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (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 2001 and Fiscal 2000.

<TABLE>
<CAPTION>


                                  Quarter Ended    Quarter Ended    Quarter Ended     Quarter Ended
                                  September 30,     December 31,       March 31,         June 30,
     Fiscal 2001                      2000              2000             2001              2001            Total
                                      ----              ----             ----              ----            -----

<S>                                 <C>              <C>               <C>              <C>               <C>
     Net sales...............       $ 32,353         $  26,180         $  33,094        $  23,768         $ 115,395
     Gross profit............         12,805             8,487            13,765            9,002            44,059
     Income from operations..          6,868             2,626             7,298            3,311            20,103
     Interest expense, net...          4,404             4,244             4,269            3,994            16,911
     Net income (loss).......            937              (621)            1,712             (519)            1,509


                                  Quarter Ended    Quarter Ended    Quarter Ended     Quarter Ended
                                  September 30,     December 31,       March 31,         June 30,
     Fiscal 2000                      1999              1999             2000              2000             Total
                                      ----              ----             ----              ----             -----

     Net sales...............       $ 28,673         $  20,843         $  25,783        $  24,512         $  99,811
     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 income (loss).......          1,281              (664)             (230)          (1,744)           (1,357)

</TABLE>





                                      F-22
<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,  stockholder's  equity and cash
flows present fairly, in all material  respects,  the financial position of AKI,
Inc.  and  Subsidiaries  at June 30,  2001 and  2000  and the  results  of their
operations  and their cash flows for each of the three years in the period ended
June 30, 2001 in conformity with generally accepted accounting principles in the
United States of America.  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 auditing  standards  generally  accepted in the United States of
America,  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 our opinion.





PricewaterhouseCoopers LLP
Knoxville, Tennessee
August 3, 2001


                                      F-23


<PAGE>


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


<TABLE>
<CAPTION>

                                                                                           June 30,
                                                                                   ------------------------
                                                                                   2001                2000
                                                                                   ----                ----

<S>                                                                             <C>                <C>
ASSETS
Current assets
Cash and cash equivalents..............................................         $    4,654         $     1,158
Accounts receivable, net...............................................             18,020              21,522
Inventory..............................................................              6,330               7,757
Prepaid expenses.......................................................                492                  92
Deferred income taxes..................................................                770                 396
                                                                                ----------         -----------
      Total current assets.............................................             30,266              30,925

Property, plant and equipment, net.....................................             15,778              17,097
Goodwill, net .........................................................            157,334             162,472
Other intangible assets, net...........................................              6,337               7,174
Deferred charges, net..................................................              3,575               4,294
Other assets...........................................................                 88                  88
                                                                                ----------         -----------
      Total assets.....................................................         $  213,378         $   222,050
                                                                                ==========         ===========


LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of capital lease obligation............................         $      503         $       847
Accounts payable, trade................................................              3,886               3,565
Accrued income taxes...................................................              1,523                 301
Accrued compensation...................................................              4,715               3,965
Accrued interest.......................................................              5,443               5,695
Accrued expenses.......................................................              3,908               2,370
                                                                                ----------         -----------
      Total current liabilities........................................             19,978              16,743

Long-term portion of capital lease obligation..........................                  -                 502
Revolving credit line..................................................                  -               9,000
Senior notes...........................................................            103,510             107,510
Deferred income taxes..................................................              2,357               2,370
Other non-current liabilities..........................................              1,863               2,399
                                                                                ----------         -----------
      Total liabilities................................................            127,708             138,524

Commitments and contingencies

Stockholder's equity
Common stock, $0.01 par, 100,000 shares authorized; 1,000
    shares issued and outstanding......................................                  -                   -
Additional paid-in capital.............................................            107,348             107,348
Accumulated deficit....................................................             (5,111)             (7,550)
Accumulated other comprehensive loss...................................               (837)               (542)
Carryover basis adjustment.............................................            (15,730)            (15,730)
                                                                                ----------         -----------
      Total stockholder's equity.......................................             85,670              83,526
                                                                                ----------         -----------

      Total liabilities and stockholder's equity.......................         $  213,378         $   222,050
                                                                                ==========         ===========

</TABLE>



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

                                      F-24


<PAGE>


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

<TABLE>
<CAPTION>


                                                                                      Year Ended June 30,
                                                                              ----------------------------------
                                                                              2001           2000           1999
                                                                              ----           ----           ----

<S>                                                                        <C>            <C>             <C>
Net sales.....................................................             $ 115,395      $  99,811       $  87,169
Cost of goods sold............................................                71,336         61,552          56,401
                                                                           ---------      ---------       ---------

   Gross profit...............................................                44,059         38,259          30,768

Selling, general and administrative expenses..................                18,199         16,980          14,500
Amortization of goodwill and other intangible assets..........                 5,757          5,336           4,606
Gain from settlement of litigation, net.......................                     -           (858)              -
                                                                           ---------      ----------      ---------

   Income from operations.....................................                20,103         16,801          11,662

Other expenses (income):
   Interest expense to stockholder(s) and affiliate...........                   320             22               -
   Interest expense, other....................................                12,892         13,646          13,028
   Management fees to stockholders and affiliate..............                   250            250             250
   Other, net.................................................                     -              -             128
                                                                           ---------      ---------       ---------

     Income (loss) before income taxes and
     extraordinary gain.......................................                 6,641          2,883          (1,744)

Income tax expense ...........................................                 4,659          2,817             847
                                                                           ---------      ---------       ---------

     Income (loss) before extraordinary gain..................                 1,982             66          (2,591)

Extraordinary gain from early retirement of debt, net
of tax   .....................................................                   457            429               -
                                                                           ---------      ---------       ---------

Net income (loss).............................................             $   2,439      $     495       $  (2,591)
                                                                           =========      =========       =========

</TABLE>


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

                                      F-25



<PAGE>


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



<TABLE>
<CAPTION>
                                                                                                   Accumulated
                                                      Additional                      Other         Carryover
                                     Common Stock       Paid-in     Accumulated   Comprehensive       Basis
                                    Shares  Amount      Capital       Deficit         Loss          Adjustment     Total
                                    ------  ------      -------       -------         ----          ----------     -----

<S>                                 <C>    <C>         <C>           <C>           <C>              <C>           <C>
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
Equity contribution by AKI
  Holding Corp..................        -        -             -            -              -                -            -
Net income......................        -        -             -        2,439              -                -        2,439
Other comprehensive loss, net
  of tax:
   Foreign currency translation
     adjustment.................        -        -             -            -           (295)               -        (295)
                                                                                                                 --------
Comprehensive income............                                                                                    2,144
                                   ------  -------     ---------     --------      ---------        ---------    --------

Balances, June 30, 2001.........    1,000  $     -     $ 107,348     $ (5,111)     $    (837)       $ (15,730)   $ 85,670
                                   ======  =======     =========     ========      =========        =========    ========

</TABLE>




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

                                      F-26


<PAGE>


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

<TABLE>
<CAPTION>

                                                                                      Year Ended June 30,
                                                                           ---------------------------------------
                                                                           2001              2000             1999
                                                                           ----              ----             ----

<S>                                                                     <C>              <C>              <C>
   Cash flows from operating activities:
     Net income (loss)........................................          $   2,439        $     495        $  (2,591)
     Adjustment to reconcile net income (loss) to net cash
       provided by operating activities:
         Depreciation and amortization of goodwill and other
           intangibles                                                     10,119            9,738            8,487
         Amortization of loan closing costs...................                575              656              636
         Deferred income taxes................................               (387)           2,166              643
         Gain on sale of equipment............................                  -                -              (50)
         Gain from early retirement of debt...................               (457)            (429)               -
         Other................................................                (84)              (1)            (308)
         Changes in operating assets and liabilities:.........
           Accounts receivable................................              3,502           (2,576)          (2,737)
           Inventory..........................................              1,427           (2,496)          (3,031)
           Prepaid expenses, deferred charges and other assets               (400)             450             (627)
           Accounts payable and accrued expenses..............              1,939           (2,637)           4,511
           Income taxes.......................................                931             (439)           5,238
                                                                        ---------        ---------        ---------

         Net cash provided by operating activities............             19,604            4,927           10,171
                                                                        ---------        ---------        ---------

   Cash flows from investing activities:
     Purchases of equipment...................................             (3,015)          (2,782)          (2,856)
     Proceeds from sale of equipment..........................                  -                -               50
     Payments for acquisitions, net of cash acquired..........                  -          (16,164)               -
     Patents..................................................               (137)            (150)               -
                                                                        ---------        ---------        ---------

         Net cash used in investing activities................             (3,152)         (19,096)          (2,806)
                                                                        ---------        ---------        ---------

   Cash flows from financing activities:
     Payments under capital leases for equipment..............               (846)            (688)            (661)
     Repayments of long-term debt.............................             (3,110)               -                -
     Net proceeds (repayments) on line of credit..............             (9,000)           9,000                -
     Repayment of other notes payable.........................                  -                -           (1,330)
                                                                        ---------        ---------         --------

         Net cash provided by (used in) financing activities..            (12,956)           8,312           (1,991)
                                                                        ---------        ---------         --------

   Net increase (decrease) in cash and cash equivalents.......              3,496           (5,857)           5,374
   Cash and cash equivalents, beginning of period.............              1,158            7,015            1,641
                                                                        ---------        ---------         --------
   Cash and cash equivalents, end of period...................          $   4,654        $   1,158         $  7.015
                                                                        =========        =========         ========

   Supplemental information:
     Cash paid (received) during the period for:
       Interest to stockholder(s).............................          $     320        $      22        $       -
       Interest, other........................................             12,233           13,188            6,512
       Income taxes...........................................              4,115            1,264           (5,123)

   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-27

<PAGE>


                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (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 (the  "Acquisition").  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 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-28

<PAGE>

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


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

          One  customer  accounted  for 14.9% of net sales during the year ended
     June 30,  2001.  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.

     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 at the time ownership  transfers,  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-29

<PAGE>


                           AKI, INC. AND SUBSIDIARIES
                (a wholly-owned subsidiary of AKI Holding Corp.)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
             (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 $15,353 and $10,546 at
     June 30, 2001 and June 30, 2000, 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 $2,442 and $1,479 at June 30, 2001 and June 30, 2000,
     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  $99,370 at June 30,  2001,  compared  to a carrying  value of
     $103,510.   The  carrying   value  of  all  other   financial   instruments
     approximates fair value at June 30, 2001.

     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
     amounted to $403,  $51 and $91 for the years ended June 30, 2001,  2000 and
     1999, respectively.


                                      F-30

<PAGE>

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


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

     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 $1,591,  $1,309 and $1,136 for the years ended
     June 30, 2001, 2000 and 1999, respectively.

     Income Taxes

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

     Use of Estimates

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

     Recently Issued Accounting Standards

          In September  2000, the Emerging Issues Task Force reached a consensus
     on Issue 00-10,  "Accounting  for  Shipping  and  Handling  Fees and Costs"
     ("Issue 00-10").  Issue 00-10 requires that all amounts billed to customers
     related to shipping and handling  should be classified  as revenues.  Issue
     00-10 was effective for the Company no later than the fourth quarter of the
     fiscal year ending  June 30,  2001,  and,  accordingly,  amounts  billed to
     customers related to shipping and handling have been reclassified from cost
     of goods sold to net sales.

          FASB  Statement of Financial  Accounting  Standards  No. 141 "Business
     Combinations"  ("SFAS  141) was issued in June 2001.  SFAS 141  changes the
     accounting and reporting for business  combinations.  SFAS 141 is effective
     for all business combinations initiated after June 30, 2001.

          FASB Statement of Financial Accounting Standards No. 142 "Goodwill and
     Other  Intangible  Assets"  ("SFAS 142") was issued in June 2001.  SFAS 142
     changes the  accounting  and  reporting  for  acquired  goodwill  and other
     intangible  assets.  SFAS 142 is effective for fiscal years beginning after
     December  15,  2001 and must be applied  at the  beginning  of an  entity's
     fiscal year. The Company is currently  assessing the effect, if any, on its
     financial statements of implementing SFAS 142.


                                      F-31

<PAGE>

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


3.   SIGNIFICANT ACQUISITIONS

          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.

          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.

4.   ACCOUNTS RECEIVABLE

     The following table details the components of accounts receivable:

                                                             June 30,
                                                       -------------------
                                                       2001           2000
                                                       ----           ----

         Trade accounts receivable..............   $   18,487      $  22,314
         Allowance for doubtful accounts........         (836)          (963)
                                                   ----------      ---------
                                                       17,651         21,351
         Other accounts receivable..............          369            171
                                                   ----------      ---------

                                                   $   18,020      $  21,522
                                                   ==========      =========

5.   INVENTORY

     The following table details the components of inventory:

                                                            June 30,
                                                      -------------------
                                                      2001           2000
                                                      ----           ----
         Raw materials
           Paper...............................   $    1,796      $   3,944
           Other raw materials.................        2,697          2,541
                                                  ----------      ---------
              Total raw materials..............        4,493          6,485
         Work in process.......................        1,837          1,272
                                                  ----------      ---------

         Total inventory.......................   $    6,330      $   7,757
                                                  ==========      =========

          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,
     2001 or June 30,  2000.  During  the year  ended  June  30,  2001,  certain
     inventory  quantity  reductions  caused  a  liquidation  of LIFO  inventory
     values, which were immaterial.


                                      F-32

<PAGE>

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


6.   PROPERTY, PLANT AND EQUIPMENT

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

                                                                 June 30,
                                        Estimated           ------------------
                                       Useful Lives         2001          2000
                                       ------------         ----          ----

         Land.......................                     $    258      $    258
         Buildings..................   7 - 15 years         1,851         1,719
         Leasehold improvements.....   1 -  3 years           651           635
         Machinery and equipment....   5 -  7 years        23,622        21,348
         Furniture and fixtures.....   3 -  5 years         3,370         3,081
         Construction in progress...                          405           101
                                                         --------      --------
                                                           30,157        27,142
         Accumulated depreciation...                      (14,379)      (10,045)
                                                         --------      --------
                                                         $ 15,778      $ 17,097
                                                         ========      ========


          Depreciation  expense  amounted  to $4,341,  $4,381 and $3,881 for the
     years ended June 30, 2001, 2000 and 1999, respectively.

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

                                                                June 30,
                                                          --------------------
                                                          2001            2000
                                                          ----            ----

         Machinery and equipment...................    $      -        $  3,000
         Building..................................         600             600
                                                       --------        --------
                                                            600           3,600
         Less accumulated depreciation.............        (500)         (1,390)
                                                       --------        --------
                                                       $    100        $  2,210
                                                       ========        ========

          Depreciation  of the assets under capital lease totaled $200, $600 and
     $515 for the years ended June 30, 2001, 2000 and 1999, respectively. Future
     minimum lease payments under the remaining leases are as follows:

                                                   Payment          Interest
                                                   -------          --------
                           2002..............     $    529         $      26



                                      F-33

<PAGE>

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


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,  2001,  the  Company's  borrowing  base  was  approximately
     $19,551.  Interest on amounts borrowed accrue at a floating rate based upon
     either  prime  or LIBOR  (7.75%  and  10.25%  at June  30,  2001 and  2000,
     respectively).  The  weighted  average  interest  rate  on the  outstanding
     balance under the Credit Agreement was 9.58%, 9.12% and 8.51% for the years
     ended June 30, 2001, 2000 and 1999, 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 did not
     have any lender guarantees outstanding at June 30, 2001. These fees totaled
     $59,  $69 and $111  for the  years  ended  June 30,  2001,  2000 and  1999,
     respectively. The Credit Agreement contains certain financial covenants and
     other restrictions  including  restrictions on additional  indebtedness and
     restrictions on the payment of dividends.  As of June 30, 2001, the Company
     was in compliance with all debt covenants.

8.   LOANS PAYABLE TO STOCKHOLDER

          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, 2001,  no amount was
     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"),  which  mature on July 1,
     2008. 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  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  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 2001, the
     Company  purchased  $4,000 of the Senior Notes for $3,110 and  recognized a
     gain, net of income taxes of  approximately  $457.  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  purchased  and
     contributed notes were subsequently retired.


                                      F-34


<PAGE>

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

10.  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.  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.  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 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.

          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.

11.  COMMITMENTS AND CONTINGENCIES

     Operating Leases

          Equipment and office,  warehouse and production  space under operating
     leases expire at various  dates.  Rent expense was $538,  $589 and $338 for
     the years ended June 30, 2001, 2000 and 1999, respectively.  Future minimum
     lease payments under the leases are as follows:

                                    2002       $    353
                                    2003            431
                                    2004            377
                                    2005            356
                                    2006            365
                                    2007            157
                                               --------
                                               $  2,039
                                               ========


                                      F-35
<PAGE>

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


11.  COMMITMENTS AND CONTINGENCIES (Continued)

     Royalty Agreements

          Royalty agreements are maintained for certain technologies used in the
     manufacture of certain products.  Under the terms of one royalty agreement,
     payments are required  based on a percentage of net sales of those products
     manufactured with the specific  technology,  or a minimum of $500 per year.
     This  agreement  expires in 2003 or when a total of  $12,500 in  cumulative
     royalty  payments  has been paid.  The Company  expensed  $500,  under this
     agreement for each of the three years ended June 30, 2001.  The Company has
     paid $5,576 in cumulative  royalty  payments under this  agreement  through
     June 30, 2001.

          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,  $625 and
     $575 under this agreement for the years ended June 30, 2001, 2000 and 1999,
     respectively.

     Employment Agreements

          The Company has employment  agreements with certain executive officers
     with terms through June 30, 2002 and 2003. Such agreements provide for base
     salaries  totaling $985 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.

     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-36

<PAGE>

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


12.  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. The
     Company  makes  contributions  to the  Plan by  matching  a  percentage  of
     employee  contributions.  Costs associated with the Plan totaled $294, $251
     and $201 for the years ended June 30, 2001, 2000 and 1999, respectively.

          Certain  hourly  employees are covered under a  multiemployer  defined
     benefit plan administered under a collective  bargaining  agreement.  Costs
     (determined by union  contract)  under the defined  benefit plan were $233,
     $215  and  $204  for  the  years  ended  June  30,  2001,  2000  and  1999,
     respectively.

13.  INCOME TAXES

          The Company is included in the consolidated  federal income tax return
     filed by AHC.  Income  taxes  related to the  Company are  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.

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

<TABLE>
<CAPTION>
                                                                               Year Ended June 30,
                                                                     ---------------------------------------
                                                                     2001             2000              1999
                                                                     ----             ----              ----

<S>                                                                <C>              <C>              <C>
         Income (loss) before income taxes and
          extraordinary gain:
            United States..................................        $   5,180        $   2,428        $  (2,266)
            Foreign........................................            1,461              455              522
                                                                   ---------        ---------        ---------

                                                                   $   6,641        $   2,883        $  (1,744)
                                                                   =========        =========        =========
</TABLE>

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

<TABLE>
<CAPTION>

                                                                               Year Ended June 30,
                                                                     ---------------------------------------
                                                                     2001             2000              1999
                                                                     ----             ----              ----

<S>                                                               <C>               <C>              <C>
         Current expense (benefit):
           Federal........................................        $   4,288         $     480        $       -
           Foreign........................................              526               171              204
           State..........................................              232                 -                -
                                                                  ---------         ---------        ---------
                                                                      5,046               651              204
                                                                  ---------         ---------        ---------

         Deferred expense (benefit):
           Federal........................................             (721)            1,740              569
           Foreign........................................                -                 -                -
           State..........................................              334               426               74
                                                                  ---------         ---------        ---------
                                                                       (387)            2,166              643
                                                                  ---------         ---------        ---------

                                                                  $   4,659         $   2,817        $     847
                                                                  =========         =========        =========
</TABLE>


                                      F-37


<PAGE>

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



13.  INCOME TAXES  (Continued)

          The significant components of deferred tax assets and (liabilities) at
     June 30, 2001 and 2000, were as follows:

<TABLE>
<CAPTION>

                                                                               June 30,
                                                     -----------------------------------------------------------
                                                                2001                             2000
                                                     ---------------------------      --------------------------
                                                     Current          Noncurrent      Current         Noncurrent
                                                     -------          ----------      -------         ----------

<S>                                                  <C>             <C>              <C>             <C>
         Deferred income tax assets:
             Accrued expenses.....................   $     474       $      -         $     215       $      -
             Allowance for doubtful accounts......         296              -               181              -
             Net operating loss carry forwards....           -             78                 -            412
             Other non-current liabilities........           -            343                 -            308
                                                     ---------       --------         ---------      ---------
                                                           770            421               396            720
         Deferred income tax liability:
             Property, plant and equipment........           -         (2,778)                -         (3,090)
                                                     ---------       --------         ---------      ---------

                Deferred tax assets (liabilities).   $     770       $ (2,357)        $     396      $  (2,370)
                                                     =========       ========         =========      =========
</TABLE>


          The income tax provision recognized by the Company for the years ended
     June 30, 2001, 2000 and 1999 differs from the amount determined by applying
     the applicable U.S. statutory federal income tax rate to pretax income as a
     result of the following:

<TABLE>
<CAPTION>
                                                                               Year Ended June 30,
                                                                     ---------------------------------------
                                                                     2001             2000              1999
                                                                     ----             ----              ----

<S>                                                               <C>               <C>              <C>
         Computed tax provision (benefit)
           at the statutory rate..........................        $   2,324         $     980        $   (593)
         State income tax provision, net of
           federal effect.................................              368               281              49
         Nondeductible expenses...........................            1,952             1,540           1,364
         Other, net.......................................               15                16              27
                                                                  ---------         ---------        --------

                                                                  $   4,659         $   2,817        $    847
                                                                  =========         =========        ========
</TABLE>


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

          Due to the Company's  losses in prior years the Company has recorded a
     long-term  deferred tax asset of $78  reflecting  cumulative  net operating
     loss  carryforwards  available  to offset  future state  taxable  income of
     approximately  $1,297 at June 30, 2001. 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.


                                      F-38

<PAGE>


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


14.  STOCK OPTIONS

          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 one to eight
     years.  Certain  options are  eligible  for  accelerated  vesting  based on
     targeted EBITDA. Options may be exercisable for up to ten years.

          A summary of AHC stock option activity and related information for the
     years ended June 30, 2001 and 2000 follows:

<TABLE>
<CAPTION>

                                                               2001                            2000
                                                     ------------------------         ------------------------
                                                                     Weighted                         Weighted
                                                                      Average                          Average
                                                                     Exercise                         Exercise
                                                       Options         Price           Options          Price
                                                       -------         -----           -------          -----

<S>                                                  <C>             <C>              <C>             <C>
         Outstanding, beginning of year..........    1,509,450       $  1.00                  -       $     -
              Granted............................       35,500          1.00          1,519,917          1.00
              Exercised..........................            -            -                   -            -
              Forfeited..........................      (90,567)         1.00            (10,467)         1.00
                                                     ---------       -------          ---------       -------

         Outstanding, end of year................    1,454,383       $  1.00          1,509,450       $  1.00
                                                     =========       =======          =========       =======

         Exercisable, end of year................      640,793       $  1.00            273,668       $  1.00
                                                     =========       =======          =========       =======

         Weighted average remaining
              contractual life...................             8.5 years                        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,  2001 and 2000 would have been
     $2,334 and $444, 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 2001 was approximately $0.27 per option.

15.  RELATED PARTY TRANSACTIONS

          The Company made  payments to an  affiliate of DLJMBII for  management
     fees of $250 for each of the three years ended June 30, 2001.


                                      F-39


<PAGE>

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


16.  GEOGRAPHIC INFORMATION

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

<TABLE>
<CAPTION>

                                                           United
     Net sales:                                            States             France               Total

<S>                                                    <C>                 <C>                 <C>
     Year ended June 30, 1999....................      $    72,016         $    15,153         $    87,169
     Year ended June 30, 2000....................           85,418              14,393              99,811
     Year ended June 30, 2001....................           96,845              18,550             115,395

     Long-lived assets:

     June 30, 1999...............................          179,464                 107             179,571
     June 30, 2000...............................          191,038                  87             191,125
     June 30, 2001...............................          183,042                  70             183,112

</TABLE>

17.  UNAUDITED QUARTERLY RESULTS OF OPERATIONS

          The  following  is a summary  of the  unaudited  quarterly  results of
     operations for Fiscal 2001 and Fiscal 2000.

<TABLE>
<CAPTION>


                                  Quarter Ended    Quarter Ended    Quarter Ended     Quarter Ended
                                  September 30,     December 31,       March 31,         June 30,
     Fiscal 2001                      2000              2000             2001              2001             Total
                                      ----              ----             ----              ----             -----

<S>                                 <C>              <C>               <C>              <C>               <C>
     Net sales...............       $ 32,353         $  26,180         $  33,094        $  23,768         $ 115,395
     Gross profit............         12,805             8,487            13,765            9,002            44,059
     Income from operations..          6,868             2,626             7,298            3,311            20,103
     Interest expense, net...          3,442             3,344             3,331            3,095            13,212
     Net income (loss).......          1,584              (509)            1,932             (568)            2,439


                                  Quarter Ended    Quarter Ended    Quarter Ended     Quarter Ended
                                  September 30,     December 31,       March 31,         June 30,
     Fiscal 2000                      1999              1999             2000              2000             Total
                                      ----              ----             ----              ----             -----

     Net sales...............       $ 28,673         $  20,843         $  25,783        $  24,512         $  99,811
     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>