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, 2003

( ) 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.

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

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)

Indicate by check mark whether the registrant is an accelerated filer (as
defined by Exchange Act Rule 12b-2). ( ) Yes (X) No

As of September 17, 2003, 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.

The aggregate market value of the voting and non-voting stock held by
non-affiliates was zero as of December 31, 2002.

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.

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
marketing, interactive advertising and sampling systems that utilize various
technologies that engage the senses of touch, sight and olfactory. Our marketing
vehicles and sampling systems are widely recognized in the fine fragrance,
cosmetics and personal care industries, as well as other consumer products
industries including the household products and food and beverage industries. We
offer an extensive portfolio of proprietary, patented and patent-pending
technologies that can be incorporated into various marketing programs designed
to reach the consumer at home or in-store, such as magazine inserts, catalog
inserts, remittance envelopes, statement enclosures, blow-ins, direct mail,
direct sell and point-of-sale materials and
gift-with-purchase/purchase-with-purchase programs.

We are a fully integrated multi-sensory marketing and sampling company,
conducting our business under the Arcade Marketing name. We believe that we are
well positioned to provide complete, interactive advertising and sampling
programs to our customers, including creative content and product sample systems
and distribution.

We believe 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. With the creation of a multi-sensory marketing program -
combining advertising with a sampling system - marketers are afforded a
cost-effective means to reach consumers in their homes on a mass scale. We 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 technologies.

In recent years, we have expanded our sampling system business by
developing and acquiring new technologies in the olfactory and beauty sampling
system categories. 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. Many of our
innovative sampling systems are designed to fill the needs of these marketers by
providing a

cost-effective means of reaching consumers in their homes on a mass scale with
quality renditions of skincare products, foundation, lipstick and cosmetic
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, 2003, 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
proprietary, patented and patent-pending sampling systems catering to the
fragrance, cosmetics and personal care industries, as well as microencapsulation
products and processes. Such sampling systems include MicroSilk(TM),
MicroDot(TM) and AromaLacquer(TM). The acquired businesses also include a
creative service division that engages in marketing communications and catalogs.

On December 18, 2001, we acquired, through a newly formed subsidiary, IST,
Corp., the business including certain assets and assumed certain liabilities of
Color Prelude, Inc. (such business referred to hereafter as "CP"). CP
manufactures interactive advertising and sampling products for cosmetic and
consumer products companies. The acquired business offers proprietary, patented
and patent-pending sampling systems including the ShadeSeal(R) family of
products primarily for lipstick and powder sampling, BeautiPak(TM) for sampling
certain lipstick products, LiqiSeal(TM) for sampling skin care and foundation
products in a unique clear packette, PowdaScent(TM) for the sampling of
fragrance products and SelectaShade(TM) which is a unique beauty tool for shade
selection for foundation.

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 including
household products and 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.

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 a
widely used technology for sampling products for the fine 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. In recent years, our products have been used
in many major new fine fragrance launches that have utilized sampling systems.
Almost all of these sampling systems have been designed to meet U.S. Postal
Service approval for subscription magazine periodical rates.

o ScentStrip(R): A proprietary technology introduced by our Company in 1979,
ScentStrip(R) is 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 and 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 fine microencapsulated
essential oil is deposited between two layers of paper that "snap" open to
deliver an olfactory sample and wearable on-skin trial when "pearls" are
touched.

o MicroDot(TM): A proprietary technology, uses microencapsulated fragrance
oil, delivered in ultra-fine capsule size form, deposited between two
layers of paper which pull apart to deliver superior on-skin fragrance
trial. The technology is available as a stand alone product, as pressure
sensitive labels or as pressure sensitive labels on perforated sheets.

o PowdaScent(TM): A patented technology in which an encapsulated fragrance
oil, in a printable form, is hygienically sealed between a board stock and
a see-thru layer of transparent film. This transparent film displays the
encapsulated fragrance which can be produced in any size, shape and color.
Once peeled open, and the capsules are touched, an aroma rendition is
delivered.

o AromaLacquer(TM): A proprietary 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(TM) releases the aroma rendition.

o AromaTouch(TM): A proprietary scented microencapsulated coating that
delivers a superior aroma rendition of nearly any fragrance, personal care,
household, food, beverage, pharmaceutical or novelty product.
AromaTouch(TM) is printable to paper or plastic substrates and is most
popular for use on product packaging. When rubbed or scratched,
AromaTouch(TM) 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 strategic 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.

o DiscCover(R): A peel-and-reveal, non-encapsulated patented sampling system
label 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 is used not only to market fine fragrances but is becoming
popular in the delivery of quality aroma in the marketing of a variety of
personal care products and food and beverage products.

o DiscCover(R)More: This patented sampling system offers all of the
attributes of the original DiscCover(R) technology enhanced to offer a
single, wearable, on-skin trial of the fragrance.

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): This patented technology 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. The product
is available in a single or dual chamber pressure-sensitive format and has
been approved by the U.S. Postal Service for subscription magazine
periodical rates. LiquaTouch(R) is also available in a stand-alone version,
which is a cost-effective alternative to fragrance vials.

Beauty Sampling Systems

Our portfolio also includes non-fragrance sampling system products,
primarily for the beauty industry, 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 and powders. Almost
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, designed to withstand significant
pressure and is approved by the U.S. Postal Service 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 ActiSeal(TM): A patented technology, with characteristics similar to
BeautiSeal(R) , which is peeled open to reveal two adjacent wells, each
well containing a formula component which are blended together by the
consumer upon application.

o LiqiSeal(TM): A patented clear top packette which can be utilized to sample
liquid, cream, lotion or gel products. The patented clear laminate has
unique barrier characteristics which allow it to pass stringent stability
tests. The product sample can contain makeup, hair care, skin care,
fragranced ancillaries and body care, among other products.

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. PowdaTouch(R) is ideal for magazine and catalogue inserts,
blow-ins, and bind-in cards among others and is approved by the Postal
Service for subscription magazine periodical rates.

o ShadeSeal(R): This patented technology is used to sample renditions of
cosmetic powders or lip products. The product rendition is deposited
between two substrates which pull apart to offer a trial sample while a
transparent "window" displays the shade. This product can be utilized in
many different formats to accommodate either multiple shades or a variety
of cosmetic products including both long-lasting and conventional
lipsticks.

o LipSeal(R): A patented technology with characteristics similar to
BeautiSeal(R) this product provides 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(R)
offers trial of any lipstick shade, finish and texture in any lipstick
formula, including long-lasting formulas.

o BeautiPak(TM): A proprietary "windowed" sampling system for a variety of
lipstick formulations. Product is sealed into one well of a thermoformed
"tray" while a second well contains a flocked lipstick applicator.

o BeautiTouch(R) Multi-Well Sampler: This proprietary 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 of 8, 10, 12 or more foundation shades on
a single carrier with no cross-contamination.

o SelectaShade(TM): A proprietary beauty tool used to determine foundation
shades that precisely match consumers' skin tones. This transparent strip
of polyester film is printed with special inks that replicate foundation
shades exactly. When SelectaShade(TM) is placed against face or hand, the
shade that best matches the users own skin will become invisible on the
chart to give each consumer an accurate shade match.

Other Products & Services

o Arcade Direct: This full service division of our Company offers a full
range of creative services to our customers in the cosmetic and fragrance
industry, and has established a niche presence in various industries
including 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.

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.
Technologies offered in this division focus on interaction with the
consumer including the dispensing of samples. Such interaction promotes
sales at the point of sale.

Formats

Mail Formats

We produce a wide and versatile range of formats approved by the U.S.
Postal Service 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 nearly all of our sampling
systems and are the most commonly produced among our sampling 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, 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 be produced with
or without sampling systems. We believe that we are the only company in the
sampling industry that can produce remittance envelopes in-house. 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.

Other Formats

Direct Sell: Many of our Company's sampling systems are widely used in
direct sales campaigns. Beauty companies, whose treatment, cosmetic and
fragrance products are sold directly to the consumer by representatives, use our
sampling technologies to promote their product offerings.

Point-of-Sale Materials: 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. Many of our other technologies, including
LiquaTouch(R), BeautiSeal(R), BeautiPak(TM), BeautiTouch(R), MicroDot(TM),
LiqiSeal(TM), ShadeSeal(R) and PowdaTouch(R)

are becoming more widely accepted for point-of-sale handouts as an alternative
to more traditional sampling methods and for salable unit doses.

Gift-with-Purchase/Purchase-with-Purchase Programs: Many of our fragrance
and cosmetic customers promote new product offerings with our sampling systems.
LiquaTouch(R) stand alones and DiscCover(R)More offer single, long-lasting
wearable fragrance trial samples. BeautiPak(TM) gives the consumer a full
application of a lipstick formula or shade and LiquiSeal(TM) can be used to
offer a full application of up to four foundation or treatment product samples.

Intellectual Property

We currently hold patents covering the proprietary processes used to
produce many of our products in both the United States 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.

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 and consumer
products companies, department stores, home shopping retailers and specialty
retailers including Avon Products, Inc., Unilever plc, Chanel, Inc., Coty, Inc.,
L'Oreal S.A., Elizabeth Arden, Estee Lauder, Inc., Mary Kay, Victoria's Secret
Beauty and The Procter & Gamble Company. Our top ten customers accounted for
approximately 71% of sales in fiscal 2003. Estee Lauder and Mary Kay were the
only customers that accounted for 10% or more of net sales in fiscal 2003. 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, Mexico 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, Baltimore, Maryland and Paris, France. A
portion of the compensation for sales executives is commission and/or
bonus-based.

Our marketing activities include direct contact with senior executives in
the cosmetic and fragrance industry, major support of industry events and
extensive joint marketing programs with magazines, retailers and fragrance
houses. We also receive 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.

Management believes that as the pressure for creativity increases with each
new product introduction, cosmetic and fragrance marketers are increasingly
looking for their vendors to contribute to the overall strategy-building effort
to introduce a new product. 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 know-how, as well as our
complete product line of sampling technologies 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 in-house
laboratories;

o printing advertising pages and other media;

o manufacturing the sampling product, 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 three of the Company's manufacturing facilities 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 strive to replicate the fragrance of a product in a bottle
containing an alcohol solution. 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 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 is typically furnished by
the customer or its advertising agency. Our digital prepress department utilizes
state-of-the-art technology to receive customer-supplied computer disks and
transfers this material directly 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 in Chattanooga, Tennessee in
a continuous in-line operation. Our formulated letterpress or flexo label
samplers (DiscCover(R), BeautiSeal(R), LipSeal(R), LiquaTouch(R) and
ScentSeal(R) ) are produced on specially modified label and finishing equipment
in our second Chattanooga facility while the Microfragrance(R) Scratch `n Sniff
operation is conducted in a third facility in Chattanooga, Tennessee. Our
specialized screen printing manufacturing process which produces our
ShadeSeal(R) and PowdaScent(TM) technologies takes place in our facility in
Baltimore, Maryland. In addition BeautiPak(TM) our proprietary thermoformed
technology for sampling lipstick and LiqiSeal(TM) our patented clear top
packette to sampler liquid, cream, lotion or gel products are produced in our
Baltimore, Maryland facility. At each facility, 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. 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 label manufacturers that 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.

Both our Chattanooga and Baltimore operations have been awarded The Procter
& Gamble Triple Pinnacle Award, which is presented to companies as recognition
for having met certain quality requirements and having demonstrated outstanding
quality assurance. Both operations are also registered with the Food and Drug
Administration for the packaging of regulated cosmetic products and we maintain
environmentally controlled cGMP (current good manufacturing practice) compliant
facilities.

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. However, our
encapsulated paper products utilize specific grades of paper which we purchase
primarily from one manufacturer. These paper products are subject to
comprehensive evaluation and certification by us for quality, consistency and
fit. Some of our laminates are purchased from single sources under certain
specifications. We have not experienced any significant material supply
shortages in the past, nor are any anticipated.

Competition

Our competitors, some of whom have substantially greater capital resources
than our Company, 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
cosmetic samplers market are the fragrance division of Vertis, Inc., Orlandi,
Inc., Delta Graphics, Inc., Nord'est, Marietta Corp., Klocke, RotaScent GmbH,
Manka Creations 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, 2003, we employed 481 persons, which included 278 hourly
and 203 salaried and management personnel. A substantial number of our zhourly
employees are represented by the Graphics Communications International Union
(GCIU) local 197-M. Management considers our relations with the union to be
good. However, the labor contract with our union expired by its terms on March
31, 2003. Since that time, members of the union have continued to work under the
terms we have proposed for a new contract. We continue to work with the union to
execute a new contract containing those terms.

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.

We have substantial indebtedness and debt service obligations. As of June
30, 2003, Holding and AKI had total consolidated indebtedness of approximately
$121.6 million. As of August 31, 2003, AKI had outstanding borrowings of $8.1
million under its term loan with Heller Financial, Inc., $18.6 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, additional borrowings of
up to approximately $1.1 million were available under the revolving loan
commitment of the credit agreement, subject to specified conditions. 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 indenture,
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, 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 indenture 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;

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 in the
future.

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 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.

An investor's right to receive payments on the notes 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 our encumbered assets. As a result, our
encumbered assets would be available to pay obligations on the notes 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 would be materially adversely affected and the value of
the notes could be eliminated. As of August 31, 2003, AKI had outstanding
borrowings under the credit agreement consisting of a $8.1 million term loan and
a $18.6 million revolving loan and could borrow an additional $1.1 million under
the revolving loan commitment of 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.

Most of our sampling systems are approved by the U.S. Postal Service
("USPS") for inclusion in subscription magazines mailed at periodical postage
rates. The USPS approved 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 USPS accounted for approximately 22% of our net sales in
fiscal 2003. There can be no assurance that the USPS will not approve other
competing types of sampling systems for use in subscription magazines without
requiring a postal surcharge, or that the USPS will not reclassify our sampling
systems such that they would incur a postal surcharge. Any such action by the
USPS 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 71% of
our net sales in fiscal 2003. None of our customers, other than Estee Lauder and
Mary Kay, accounted for 10% or more of net sales in fiscal 2003. 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 or
Mary Kay, 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 the fragrance division of Vertis, Inc., Orlandi Inc., Delta
Graphics, Nord'est, Marietta Corp., Klocke, 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. 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.
Competition in our market is primarily based upon price, product quality,
product technologies, customer relationships 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 and patented 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 we cannot estimate any future expense. 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.

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

The advertising and marketing budgets of our customers, and therefore our
revenues, are susceptible to prevailing economic cycles and market conditions
that affect advertising and marketing expenditures, the performance of the
products of our customers in the marketplace and other related factors. 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 and marketing campaigns, which have traditionally been
concentrated prior to the Christmas and spring holiday seasons. 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. If we fail to adequately plan for our seasonal
fluctuations, our business may be adversely affected.

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 18% of our cost of goods
sold in each of fiscal 2003 and 2002 and 28% of our cost of goods sold in fiscal
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 ScentStrip(R) sampling systems, which accounted
for approximately 39% of our net sales in fiscal 2003, 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 our 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.

Certain of our label sampling systems, which accounted for approximately
26% of our net sales in fiscal 2003, utilize component materials that are
sourced from one qualified vendor. 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 24% of our net sales in fiscal 2003 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.

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 and may take actions that adversely affect the interests of the holders of
the notes.

Our business may be adversely affected by a labor dispute.

As of August 31, 2003, approximately 47% of our employees worked under a
collective bargaining agreement that expired on March 31, 2003. Since that time,
members of the union have continued to work under the terms we have proposed for
a new contract. There can be no

assurance that the union will execute a collective bargaining agreement
containing our proposed terms. A prolonged labor dispute (which may 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 have
a third facility at 3501 St. Elmo Avenue in Chattanooga, Tennessee, which is
used for production and warehousing. This facility is located on 1.875 acres and
encloses approximately 29,500 square feet.

We lease buildings in Baltimore, Maryland, that are used for production and
warehousing. The production facility at 7600 Energy Parkway encloses
approximately 50,000 square feet and its lease expires in August, 2004. The
warehouse facility at 7525 Perryman Court encloses approximately 13,000 square
feet and its lease expires in May, 2004 with options to renew the lease for two
additional one year periods.

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

None.

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, 2003, 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 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, 2003, 2002, 2001, 2000 and 1999 and the years ended June 30, 2003,
2002, 2001, 2000 and 1999 have been derived from the historical consolidated
financial statements of our company. The information contained in this table
should be read in conjunction with "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.

June 30, June 30, June 30, June 30, June 30,
(dollars in thousands) 2003 2002 2001 2000 1999
---- ---- ---- ---- ----

Statement of Operations Data:
Net sales $ 115,308 $ 120,893 $ 115,395 $ 99,811 $ 87,169
Cost of goods sold 73,883 73,888 71,336 61,552 56,401
--------- --------- --------- --------- ---------
Gross profit 41,425 47,005 44,059 38,259 30,768
Selling, general and
administrative expenses 17,971 18,943 18,199 16,980 14,500
Amortization of goodwill 1,143 6,451 5,757 5,336 4,606
Gain from settlement, net - (992) - (858) -
--------- --------- --------- -------- ---------
Income from operations 22,311 22,603 20,103 16,801 11,662
Interest expense, net 14,355 15,633 16,911 17,401 16,740
Management fees 325 250 250 250 250
(Gain) loss from early
retirement of debt (1) 871 (3,941) (3,302) (1,787) -
Other, net 33 - - - 128
Income tax expense (benefit) 2,260 5,924 4,735 2,294 (340)
--------- --------- --------- --------- ---------
Net income (loss) $ 4,467 $ 4,737 $ 1,509 $ (1,357) $ (5,116)
========= ========= ========= ========= =========

Balance Sheet Data (at end
of period):
Cash and cash equivalents $ 1,470 $ 1,875 $ 4,654 $ 1,158 $ 7,015
Working capital 13,832 11,571 10,169 13,759 14,853
Total assets (2) 218,702 226,279 214,184 223,274 210,386
Total debt 121,635 131,661 127,939 145,722 146,688
Total stockholder's equity 75,245 69,897 64,769 58,834 49,797

Other Data:
Capital expenditures $ 2,345 $ 1,338 $ 3,015 $ 2,782 $ 2,856
Ratio of earnings to fixed
charges (3) 1.5x 1.7x 1.4x 1.1x ---

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

(1) Extraordinary gains from previous years have been reclassed to conform with
current year presentation, in accordance with the provisions of SFAS 145.
(2) Total assets at June 30, 2002 have been restated to conform with current
year presentation.
(3) 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 $5,456 for the year ended June 30, 1999.

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.

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. All of these
debentures have been repurchased by the Company as of June 30, 2003.

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

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 $7.3 million in cash and the assumption of a liability of $0.2
million 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 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.

Color Prelude Acquisition

On December 18, 2001, we acquired the CP business for $19.4 million. We
financed the CP acquisition with borrowings under our credit agreement.

Results of Operations

Fiscal Year Ended June 30, 2003 Compared to Fiscal Year Ended June 30, 2002

Net Sales. Net sales for the fiscal year ended June 30, 2003 decreased $5.6
million, or 4.6%, to $115.3 million as compared to $120.9 million for the fiscal
year ended June 30, 2002. The decrease in net sales was primarily attributable
to a decrease in sales of sampling technologies for advertising and marketing of
domestic cosmetic products and international fragrance products partially offset
by an increase in the sales of sampling technologies for advertising and
marketing of domestic consumer products and international cosmetic products and
favorable foreign exchange rates.

Gross Profit. Gross profit for the fiscal year ended June 30, 2003
decreased $5.6 million, or 11.9%, to $41.4 million as compared to $47.0 million
for fiscal year ended June 30, 2002. Gross profit as a percentage of net sales
decreased to 35.9% in the fiscal year ended June 30, 2003, from 38.9% in the
fiscal year ended June 30, 2002. The decrease in gross profit and gross profit
as a percentage of net sales is primarily due to the decrease in sales volume
and changes in product mix and increased fixed costs associated with a full-year
operation of CP partially offset by favorable foreign exchange rates.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the fiscal year ended June 30, 2003 decreased $0.9
million, or 4.8% to $18.0 million as compared to $18.9 million for the fiscal
year ended June 30, 2002. Selling, general and administrative expenses as a
percent of net sales was 15.6% in the fiscal years ended June 30, 2003 and 2002.
The decrease in selling, general and administrative expenses is primarily

related to a decrease in legal fees and incentive compensation expense partially
offset by increased expenses associated with a full-year operation of CP.

Amortization of Goodwill. Amortization of goodwill for the fiscal year
ended June 30, 2003 decreased $4.8 million, or 100%, to $0, as compared to $4.8
million for the fiscal year ended June 30, 2002. The decrease in amortization of
goodwill resulted from the adoption of FASB Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets". We completed our
initial and first annual tests of the carrying value of goodwill which resulted
in no impairment.

Income from Operations. Income from operations for the fiscal year ended
June 30, 2003 decreased $0.3 million, or 1.3%, to $22.3 million as compared to
$22.6 million for the fiscal year ended June 30, 2002. Income from operations as
a percentage of net sales increased to 19.3% in the fiscal year ended June 30,
2003 from 18.7% in the fiscal year ended June 30, 2002. The increase in income
from operations and income from operations as a percentage of net sales is
principally the result of the factors described above.

Interest Expense. Interest expense for the fiscal year ended June 30, 2003
decreased $1.2 million, or 7.7% to $14.4 million, as compared to $15.6 million
for the fiscal year ended June 30, 2002. Interest expense as a percentage of net
sales decreased to 12.5% in the fiscal year ended June 30, 2003 from 12.9% in
the fiscal year ended June 30, 2002. The decrease in interest expense, including
the amortization of deferred financing costs, is primarily due to a decrease in
interest expense related to retired Senior Discount Debentures partially offset
by a full year of interest payable on the term loan incurred in connection with
the CP acquisition.

Interest expense for AKI for the fiscal year ended June 30, 2003 increased
$0.2 million, or 1.6%, to $12.7 million, as compared to $12.5 million for the
fiscal year ended June 30, 2002. Interest expense as a percentage of net sales
increased to 11.0% in the fiscal year ended June 30, 2003 from 10.3% in the
fiscal year ended June 30, 2002. The increase in interest expense, including the
amortization of deferred financing costs, is primarily due to a full year of
interest payable on the term loan incurred in connection with the CP
acquisition.

Gain / Loss from Early Retirement of Debt. A loss from early retirement of
debt of $0.9 million for the fiscal year ended June 30, 2003 and a gain of $3.9
million for the fiscal year ended June 30, 2002 resulted from the purchase of
Senior Discount Debentures. The purchased securities were subsequently retired.

Income Tax Expense. The income tax expense for the fiscal year ended June
30, 2003 decreased $3.6 million to $2.3 million as compared to $5.9 million for
the fiscal year ended June 30, 2002. The decrease is due to the decrease in
income before income taxes and non-deductible expenses principally as a result
of the factors described above and the loss from early retirement of debt.

Income tax expense for AKI for the fiscal year ended June 30, 2003
decreased $2.3 million to $3.4 million as compared to $5.7 million for the
fiscal year ended June 30, 2002. The decrease is due to the decrease in income
before income taxes and non-deductible expenses principally as a result of the
factors described above.

Fiscal Year Ended June 30, 2002 Compared to Fiscal Year Ended June 30, 2001

Net Sales. Net sales for the fiscal year ended June 30, 2002 increased $5.5
million, or 4.8%, to $120.9 million as compared to $115.4 million for the fiscal
year ended June 30, 2001. The increase was attributable to sales of sampling
technologies for advertising and marketing of cosmetics by CP, partially offset
by decreases in volume of core product sales of sampling technologies for
advertising and marketing of fragrance, cosmetic and consumer products. We
believe the decline in core product sales is predominately attributable to the
weak economic conditions in the United States, particularly in the advertising
industry. We cannot predict if this trend will worsen or when sales may increase
in the future. Sales of the CP products in the fiscal year ended June 30, 2002
totaled $24.0 million, a significant increase compared to CP's historical levels
due to sales related to a new sampling technology and the major introduction of
new products by Mary Kay. We do not believe that sales increases of this
magnitude will continue long-term.

Gross Profit. Gross profit for the fiscal year ended June 30, 2002
increased $2.9 million, or 6.6%, to $47.0 million as compared to $44.1 million
for fiscal year ended June 30, 2001. Gross profit as a percentage of net sales
increased to 38.9% in the fiscal year ended June 30, 2002, from 38.2% in the
fiscal year ended June 30, 2001. The increase in gross profit and gross profit
as a percentage of net sales is primarily due to the increase in sales volume
and to a lessor extent manufacturing scheduling efficiencies, reduced premium
labor and certain material costs.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the fiscal year ended June 30, 2002 increased $0.7
million, or 3.9% to $18.9 million as compared to $18.2 million for the fiscal
year ended June 30, 2001. The increase in selling, general and administrative
expenses was primarily due to increased expenses related to the CP operation and
acquisition, an increase in legal fees related to a patent infringement lawsuit
brought by AKI, an estimated loss on office lease abandonment and an estimated
loss to settle a foreign value added tax audit partially offset by a decrease in
personnel in fiscal year 2002, a decrease in sales commissions and incentive
bonuses and foreign exchange transaction gains. Selling, general and
administrative expenses as a percent of net sales decreased to 15.6% in the
fiscal year ended June 30, 2002 from 15.8% in the fiscal year ended June 30,
2001.

Income from Operations. Income from operations for the fiscal year ended
June 30, 2002 increased $2.5 million, or 12.4%, to $22.6 million as compared to
$20.1 million for the fiscal year ended June 30, 2001. Income from operations as
a percentage of net sales increased to 18.7% in the fiscal year ended June 30,
2002 from 17.4% in the fiscal year ended June 30, 2001, principally as a result
of the factors described above and the net settlement of the RCC purchase price
dispute.

Interest Expense. Interest expense for the fiscal year ended June 30, 2002
decreased $1.3 million, or 7.7% to $15.6 million, as compared to $16.9 million
for the fiscal year ended June 30, 2001. Interest expense as a percentage of net
sales decreased to 12.9% in the fiscal year ended June 30, 2002 from 14.6% in
the fiscal year ended June 30, 2001. 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 Discount
Debentures and Senior Notes and reduced average borrowings and lower interest
rates under the revolving loan and the promissory note to a stockholder
partially offset by the additional term loan incurred in connection with the CP
acquisition.

Interest expense for AKI for the fiscal year ended June 30, 2002 decreased
$0.7 million, or 5.3%, to $12.5 million, as compared to $13.2 million for the
fiscal year ended June 30, 2001. Interest expense as a percentage of net sales
decreased to 10.3% in the fiscal year ended June 30, 2002 from 11.4% in the
fiscal year ended June 30, 2001. 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 and reduced
average borrowings and lower interest rates under the revolving loan and the
promissory note to an affiliate partially offset by the additional term loan
incurred in connection with the CP acquisition.

Gain from early retirement of debt. A gain from early retirement of debt of
$3.9 million for the fiscal year ended June 30, 2002 and $3.3 million for the
fiscal year ended June 30, 2001 resulted from the purchase of Senior Discount
Debentures in fiscal year 2002 and from the purchase and subsequent contribution
in fiscal 2001 of Senior Discount Debentures by AHC, and the purchase of Senior
Notes in fiscal 2001. The purchased and contributed securities were subsequently
retired.

A gain from early retirement of debt for AKI of $0.7 for the fiscal year
ended June 30, 2001 resulted from the purchase in fiscal year 2001 of Senior
Notes. The purchased securities were subsequently retired.

Income Tax Expense. The income tax expense for the fiscal year ended June
30, 2002 increased $1.3 million to $4.7 million as compared to $3.4 million for
the fiscal year ended June 30, 2001. 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, 2002
increased $1.0 million to $5.7 million as compared to $4.7 million for the
fiscal year ended June 30, 2001. The increase is due to the increase in income
before income taxes and extraordinary gain.

Commitments and Contingencies

The following table summarizes our contractural obligations and other
contingencies as of June 30, 2003:

Payments due by fiscal year
--------------------------------------------------------------------------------
2004 2005 2006 2007 2008 Thereafter Total
---- ---- ---- ---- ---- ---------- -----

Debt obligations:
Principal................. $ 1,875 $ 2,125 $ 2,625 $ 1,500 $ 108,510 $ - $ 116,635
Interest*................. 11,616 11,498 11,363 11,203 11,019 - 56,699
Standby letter of credit...... - - 87 - - 291 378
Operating leases.............. 1,375 1,051 1,017 809 656 2,217 7,125
Minimum royalties**........... 1,190 1,190 1,190 1,190 1,190 5,416 11,366
Unconditional raw material
purchase obligations.......... 8,461 - - - - - 8,461
Other long-term obligations... 750 750 - - - - 1,500
----------- ----------- ----------- ----------- ----------- ----------- -----------

Total................... $ 25,267 $ 16,614 $ 16,282 $ 14,702 $ 121,375 $ 7,924 $ 202,164
=========== =========== =========== =========== =========== =========== ===========

* Interest for floating rate obligations has been calculated using the
rates in effect as of June 30, 2003.
** Minimum royalties which are subject to CPI adjustment have been
calculated based on the CPI as of June 30, 3003.

Liquidity and Capital Resources

We have substantial indebtedness and significant debt service obligations.
As of June 30, 2003, we had consolidated indebtedness in an aggregate amount of
$121.6 million (excluding trade payables, accrued liabilities and deferred
taxes), which is a direct obligation of AKI relating to its notes, term loan and
revolving credit line. At June 30, 2003, AKI had $21.8 million in accrued
liabilities (including trade payables, accrued liabilities, deferred taxes and
other liabilities). As of August 31, 2003, AKI had outstanding borrowings of
$8.1 million under the term loan of the credit agreement, $18.6 million under
the revolving loan commitment of the credit agreement and $0.4 million under a
promissory note with AHC.

Borrowings under the revolving credit line are limited to a maximum amount
equal to $20.0 million. At June 30, 2003 and August 31, 2003, AKI had borrowing
availability of approximately $9.7 million and $1.1 million, respectively,
subject to a borrowing base calculation and the achievement of specified
financial ratios and compliance with specified conditions. The interest rate for
borrowings under the credit agreement are determined from time to time based on
our choice of formulas, plus a margin. The credit agreement will mature on
December 31, 2006.

The indenture governing the notes and the credit agreement permit AKI to
incur additional indebtedness, subject to specified limitations. In addition,
the indenture contains restrictive covenants that, among other things, limit the
ability of AKI 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. The Company was in compliance with all such covenants
as of June 30, 2003.

AKI's principal liquidity requirements are for operating working capital,
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 $14.2 million and $13.8 million for fiscal 2003 and 2002,
respectively, together with borrowings under revolving credit facilities. Net
cash provided by operating activities during fiscal 2003 resulted primarily from
net income before depreciation and amortization and a decrease in inventory
levels, net of CP acquisition, partially offset by increased accounts receivable
and a decrease in accounts payable and accrued expenses.

We define Adjusted EBITDA (also referred to as EBITDA in our credit
agreement) as net income or loss plus income taxes, interest expense, loss from
early retirement of debt, depreciation, amortization and impairment loss of
goodwill and amortization of other intangibles less gain from early retirement
of debt. Adjusted EBITDA is not a measure of financial or operating performance,
cash flow or liquidity under generally accepted accounting principles, and
should not be used by itself or in the place of net income, cash flows from
operating activities or other income or cash flow statement data prepared in
accordance with generally accepted accounting principles as a financial or
liquidity measure.

We use Adjusted EBITDA to manage and evaluate our business operations. Our
management evaluates Adjusted EBITDA because it excludes certain cash and
non-cash items that are either beyond our immediate control or that we believe
are not characteristic of our underlying business operation for the period in
which they are recorded, or both. We believe the presentation of Adjusted EBITDA
is relevant because Adjusted EBITDA is a measurement that we and our lenders use
to comply with our debt covenants and establish our interest rate on a portion
of our debt. Investors should be aware that the way by which we calculate
Adjusted EBITDA may not be comparable with similarly titled measures presented
by other companies and comparisons of such amounts could be misleading unless
all companies and analysts calculate such measures in the same manner.

The calculation of adjusted EBITDA for the years ended June 30, 2003 and
2002 for Holding and AKI is as follows (dollars in millions):

Holding AKI
------------------------------------- ------------------------------------
2003 2002 2001 2003 2002 2001
---- ---- ---- ---- ---- ----

Net income....................... $ 4.4 $ 4.7 $ 1.5 $ 5.8 $ 4.1 $ 2.4

Income tax expense............... 2.3 5.9 4.7 3.5 5.7 4.9
Interest expense................. 14.4 15.6 16.9 12.7 12.5 13.2
Depreciation and amortization
of goodwill and other
intangibles................. 7.3 12.1 10.1 7.3 12.1 10.1
Loss (gain) from early
retirement of debt.......... 0.9 (3.9) (3.3) -- -- (0.7)
-------- -------- -------- -------- -------- --------

Adjusted EBITDA.................. $ 29.3 $ 34.4 $ 29.9 $ 29.3 $ 34.4 $ 29.9
======== ======== ======== ======== ======== ========

In fiscal 2003 and fiscal 2002, we had capital expenditures of
approximately $2.3 million and $1.3 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 December 18, 2001, we acquired the CP business for $19.4 million. We
financed the CP acquisition with borrowings under our 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, 2003, AHC had outstanding $62.7 million of floating rate notes
which bear interest at approximately 16% per annum and mature on December 15,
2009, and approximately $114.7 million of Senior Preferred Stock which accrue
dividends at 15% per annum and must be redeemed by December 15, 2012. Interest
on the notes and dividends on the senior preferred stock may be settled through
the issuance of additional floating rate notes and senior preferred stock
through maturity or redemption, respectively. The floating rate notes are
general, unsecured obligations of AHC and are not obligations of, or guaranteed
by Holding, AKI or any of its subsidiaries. AHC is a holding company and is
dependent upon the cash flows of its subsidiaries and the payment to it of funds
by its subsidiaries.

During the year ended June 30, 2003, Holding purchased, with proceeds from
distributions from AKI, its 13.5% Senior Discount Debentures due 2009 with an
accreted value of $17.5 million for $18.0 million. The purchase caused there to
be no outstanding Debentures for Holding as of such date. AKI funded the
distribution through borrowings under its credit agreement.

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.
Substantially all of the proceeds were used in fiscal 2001 and 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, 2004 are budgeted
to be between approximately $3.0 million and $4.0 million. Based on borrowings
outstanding (other than pursuant to the revolving credit agreement) as of June
30, 2003 and borrowings outstanding under the revolving credit agreement as of
August 31, 2003, we expect total cash payments for debt service in fiscal 2004
to be approximately $14.1 million, consisting of $1.9 million in term loan
principal payments, $10.9 million in interest payments on the Notes and $1.3
million in interest and fees under the credit agreement. We also expect to make
royalty payments of approximately $1.2 million during fiscal 2004.

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 Notes for fiscal 2004. In the event
we consummate any additional acquisitions, we may seek additional debt or equity
financings subject to compliance with the terms of the indenture.

At June 30, 2003, AKI's consolidated cash and cash equivalents and net
working capital were $1.5 million and $10.6 million, respectively, representing
a decrease in cash and cash equivalents of $0.4 million and a decrease in net
working capital of $1.0 million from June 30, 2002. Account receivables, net, at
June 30, 2003 decreased 10.1% or $2.4 million over the June 30, 2002 amount,
primarily due to a decrease in fourth quarter sales.

Seasonality

Our sales of sampling technologies for advertising and marketing of
fragrance products 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 generally
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. The severity of our seasonal sales variations has
decreased over time as we have developed and acquired other sampling
technologies for advertising and marketing of cosmetic and consumer products.

Recently Issued Accounting Standards

Financial Accounting Standards Board ("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 was applied at the beginning of our
2003 fiscal year. The adoption of SFAS 142 eliminated the amortization of
goodwill, approximately $4.8 million in fiscal 2002, while requiring annual
tests for impairment of goodwill. The Company completed its initial and first
annual tests of the carrying value of goodwill which resulted in no impairment.

FASB Statement of Financial Accounting Standards No. 145 "Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections" ("SFAS 145") was issued in April 2002. The most
significant aspects of this pronouncement, with respect to the Company, is the
elimination of SFAS No. 4, "Reporting Gains and Losses from Extinguishment of
Debt". As a result of the elimination of SFAS No. 4, gains and losses from
extinguishment of debt are classified as extraordinary items only if they meet
the criteria in APB No. 30, "Reporting the Results of Operations - Discontinued
Events and Extraordinary Items". SFAS No. 145, which the Company adopted in
fiscal 2003, requires early retirements of debt to be included in income from
continuing operations. Gains and losses on early retirement of debt that were
classified as extraordinary items in prior periods that do not meet the criteria
in APB No. 30 for classification as an extraordinary item were reclassified. In
fiscal 2002 the Company reported an approximate $2.7 million extraordinary gain
from early retirement of debt, net of tax.

FASB Statement of Financial Standards No. 146 "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146") was issued in June
2002. SFAS 146 addresses financial accounting and reporting for costs associated
with exit or disposal activities and nullifies Emerging Issues Task Force (EITF)
Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity. SFAS 146 requires that a liability for a
cost associated with an exit or disposal activity be recognized and measured
initially at fair value only when the liability is incurred. SFAS 146 is
effective for exit or disposal activities that are initiated after December 31,
2002. The Company does not anticipate that the provisions of this statement will
have a material impact on the Company's reported results of operations,
financial positions or cash flows.

FASB Interpretation No. 45 "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others" ("FIN 45") was issued in November 2002. FIN 45 elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also requires the guarantor to recognize, at the inception of the guarantee, a
liability for the fair value of obligation undertaken in issuing the guarantee.
The disclosure requirements are effective for quarters ending after December 15,
2002 and the liability recognition is in effect for guarantees initiated after
December 31, 2002. The Company does not anticipate that the provisions of this
statement will have a material impact on the Company's reported results of
operations, financial positions or cash flows.

FASB Interpretation No. 46 "Consolidation of Variable Interest Entities"
("FIN 46") was issued in January 2003. FIN 46 requires an investor with a
majority of the variable interests in a variable interest entity ("VIE") to
consolidate the entity and also requires majority and significant variable
interest investors to provide certain disclosures. A VIE is an entity in which
the equity investor does not have a controlling interest, or the equity
investment risk is insufficient to finance the entity's activities without
receiving additional subordinated financial support from the other parties. For
arrangements entered into with VIEs created prior to January 31, 2003, the
provisions of FIN 46 are required to be adopted at the beginning of the first
interim or annual period beginning after June 15, 2002. The Company does not
anticipate that the provisions of this interpretation will have a material
impact on the Company's reported results of operations, financial position or
cash flows.

Critical Accounting Policies

We have chosen accounting policies that we believe are appropriate to
accurately and fairly report our operating results and financial position, and
we apply those accounting policies in a consistent manner. The significant
accounting policies are summarized in Note 2 to the consolidated financial
statements.

The preparation of financial statements in conformity with generally
accepted accounting principles requires that we make estimates and assumptions
that affect the reported amounts of assets, liabilities, revenues and expenses.
These estimates and assumptions are based on historical and other factors
believed to be reasonable under the circumstances. We evaluate these estimates
and assumptions on an ongoing basis and may retain outside professional advisors
to assist in our evaluation. We believe the following accounting policies are
the most critical because they involve the most significant judgments and
estimates used in preparation of our consolidated financial statements:

o Allowance for doubtful accounts. We maintain an allowance for doubtful
receivables for estimated losses resulting from the inability of our trade
customers to make required payments. We provide an allowance for specific
customer accounts where collection is doubtful and also provide a general
allowance for other accounts based on historical collection and write-off
experience. Judgment is necessary and if the financial condition of our
customers were to worsen, additional allowances may be required.

o Inventories. Our inventories, which consist of raw materials and
work-in-process, are valued at the lower of cost or market value. We
evaluate all of our raw material inventory for slow moving product based on
recent usage, projections of future demand and market conditions. For those
units in inventory that are so identified, we estimate their market value
based on current realization trends. If the projected net realizable value
is less than cost, we provide a provision to reflect the lower value of
that inventory. This methodology recognizes projected inventory losses at
the time such losses are evident.

o Intangible assets. When we acquire other companies or businesses we
allocate the purchase price, including expenses and assumed liabilities, to
the assets and liabilities acquired including intangible assets and
goodwill. We estimate the useful lives of the intangible assets by
factoring in the characteristics of the related products such as: existing
sales contracts, patent protection, estimated future introductions of
competing products and other issues. The factors that drive the estimate of
the life of the asset are inherently uncertain.

o Long-lived assets. We review our property, intangible assets and goodwill
for possible impairment whenever events or circumstances indicate that the
carrying amount of an asset may not be recoverable. Assumptions and
estimates used in the evaluation of impairment may affect the carrying
value of long-lived assets, which could result in impairment charges in
future periods. Such assumptions include projections of future cash flows
and, in some cases, the current fair value of the asset. In addition, our
depreciation and amortization policies reflect judgments on the estimated
useful lives of assets.

o Revenue recognition. We recognize revenue when the risks and rewards of
ownership are assumed by the buyer. This generally occurs upon delivery of
product to the buyer.

o Deferred income tax assets. We have recorded deferred income tax assets
related to the temporary differences between the tax bases and financial
reporting bases of assets and liabilities. An adjustment to income tax
expense would be required in a future period if we determine that the
amount of deferred tax assets to be realized differs from the net recorded
amount.

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 or 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: (1) economic conditions in general and
in our specific market areas; (2) the significant indebtedness of our company;
(3) changes in operating strategy or development plans; (4) the competitive
environment in the sampling industry in general and in our specific market
areas; (5) changes in prevailing interest rates; (6) changes in or failure to
comply with postal regulations or other federal, state and/or local government
regulations; (7) changes in cost of goods and services; (8) changes in our
capital expenditure plans; (9) the ability to attract and retain qualified
personnel; (10) inflation; (11) liability and other claims asserted against us;
(12) labor disturbances 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 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 2003, we generated approximately 24% of our sales from customers
outside the United States, principally in Europe. International sales are
generated primarily 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, 2003, 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.

ITEM 9A. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures. Our chief executive
officer and chief financial officer have evaluated the effectiveness of the
design and operation of our disclosure controls and procedures (as defined in
Exchange Act Rule 13a-14(c)) as of the end of the period covered by this report.
Based on that evaluation, the chief executive officer and chief financial
officer have concluded as of the end of the period covered by this report that
our disclosure controls and procedures are effective.

(b) Changes in Internal Controls. There have not been any significant
changes in our internal controls or in other factors that could significantly
affect these controls during the period covered by this report.

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, 2003.

Name Age Position
- ---- --- --------
David M. Wittels * 39 Chairman of the Board and Director
William J. Fox * 47 President, Chief Executive Officer and
Director
Kenneth A. Budde 54 Senior Vice President, Chief Financial
Officer and Secretary
A. Bruce Prashker 41 Senior Vice President and Assistant
Secretary
Hugh R. Kirkpatrick 66 Director
David A. Durkin * 34 Director
Douglas B. Fox 55 Director

- ----------------------
* Member of Executive Committee

David M. Wittels was elected as Chairman of the Board in August 2003 and
has served as a director of Holding since December 1997. Mr. Wittels has been a
Managing Director of DLJ Merchant Banking since January 2001 and has served in
various capacities with DLJ Merchant Banking for the past five years. Mr.
Wittels also serves as a director of Mueller Holdings (N.A.), Inc., Ziff Davis
Holdings, Inc., Advanstar, Inc. and Advanstar Communications 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 is also Co-Chairman of the Board
and a Director of Loehmann's Holdings, Inc., a Director of MM Companies, Inc.
and a Director of Liquid Audio, Inc. He also serves on the Advisory Board of
Barrington Companies Investors, LLC.

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.

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 A. Durkin has served as a director of Holding since May 2002. Mr.
Durkin has been a Vice President of DLJ Merchant Banking since 2000. Prior to
that, he served as a Vice President in the Leveraged Finance Group and other
roles in the Investment Banking Department of DLJ Securities Corporation since
1996. Mr. Durkin also serves as a director of Seabulk International, Inc.

Douglas B. Fox has served as a director of the Corporation and as a
director of Holding since August 2003. Mr. Fox is a management consultant and
private investor. Since May 2001, he has served as the Chief Executive Officer
of Renaissance Brands LLC. Prior to that, he was Senior Vice President of
Marketing and Strategy for Compaq Computer Corporation from July 2000 to May
2001 and Chief Marketing Officer and Senior Vice President of Marketing for
International Paper Co. from April 1997 to December 1999. Mr. Fox also serves on
the board of directors of Bowne & Co., Inc., Ziff-Davis Media Inc. and Advanstar
Communications Inc.

Compensation of Directors

Except for Mr. Hugh Kirkpatrick, who receives an annual fee of $20,000, and
Mr. Douglas Fox, who receives an annual fee of $50,000, 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 an option to purchase 5,000 shares of common stock of AHC I
in fiscal 2000.

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

Long Term
Annual Compensation Compensation
------------------- ------------

Fiscal Securities All Other
Name and Principal Position Year Salary Bonus Underlying Options Compensation(1)
--------------------------- ---- ------ ----- ------------------ ---------------

William J. Fox 2003 $ 788,175 $ 491,217 -- 11,091
President and Chief Executive 2002 775,000 1,190,724 -- 8,545
Officer 2001 700,000 1,125,000 -- 8,545

Kenneth A. Budde 2003 220,500 90,074 8,000 8,000
Chief Financial Officer 2002 210,000 121,653 -- 6,800
2001 190,000 135,000 -- 6,800

A. Bruce Prashker 2003 215,300 75,000 -- 8,000
Senior Vice President 2002 205,000 77,613 -- 6,800
2001 190,000 90,000 -- 4,787

(1) Represents amounts contributed on behalf of the named executive to 401(k)
retirement savings plan and amounts paid for supplemental life insurance
premiums.

Option Grants in Last Fiscal Year

The following table sets forth information regarding stock options granted
during fiscal 2003 to each of the executive officers named in the "Summary
Compensation Table" above, including the potential realizable value over the
term of the options, based on assumed rates of stock appreciation of 5% and 10%,
compounded annually. These assumed rates are mandated by the rules of the
Securities and Exchange Commission and do not represent our estimate of future
stock price performance. Actual gains, if any, on stock option exercises, will
be dependent on the future performance of our common stock.

Options Grant in Last Fiscal Year

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

Kenneth A. Budde 8,000 8.33% 1.00 November 7, 5,031 12,750
Chief Financial 2012
Officer

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, 2003. 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

Number of securities
underlying unexercised Value of unexercised in-the-
options at June 30, 2003 money options at June 30, 2003
--------------------------------- -------------------------------

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

William J. Fox 888,000 -- -- --
President, Chief Executive Officer
And Director

Kenneth A. Budde 162,000 6,000 -- --
Chief Financial Officer

A. Bruce Prashker 50,000 -- -- --
Senior Vice President

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

AHC granted 96,000 options for shares of capital stock in fiscal 2003 and
no options for shares of capital stock of AHC were exercised in fiscal 2003.
These options vest over a four year period.

Employment Agreements

Fox Agreement

On January 27, 1999, William J. Fox entered into an employment agreement
with us effective February 1, 1999, which was 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, 2003 the agreement ends on September 1, 2005.

Mr. Fox's base salary is $810,000 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 received options
to acquire 5% of AHC's issued and outstanding common stock on a pro forma fully
diluted basis, subject to anti-dilution protection. 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, in either case 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. 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 $230,000 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, 2004, 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.

Prashker Agreement

Mr. Prashker is presently retained as senior vice president at an annual
salary base of $230,000. Mr. Prashker has a salary continuation agreement,
whereby, if Mr. Prashker is terminated by us without cause within one year of a
change of control, Mr. Prashker is entitled to 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
2003. Members of our executive committee 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,
in consultation with the executive committee of our board of directors.

Report of the Executive Committee of the Board of Directors on Executive
Compensation

The following is a report of the executive committee of the board of
directors, which functions as the compensation committee, describing the
compensation policies applicable to our executive officers during the fiscal
year ended June 30, 2003. The committee is responsible for establishing and
monitoring our general compensation policies and compensation plans, as well

as the specific compensation levels for executive officers. It also makes
determinations concerning the granting of awards under our stock plans.

For the fiscal year ended June 30, 2003, the process utilized by the
committee in determining executive compensation levels was based on performance
related results, contract increases to consumer price index and the subjective
judgment of the committee. Among the factors considered by the committee were
the recommendations of the chief executive officer with respect to the
compensation of our key executive officers. However, the committee made the
final compensation decisions concerning those officers.

General Compensation Policy

Our compensation policy is designated to attract and retain qualified key
executives critical to our growth and long-term success. It is the objective of
the committee to have a portion of each executive's compensation contingent upon
our financial performance as well as upon the individual's personal performance.
Accordingly, each executive officer's compensation package is comprised of three
elements: (i) base salary which reflects individual performance and expertise,
(ii) variable bonus awards payable in cash and ties to the achievement of
certain performance goals that the board establishes from time to time and (iii)
long-term stock-based incentive awards which are designed to strengthen the
mutuality of interests between the executive officers and our stockholders.

The summary below describes in more detail the factors which we consider in
establishing each of the three primary components of the compensation package
provided to the executive officers.

Base Salary

The level of base salary is established primarily on the basis of the
individual's qualifications and relevant experience, the strategic goals for
which he or she has responsibility, the compensation levels at companies which
compete with us for business and executive talent and the incentives necessary
to attract and retain qualified management. Base salary may be adjusted each
year to take into account the individual's performance and to maintain a
competitive salary structure.

Cash-Based Incentive Compensation

Cash bonuses are awarded to executive officers based upon a performance
based plan measured by their success in achieving designated individual goals
and our success in achieving specific Company-wide EBITDA goals.

Long-Term Incentive Compensation

We have utilized our stock option plan to provide executives and other key
employees with incentives to maximize long-term shareholder value. Awards under
this plan take the form of stock options designed to give the recipient a
significant equity stake in the Company and thereby closely align his or her
interests with those of our stockholders. Factors considered in making such
awards include the individual's position, his or her performance and
responsibilities

as well as industry practices and standards. Long-term incentives granted in
prior years and existing level of stock ownership are also taken into
consideration.

Each option grant allows the executive officer to acquire shares of common
stock at a fixed price per share (the greater of the fair market value on the
date of grant or $1.00) over a specified period of time (up to ten years). The
number of awards granted to individual executives is based on demonstrated
performance and independent survey data reflecting competitive market practice.
Accordingly, the award grant will provide a return to the executive officer only
if he or she remains in our service, and then only if the market price of the
common stock appreciates over the award term.

Compensation of the Chief Executive Officer

William Fox was appointed our chief executive officer in January 1999. The
committee determined Mr. Fox's base salary after evaluating a number of factors,
including Mr. Fox's then current salary, salaries of chief executive officers of
other companies of similar size in the industry and Mr. Fox's performance in
general. Mr. Fox's base salary in 2003 rose to $788,715 from $775,000 in 2002.
We paid Mr. Fox a cash bonus of $491,217 for fiscal 2003, in comparison to a
cash bonus of $1,190,724 for fiscal 2002.

Deductibility of Executive Compensation

The committee has considered the impact of Section 162(m) of the Internal
Revenue Code adopted under the Omnibus Budget Reconciliation Act of 1993, which
section disallows a deduction for any publicly held corporation for individual
compensation exceeding $1 million in any taxable year for the chief executive
officer and four other most highly compensated executive officers, respectively,
unless such compensation meets the requirements for the "performance-based"
exception to Section 162(m). It is the committee's policy to qualify, to the
extent reasonable, our executive officers' compensation for deductibility under
applicable tax law. However, we may from time to time pay compensation to our
executive officers that may not be deductible.

Executive Committee of the Board of Directors,

David Wittels
David Durkin
William Fox (with respect to matters other than Chief Executive Officer
Compensation)

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

All of AKI's issued and outstanding capital stock is owned by Holding. All
of Holding's issued and outstanding capital stock is owned by AHC. The following
table sets forth certain information as of September 12, 2003 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 Common
Beneficial Owner Owned Stock
---------------- ----- -----

DLJ Merchant Banking Partners, II, L.P. and affiliated entities (1) 15,921,111 98.8%

William J. Fox (2) 888,000 5.2%

Hugh R. Kirpatrick (2) 5,000 *

David A. Durkin (3) - -

David M. Wittels (3) - -

Douglas B. Fox - -

Kenneth A. Budde (2) 162,000 1.0%

A. Bruce Prashker (2) 50,000 *

All directors and executive officers as a group (2) 1,105,000 6.4%

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

* Less than one percent.

(1) Consists of shares held directly by the following affiliated investors: DLJ
Merchant Banking Partners II, L.P; DLJ Merchant Banking Partners II-A, LP
("DLJMBII-A); DLJ Offshore Partners II, C.V. ("Offshore Partners II"); DLJ
Diversified Partners, L.P. ("Diversified Partners"); DLJ Diversified
Partners-A, L.P ("Diversified Partners-A"); DLJMB Funding II, Inc. ("DLJ
Funding II"); DLJ Millennium Partners, L.P. ("Millennium Partners"); DLJ
Millennium Partners-A, L.P, ("Millennium Partners-A"); DLJ EAB Partners,
L.P ("EAB Partners"); UK Investment Plan 1997 Partners ("UK Partners"); and
DLJ First ESC L.P ("First ESC"). 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 II 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 September 12, 2003.

(3) Mr. Wittels is an officer of DLJ Merchant Banking, an affiliate of DLJMBII.
Share data shown for such individuals excludes shares shown as held by
DLJMBII or its affiliates, as to which such individuals disclaim beneficial
ownership. The address of each of Messrs. Durkin and Wittels is Eleven
Madison Avenue, New York, New York 10010.

Equity Compensation Plan Information

The table below sets forth information relating to our compensation plans
as of June 30, 2003:

Number of securities
remaining available
Number of securities for future issuance
to be issued upon Weighted-average under equity
exercises of exercises price of compensation plans
outstanding options, outstanding options, (excluding securities
warrants and rights warrants and rights reflected in column (a))
Plan Category (a) (b) (c)
- ------------------------------------ -------------------------- --------------------------- --------------------------

1998 Stock Option Plan........ 1,532,250 $ 1.00 117,750

Total......................... 1,532,250 1.00 117,750

ITEM 13. RELATED PARTY TRANSACTIONS

Transactions with DLJMBII and their Affiliates

Mr. Wittels, who is a director of AKI and an officer and director of
Holding and AHC, is an officer 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 Credit Suisse First Boston Corporation
("CSFB") and AHC, CSFB receives an annual fee of $400,000 ($250,000 for the year
ended December 31, 2002) for acting as the exclusive financial and investment
banking advisor until December 31, 2003 and shall be extended automatically for
successive terms of one year unless otherwise terminated by either party within
60 days prior to the expiration of the agreement. Our Company has agreed to
indemnify CSFB 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 the shares of capital stock of AHC that it owns.

Stockholder Note

Our Company has a promissory note payable to AHC which allows us to borrow
up to $10 million at such interest rates and maturity dates as agreed upon by
the Company and AHC. Interest paid to AHC in connection with the promissory note
totaled approximately $20,000, $14,000 and $320,000 for the years ended June 30,
2003, 2002 and 2001, respectively.

Transactions with Loehmann's, Inc.

In fiscal 2003 and 2002 we performed marketing and design services for
Loehmann's, Inc. totaling approximately $86,000 and $47,000, respectively. Mr.
Fox, our President and Chief Executive Officer, is also on the Board of
Directors of Loehmann's, Inc. We believe that our services provided to
Loehmann's, Inc. are on terms no less favorable than could have been provided to
an unaffiliated third party.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Audit Fees

The Company retained PricewaterhouseCoopers LLP ("PWC") to audit our
consolidated financial statements for fiscal 2003. We understand the need for
PWC to maintain objectivity and independence in its audit of our financial
statements. To minimize relationships that could appear to impair the
objectivity of PWC, our board of directors has restricted the non-audit services
that PWC may provide to us primarily to tax services and audit related services
and determined that we would obtain non-audit services from PWC only when the
services offered by PWC are more effective or economical than services available
from other service providers, and, to the extent possible, only after
competitive bidding. These determinations are among the key practices adopted by
the board of directors effective June 30, 2002.

The board has also adopted policies and procedures for pre-approving all
non-audit work performed by PWC after July 1, 2003. Specifically, the board
pre-approved the use of PWC for the following categories of non-audit service:
merger and acquisition due diligence and audit services; tax services; internal
control reviews; employee benefit plan audits; and reviews and procedures that
the Company requests PWC to undertake to provide assurances on matters not
required by laws or regulations.

The following summary discloses all of the fees billed by
PricewaterhouseCoopers LLP during fiscal 2003 and fiscal 2002 for the following
services:

2003 2002
---- ----

Audit fees...................... $ 144 $ 131
Audit-related fees.............. 1 130
Tax fees........................ 178 108
All other fees.................. - -
----------- -----------

Total........................... $ 323 $ 369
=========== ===========

In the above table, in accordance with new SEC definitions and rules,
"audit fees" are fees the Company paid PWC for professional services for the
audit of our consolidated financial statements, included in Form 10-K and review
of financial statements included in Form 10-Qs, or for services that are
normally provided by the accountant in connection with statutory and regulatory
filings or engagements; "audit-related fees" are fees billed by PWC for
assurance and related services that are reasonably related to the performance of
the audit or review of our financial statements; "tax fees" are fees for tax
compliance, tax advice, and tax planning; and "all other fees" are fees billed
by PWC to us for any services not included in the first three categories.

PART IV

ITEM 15. 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. (1)

3.2 Certificate of Incorporation of AKI. (2)

3.3 Bylaws of Holding. (1)

3.4 Bylaws of AKI. (2)

4.1 Indenture dated as of June 25, 1998 between Holding and State Street Bank
and Trust Company, as Trustee. (1)

4.2 Indenture dated as of June 25, 1998 between AKI and IBJ Schroder Trust
Company, as Trustee. (2)

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
betweem Holding and DLJMBII. (1)

10.2 Registration Rights Agreement of AKI, dated as of June 25, 1998, between
AKI and DLJMBII. (2)

10.3 AHC Stock Option Plan. (1)

10.4 Employment Agreement dated as of February 1, 1999 between Holding and
William J. Fox. (3) +

10.5 Amendment to Employment Agreement dated as of September 17, 2001 between
Holding and William J. Fox. (4) +

10.6 Salary Continuation Agreement dated as of October 1, 2001 between Arcade
Marketing, Inc. and Bruce Prashker. (5) +

10.7 Employment Agreement dated as of July 1, 2000 between Holding and Kenneth
A. Budde. (6) +

10.8 Amended and Restated Credit Agreement dated as of December 8, 2001
beween the Company and Heller Financial, Inc. (7)

10.9 Financial Advisory Agreement dated as of December 12, 1997 between AHC
and DLJ. (1)

12.1 Computation of Ratio of Earnings to Fixed Charges. *

21.1 Subsidiaries of Holding. *

31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *

31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *

31.3 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *

31.4 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *

32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
section 906 of the Sarbanes-Oxley Act of 2002. *

32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
section 906 of the Sarbanes-Oxley Act of 2002. *

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

(1) 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.

(2) 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.

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

(4) Incorporated by reference from Registrant's Annual Report on Form 10-K
filed with the Securities and Exchange Commission on September 18, 2001.

(5) Incorporated by reference from Registrant's Quarterly Report on Form 10-Q
filed with the Securities and Exchange Commission on November 9, 2001.

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

(7) Incorporated by reference from Registrant's Report on Form 8-K filed with
the Securities and Exchange Commission on December 26, 2001.

* Filed herewith

+ Compensatory Contract

(b) Reports on Form 8-K.

No reports on Form 8-K were filed during the three months ended
June 30, 2002.

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 24th day of
September, 2003.

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 A. 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 24th day of September, 2003.

SIGNATURE TITLE
--------- -----

/S/ David M. Wittels Chairman and Director
- -------------------------
David M. Wittels

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

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

/S/ David A. Durkin Director
- -------------------------
David A. Durkin

/S/ Douglas B. Fox Director
- -------------------------
Douglas B. Fox

/S/ Hugh R. Kirkpatrick Director
- -------------------------
Hugh R. Kirkpatrick

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 24th day of
September, 2003.

AKI, INC.

(Registrant)

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

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities indicated on
the 24th day of September, 2003.

SIGNATURE TITLE
--------- -----

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

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

/S/ David A. Durkin Director
- -------------------------
David A. Durkin

/S/ Douglas B. Fox Director
- -------------------------
Douglas B. Fox

/S/ Hugh R. Kirkpatrick Director
- -------------------------
Hugh R. Kirkpatrick

/S/ David M. Wittels Director
- -------------------------
David M. Wittels

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.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED FINANCIAL STATEMENTS OF AKI HOLDING CORP.:

Report of Independent Auditors....................................... F-2

Consolidated Balance Sheets at June 30, 2003 and 2002................ F-3

Consolidated Statements of Operations for the years ended
June 30, 2003, 2002 and 2001 .................................... F-4

Consolidated Statements of Stockholder's Equity
for the years ended June 30, 2003, 2002 and 2001 ................ F-5

Consolidated Statements of Cash Flows for the years ended
June 30, 2003, 2002 and 2001 .................................... F-6

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

CONSOLIDATED FINANCIAL STATEMENTS OF AKI, INC.:

Report of Independent Auditors....................................... F-24

Consolidated Balance Sheets at June 30, 2003 and 2002 ............... F-25

Consolidated Statements of Operations for the years ended
June 30, 2003, 2002 and 2001 .................................... F-26

Consolidated Statements of Stockholder's Equity
for the years ended June 30, 2003, 2002 and 2001 ................ F-27

Consolidated Statements of Cash Flows for the years ended
June 30, 2003, 2002 and 2001 .................................... F-28

Notes to Consolidated Financial Statements........................... F-29

F-1

REPORT OF INDEPENDENT AUDITORS

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, 2003 and 2002, and the results of
their operations and their cash flows for each of the three years in the period
ended June 30, 2003 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.

As discussed in Note 2 to the consolidated financial statements, the
Company changed its accounting policy for goodwill amortization in fiscal 2003.

PricewaterhouseCoopers LLP
Knoxville, Tennessee
August 5, 2003

F-2

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

June 30,
----------------------------
2003 2002
---- ----

ASSETS
Current assets
Cash and cash equivalents.............................................. $ 1,470 $ 1,875
Accounts receivable, net............................................... 20,267 23,537
Inventory, net......................................................... 7,265 8,014
Income tax receivable.................................................. 4,166 -
Prepaid expenses....................................................... 671 667
Deferred income taxes.................................................. 808 977
----------- -----------
Total current assets............................................. 34,647 35,070

Property, plant and equipment, net..................................... 16,584 19,616
Goodwill, net ......................................................... 152,994 153,277
Other intangible assets, net........................................... 11,307 13,142
Deferred charges, net.................................................. 3,032 4,059
Deferred income taxes.................................................. - 692
Other assets........................................................... 138 164
----------- -----------
Total assets..................................................... $ 218,702 $ 226,020
=========== ===========

LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of long-term debt...................................... $ 1,875 $ 1,375
Accounts payable, trade................................................ 5,444 5,826
Accrued income taxes................................................... - 2,007
Accrued compensation................................................... 4,333 5,338
Accrued interest....................................................... 5,502 5,570
Accrued expenses....................................................... 3,661 3,383
----------- -----------
Total current liabilities........................................ 20,815 23,499

Revolving credit line.................................................. 10,000 2,750
Term loan.............................................................. 6,250 8,125
Senior notes........................................................... 103,510 103,510
Senior discount debentures............................................. - 15,901
Deferred income taxes.................................................. 1,142 -
Other non-current liabilities.......................................... 1,740 2,338
----------- -----------
Total liabilities................................................ 143,457 156,123

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 93,656
Accumulated deficit.................................................... (3,116) (7,583)
Accumulated other comprehensive income (loss).......................... 435 (446)
Carryover basis adjustment............................................. (15,730) (15,730)
----------- -----------
Total stockholder's equity....................................... 75,245 69,897
----------- -----------

Total liabilities and stockholder's equity....................... $ 218,702 $ 226,020
=========== ===========

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

F-3

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

Year Ended June 30,
----------------------------------------
2003 2002 2001
---- ---- ----

Net sales..................................................... $ 115,308 $ 120,893 $ 115,395
Cost of goods sold............................................ 73,883 73,888 71,336
--------- --------- ---------

Gross profit............................................. 41,425 47,005 44,059

Selling, general and administrative expenses ................. 17,971 18,943 18,199
Amortization of goodwill...................................... - 4,806 4,806
Amortization of other intangible assets....................... 1,143 1,645 951
Gain from settlement of purchase price dispute, net........... - (992) -
--------- --------- ---------

Income from operations................................... 22,311 22,603 20,103

Other expenses (income):
Interest expense........................................... 14,355 15,633 16,911
Management fees to affiliate............................... 325 250 250
(Gain) loss from early retirement of debt.................. 871 (3,941) (3,302)
Loss from sale and disposal of fixed assets................ 33 - -
--------- --------- ---------

Income before income taxes............................... 6,727 10,661 6,244

Income tax expense............................................ 2,260 5,924 4,735
--------- --------- ---------

Net income............................................... $ 4,467 $ 4,737 $ 1,509
========= ========= =========

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

F-4

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

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

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
Net income....................... - - - 4,737 - - 4,737
Other comprehensive loss, net
of tax:
Foreign currency translation
adjustment.................. - - - - 391 - 391
--------
Comprehensive income............. 5,128
----- ------ --------- ---------- --------- ----------- --------

Balances, June 30, 2002.......... 1,000 - 93,656 (7,583) (446) (15,730) 69,897
Net income....................... - - - 4,467 - - 4,467
Other comprehensive loss, net
of tax:
Foreign currency translation
adjustment.................. - - - - 881 - 881
--------
Comprehensive income............. 5,348
----- ------ --------- ---------- --------- ----------- --------

Balances, June 30, 2003.......... 1,000 $ - $ 93,656 $ (3,116) $ 435 $ (15,730) $ 75,245
===== ====== ========= ========== ========= =========== ========

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

F-5

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

Year Ended June 30,
--------------------------------------------
2003 2002 2001
---- ---- ----

Cash flows from operating activities:
Net income ................................................ $ 4,467 $ 4,737 $ 1,509
Adjustment to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization of goodwill and other
intangibles............................................ 7,331 12,096 10,119
Amortization of debt discount............................ 1,640 3,029 3,610
Amortization of loan closing costs....................... 646 693 808
Deferred income taxes.................................... 2,003 (918) (712)
Loss (gain) from early retirement of debt................ 871 (3,941) (3,446)
Other.................................................... 592 472 (84)
Changes in operating assets and liabilities:
Accounts receivable.................................... 3,270 (3,177) 4,364
Inventory.............................................. 749 690 1,427
Prepaid expenses, deferred charges and other assets.... (4) (131) (400)
Accounts payable and accrued expenses.................. (1,177) (118) 1,077
Income taxes........................................... (6,173) 365 1,332
--------- --------- ---------

Net cash provided by operating activities.............. 14,215 13,797 19,604
--------- --------- ---------

Cash flows from investing activities:
Purchases of equipment..................................... (2,345) (1,338) (3,015)
Payments for acquisitions, net of cash acquired............ - (19,422) -
Patents.................................................... (119) (79) (137)
--------- --------- ---------

Net cash used in investing activities................ (2,464) (20,839) (3,152)
--------- --------- ---------

Cash flows from financing activities:
Payments under capital leases for equipment................ - (503) (846)
Repayments of long-term debt............................... (18,031) (6,805) (3,110)
Net proceeds (repayments) on revolving loan................ 7,250 2,750 (9,000)
Proceeds (repayments) on term loan, net of repayment
of $500 in 2002.......................................... (1,375) 9,500 -
Payments of loan closing costs............................. - (679) -
--------- --------- ---------

Net cash provided by (used in) financing activities...... (12,156) 4,263 (12,956)
--------- --------- ---------

Net increase (decrease) in cash and cash equivalents.......... (405) (2,779) 3,496
Cash and cash equivalents, beginning of period................ 1,875 4,654 1,158
--------- --------- ---------
Cash and cash equivalents, end of period...................... $ 1,470 $ 1,875 $ 4,654
========= ========= =========

Supplemental information:
Cash paid during the period for:
Interest to stockholder and affiliate................... $ 21 $ 14 $ 320
Interest, other......................................... 11,950 11,600 12,233
Income taxes............................................ 6,616 6,857 4,115

Significant non-cash activities:
Contribution of equity and retirement of senior discount
debentures and senior notes.............................. $ - $ - $ 4,721

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

F-6

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 of cash 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 and Baltimore, Maryland 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.

Two customers accounted for 29.7% and 31.3% of net sales during the
years ended June 30, 2003 and June 30, 2002, respectively. One customer
accounted for 14.9% of net sales during the year ended June 30, 2001.

F-7

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)

Concentration of Purchasing

Products accounting for a significant portion of the Company's net
sales utilize specific grades of paper that are produced exclusively for
the Company by one domestic supplier or specific component materials that
are sourced from one qualified supplier. The Company does not have purchase
agreements with their suppliers. 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 and alternate component
materials from multiple suppliers. Until such methods are developed and
alternative sources located, a loss of supply of these specific materials
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 risk of 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 and risk of ownership has passed to the customer.

Shipping and Handling Costs

The costs associated with shipping and handling are included as a
component of cost of goods sold.

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.

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. The cost and accumulated

F-8

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)

amortization of goodwill was $173,153 and $20,159 at June 30, 2003 and
$173,436 and $20,159 at June 30, 2002, respectively. In accordance with
SFAS 142 goodwill is no longer being amortized. The following pro forma
amounts reflect goodwill amortization and net income had SFAS 142 been
implemented at the beginning of fiscal 2001:

2003 2002 2001
---- ---- ----

Net income as reported............... $ 4,467 $ 4,737 $ 1,509
Goodwill amortization................ - 4,806 4,806
----------- ----------- -----------

Pro forma net income................. $ 4,467 $ 9,543 $ 6,315
=========== =========== ===========

Management annually tests the carrying value of its goodwill and other
long-lived assets which have resulted in no impairment.

Stock Based Compensation

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 for the years ended June 30, 2003, 2002 and 2001 would have been as
follows:

2003 2002 2001
---- ---- ----

Net income as reported............... $ 4,467 $ 4,737 $ 1,509
Stock based compensation expense..... 35 105 105
----------- ----------- -----------

Pro forma net income................. $ 4,435 $ 4,632 $ 1,404
=========== =========== ===========

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.

F-9

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)

Other Intangible Assets

Other intangible assets include patents, customer lists, covenants not
to compete and other intangible assets and are being amortized over their
estimated lives using the straight-line method. The following table details
the components of other intangible assets:

June 30,
------------------------------------------------------------------------------------
2003 2002
---------------------------------------- ----------------------------------------
Accumulated Accumulated
Costs Amortization Net Costs Amortization Net
----- ------------ --- ----- ------------ ---

Patents................... $ 8,433 $ 1,286 $ 7,147 $ 8,314 $ 476 $ 7,838
Customer lists............ 7,289 3,645 3,644 7,289 2,916 4,373
Covenants not to compete.. 1,375 1,010 365 1,375 735 640
Other..................... 694 543 151 694 403 291
-------- --------- --------- -------- --------- ---------
$ 17,791 $ 6,484 $ 11,307 $ 17,672 $ 4,530 $ 13,142
======== ========= ========= ======== ========= =========

Future amortization of other intangible assets is as follows:

2004.................... $ 1,951
2005.................... 1,603
2006.................... 1,563
2007.................... 1,551
2008.................... 1,537
Thereafter.............. 3,102
---------
$ 11,307
=========

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 $106,098 at June 30, 2003 compared to a carrying value of
$103,510. The carrying value of all other financial instruments
approximated fair value at June 30, 2003.

Foreign Currency Transactions

Gains and (losses) on foreign currency transactions have been included
in the determination of net income in accordance with SFAS No. 52, "Foreign
Currency Translation." Foreign currency gains and (losses) amounted to
($44), $301 and ($403) for the years ended June 30, 2003, 2002 and 2001,
respectively.

F-10

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 $2,135, $1,766 and $1,591 for the years ended
June 30, 2003, 2002 and 2001, 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. Management makes significant estimates in the
areas of accounts receivable, inventory, intangible assets, long-lived
assets and deferred income tax. Actual results could differ from those
estimates.

Recently Issued Accounting Standards

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 was applied at the beginning of our 2003 fiscal year.
The adoption of SFAS 142 eliminated the amortization of goodwill,
approximately $4,800 in fiscal 2002, while requiring annual tests for
impairment of goodwill. The Company completed its initial and first annual
tests of the carrying value of goodwill which resulted in no impairment.

FASB Statement of Financial Accounting Standards No. 145 "Rescission
of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13,
and Technical Corrections" ("SFAS 145") was issued in April 2002. The most
significant aspects of this pronouncement, with respect to the Company, is
the elimination of SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt". As a result of the elimination of SFAS No. 4,
gains and losses from extinguishment of debt are classified as
extraordinary items only if they meet the criteria in APB No. 30,
"Reporting the Results of Operations - Discontinued Events and
Extraordinary Items". SFAS No. 145, which the Company adopted in fiscal
2003, requires early retirements of debt to be included in income from
continuing operations. Gains and losses on early retirement of debt that
were classified as extraordinary items in prior periods that do not meet
the criteria in APB No. 30 for classification as an

F-11

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)

extraordinary item were reclassified. In fiscal 2002 the Company reported
an approximate $2,700 extraordinary gain from early retirement of debt, net
of tax.

FASB Statement of Financial Accounting Standards No. 146 "Accounting
for Costs Associated with Exit or Disposal Activities" ("SFAS 146") was
issued in June 2002. SFAS 146 addresses financial accounting and reporting
for costs associated with exit or disposal activities and nullifies EITF
Issues No. 94-3, Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity. SFAS 146 requires that a
liability for a cost associated with an exit or disposal activity be
recognized and measured initially at fair value only when the liability is
incurred. SFAS 146 is effective for exit or disposal activities that are
initiated after December 31, 2002. The Company does not anticipate that the
provisions of this statement will have a material impact on the Company's
reported results of operations, financial positions or cash flows.

FASB Interpretation No. 45 "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness
of Others" ("FIN 45") was issued in November 2002. Fin 45 elaborates on the
disclosure to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has
issued. It also requires the guarantor to recognize, at the inception of
the guarantee, a liability for the fair value of obligation undertaken in
issuing the guarantee. The disclosure requirements are effective for
quarters ending after December 15, 2002 and the liability recognition is in
effect for guarantees initiated after December 31, 2002. The Company does
not anticipate that the provisions of this statement will have a material
impact on the Company's reported results of operations, financial positions
or cash flows.

FASB Interpretation No. 46 "Consolidation of Variable Interest
Entities" ("FIN 46") was issued in January 2003. FIN 46 requires an
investor with a majority of the variable interests in a variable interest
entity ("VIE") to consolidate the entity and also requires majority and
significant variable interest investors to provide certain disclosures. A
VIE is an entity in which the equity investor does not have a controlling
interest, or the equity investment risk is insufficient to finance the
entity's activities without receiving additional subordinated financial
support from the other parties. For arrangements entered into with VIEs
created prior to January 31, 2003, the provisions of FIN 46 are required to
be adopted at the beginning of the first interim or annual period beginning
after June 15, 2002. The Company does not anticipate that the provisions of
this interpretation will have a material impact on the Company's reported
results of operations, financial position or cash flows.

3. SIGNIFICANT ACQUISITIONS

On December 18, 2001, the Company acquired the business including
certain assets and assumed certain liabilities of Color Prelude, Inc.
("CP") for $19,423 including direct acquisition costs of $540. The
acquisition was accounted for using the purchase method of accounting in
accordance with Statement of Financial Accounting Standards (SFAS) No. 141,
"Business Combinations". 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 $407 which
will not be amortized in accordance with Statement of Financial

F-12

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

3. SIGNIFICANT ACQUISITIONS (Continued)

Accounting Standards (SFAS) No. 142 "Goodwill and Other Intangible Assets".
The following shows the allocation of the purchase price:

Cash........................................... $ 1
Other current assets........................... 5,680
Property, plant and equipment.................. 7,695
Patents........................................ 7,750
Other intangible assets........................ 1,069
Goodwill....................................... 407
-----------
Total allocation to assets..................... $ 22,602
===========

Current liabilities............................ $ 3,179
===========

Patents are being amortized over a ten year period and other
intangible assets are being amortized over periods ranging from one to four
years.

The results of the acquired operations are included in the financial
statements since the date of acquisition. The following pro forma results
include cost savings and other effects of the planned integration and are
not necessarily indicative of the results which would have occurred if the
business combination had been in effect on the dates indicated. Pro forma
results had CP been acquired at the beginning of fiscal 2001 are as
follows:

2002 2001
---- ----
(unaudited) (unaudited)

Revenue........................ $ 127,226 $ 129,122
Net income..................... 4,696 2,307

In April 2002 the Company settled a dispute with the former owners of
RetCom Holdings Ltd. In connection with the settlement the Company received
approximately $1,000 and has included this settlement amount net of related
expenses in income from operations.

4. ACCOUNTS RECEIVABLE

The following table details the components of accounts receivable:

June 30,
-------------------------
2003 2002
---- ----

Trade accounts receivable.................. $ 20,633 $ 23,824
Allowance for doubtful accounts............ (557) (608)
---------- ----------
20,076 23,216
Other accounts receivable.................. 191 321
---------- ----------
$ 20,267 $ 23,537
========== ==========

F-13

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

5. INVENTORY

The following table details the components of inventory:

June 30,
-------------------------
2003 2002
---- ----
Raw materials
Paper.................................... $ 1,740 $ 2,180
Other raw materials...................... 2,353 4,216
---------- ----------
Total raw materials................... 4,093 6,396
Work in process............................ 3,857 2,468
Reserve for obsolescence................... (685) (850)
---------- ----------

Total inventory............................ $ 7,265 $ 8,014
========== ==========

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,
2003 or June 30, 2002.

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 2003 2002
------------ ---- ----

Land....................... $ 258 $ 258
Building................... 7 - 15 years 2,999 2,690
Leasehold improvements..... 1 - 3 years 717 353
Machinery and equipment.... 5 - 7 years 33,240 32,000
Furniture and fixtures..... 3 - 5 years 4,141 3,609
Construction in progress... 31 255
-------- --------
41,386 39,165
Accumulated depreciation... (24,802) (19,549)
-------- --------
$ 16,584 $ 19,616
======== ========

Depreciation expense amounted to $5,360, $5,197 and $4,341 for the
years ended June 30, 2003, 2002 and 2001, respectively.

7. CREDIT AGREEMENT

On December 18, 2001, the Company amended and restated its Credit
Agreement. The Credit Agreement provides for a $10,000 term loan which
matures on December 31, 2006 with varying quarterly principal payments and,
under certain circumstances, payments of "excess cash flow" as defined in
the Credit Agreement. Interest on amounts borrowed accrue at a floating
rate based upon either prime or LIBOR (the weighted average interest rate
on the outstanding balance under the term loan was 4.56% at June 30, 2003).
The weighted average

F-14

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

7. CREDIT AGREEMENT (Continued)

interest rate on the outstanding balance under the term loan was 5.78% for
the year ending June 30, 2003. Future minimum principal payments under the
term loan are as follows:

2004................ $ 1,875
2005................ 2,125
2006................ 2,625
2007................ 1,500
-----------
$ 8,125
===========

The Credit Agreement also provides for a revolving loan commitment up
to a maximum of $20,000 and expires on December 31, 2006. 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, 2003, the Company's borrowing base was
approximately $24,088. Interest on amounts borrowed accrue at a floating
rate based upon either prime or LIBOR (the weighted average interest rate
on the outstanding balance under the revolving loan was 6.0% and 6.49% at
June 30, 2003 and 2002, respectively). The weighted average interest rate
on the outstanding balance under the revolving loan was 6.14%, 6.45% and
9.58% for the years ended June 30, 2003, 2002 and 2001, respectively.

The Company is required to pay commitment fees on the unused portion
of the revolving loan commitment at a rate of approximately 0.5% per annum.
In addition, the Company is required to pay fees equal to 2.5% of the
average daily outstanding amount of lender guarantees. The Company had $291
of lender guarantees outstanding at June 30, 2003. These fees totaled $76,
$65 and $59 for the years ended June 30, 2003, 2002 and 2001, 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, 2003, 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 $10,000 at such interest rates and due
as agreed upon by the Company and AHC. At June 30, 2003 no amount was
outstanding under the promissory note. Interest paid to AHC in connection
with the promissory note totaled $21, $14 and $320 for the years ended June
30, 2003, 2002 and 2001, respectively.

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. 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

F-15

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

9. SENIOR NOTES (Continued)

and Exchange Commission. During fiscal 2001, AKI purchased $4,000 of the
Senior Notes for $3,110 and recognized a gain of approximately $748. The
purchased 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 were general unsecured obligations of Holding to mature on July
1, 2009. The Debentures were not required to 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 was 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 $2,219 at June
30, 2002. During fiscal 2003, Holding purchased, with proceeds from a
distribution from AKI, the remaining outstanding Senior Discount Debentures
with a carrying value of $17,541 for $18,032 and recognized a loss of
approximately $871. During fiscal 2002, Holding purchased, with proceeds
from a distribution from AKI, Senior Discount Debentures with a carrying
value of $11,054 for $6,804 and recognized a gain of approximately $3,941.
The purchased Debentures were subsequently retired. During fiscal 2001, AHC
purchased Senior Discount Debentures with a carrying value of $7,547 for
$4,721, resulting in the Company recognizing a gain of approximately
$3,302. The Debentures, purchased by AHC, 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.

F-16

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

11. INITIAL CAPITALIZATION (Continued)

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.

12. COMMITMENTS AND CONTINGENCIES

Operating Leases

Equipment and office, warehouse and production space under operating
leases expire at various dates. Rent expense was $1,293, $559 and $538 for
the years ended June 30, 2003, 2002 and 2001, respectively. Future minimum
lease payments under the leases are as follows:

2004.......... $ 1,375
2005.......... 1,051
2006.......... 1,017
2007.......... 809
2008.......... 656
Thereafter.... 2,217
---------
$ 7,125
=========

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
adjusted for changes in the CPI. This agreement expires the earlier of (1)
when a total of $11,800 in cumulative royalty payments has been paid or (2)
December 31, 2004 unless renewed by the Company for successive one-year
periods. The Company expensed $653, $500 and $500 under this agreement for
the years ended June 30, 2003, 2002 and 2001, respectively. The Company has
paid $6,576 in cumulative royalty payments under this agreement through
June 30, 2003.

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 of $625 per year through
the expiration of the agreement in 2012. The Company expensed $625 under
this agreement for each of the three years ended June 30, 2003.

Employment Agreements

The Company has employment and salary continuation agreements with
certain executive officers with terms through June 30, 2004 and 2005. Such
agreements provide for base salaries totaling $1,270 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 and one officer's agreement provides,
in the event of termination resulting from a change of control,

F-17

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

12. COMMITMENTS AND CONTINGENCIES (Continued)

a severance benefit of two times his highest aggregate amount of base
salary and bonus in any of the three calendar years prior to the effective
date of termination.

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 Printing
Services Agreement, which expires December 31, 2004, with a former
shareholder of RetCom. The Printing Services Agreement requires annual
purchases of printing services totaling $5,000 with 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. The liability
balance at June 30, 2003 was approximately $2,163.

13. RETIREMENT PLANS

A 401(k) defined contribution plan (the "Plan") is maintained for
substantially all full-time salaried employees and certain non-union hourly
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 $424, $323 and $294 for the years ended
June 30, 2003, 2002 and 2001, 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 $245,
$221 and $233 for the years ended June 30, 2003, 2002 and 2001,
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.

F-18

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

14. INCOME TAXES (Continued)

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

Year Ended June 30,
-----------------------------------
2003 2002 2001
---- ---- ----

Income before income taxes:
United States................. $ 5,026 $ 8,519 $ 4,783
Foreign....................... 1,701 2,142 1,461
-------- -------- --------

$ 6,727 $ 10,661 $ 6,244
======== ======== ========

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

Year Ended June 30,
-----------------------------------
2003 2002 2001
---- ---- ----

Current expense:
Federal....................... $ (701) $ 4,838 $ 4,208
Foreign....................... 613 1,042 526
State......................... 345 962 278
-------- -------- --------
257 6,842 5,012
-------- -------- --------
Deferred expense (benefit):

Federal....................... 1,965 (832) (611)
Foreign....................... - - -
State......................... 38 (86) 334
-------- -------- --------
2,003 (918) (277)
-------- -------- --------

$ 2,260 $ 5,924 $ 4,735
======== ======== ========

The significant components of deferred tax assets (liabilities) at
June 30, 2003 and 2002, were as follows:

June 30,
--------------------------------------------------------
2003 2002
---- ----
Current Noncurrent Current Noncurrent
------- ---------- ------- ----------

Deferred income tax assets:
Accrued expenses........................ $ 376 $ - $ 483 $ 1,923
Allowance for doubtful accounts......... 213 - 216 -
Reserve for inventory obsolescence...... 219 - 278 -
Amortization of intangibles............. - 879 - 773
--------- -------- --------- ---------
808 879 977 2,696

Deferred income tax liability:
Property, plant and equipment......... - (2,021) - (2,004)
--------- -------- --------- ---------

Deferred tax assets (liabilities).. $ 808 $ (1,142) $ 977 $ 692
========= ======== ========= =========

F-19

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

14. INCOME TAXES (Continued)

The income tax provision recognized by the Company for the years ended
June 30, 2003, 2002 and 2001 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:

Year Ended June 30,
--------------------------------------------
2003 2002 2001
---- ---- ----

Computed tax provision at the
statutory rate................................. $ 2,287 $ 3,625 $ 2,123
State income tax provision, net of
federal effect................................. 253 570 397
Nondeductible expenses........................... 32 1,511 2,036
Extraterritorial income exclusion................ (86) - -
Other, net....................................... (226) 218 179
--------- -------- ---------

$ 2,260 $ 5,924 $ 4,735
========= ======== =========

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. EBITDA is net income or loss plus income taxes, interest
expense, management fees, loss from early retirement of debt, loss from
sale and disposal of fixed assts, depreciation, amortization and impairment
loss of goodwill and amortization of other intangibles less gains from
early retirement of debt and settlement of purchase price dispute. 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, 2003, 2002 and 2001 follows:

2003 2002 2001
------------------------ ------------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------- ----- ------- ----- ------- -----

Outstanding, beginning of year..... 1,469,050 $ 1.00 1,464,850 $ 1.00 1,509,450 $ 1.00
Granted....................... 96,000 1.00 21,000 1.00 35,500 1.00
Exercised..................... - - - - - -
Forfeited..................... (32,800) 1.00 (16,800) 1.00 (80,100) 1.00
--------- ------- --------- ------- --------- -------

Outstanding, end of year........... 1,532,250 $ 1.00 1,469,050 $ 1.00 1,464,850 $ 1.00
========= ======= ========= ======= ========= =======

Exercisable, end of year........... 1,436,073 $ 1.00 1,106,343 $ 1.00 640,793 $ 1.00
========= ======= ========= ======= ========= =======

Weighted average remaining
contractual life................... 6.7 years 7.5 years 8.5 years

F-20

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

16. RELATED PARTY TRANSACTIONS

The Company made payments to an affiliate of DLJMBII for management
fees of $325, $250 and $250 for the years ended June 30, 2003, 2002 and
2001, respectively.

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.

United
Net sales: States France Total
------ ------ -----

Year ended June 30, 2001............... $ 96,845 $ 18,550 $ 115,395
Year ended June 30, 2002............... 103,138 17,755 120,893
Year ended June 30, 2003............... 99,757 15,551 115,308

Long-lived assets:

Year ended June 30, 2001............... $ 183,848 $ 70 $ 183,918
Year ended June 30, 2002............... 190,868 82 190,950
Year ended June 30, 2003............... 183,949 106 184,055

18. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS

The following condensed balance sheets at June 30, 2003 and June 30,
2002 and condensed statements of operations, stockholder's equity and cash
flows for the years ended June 30, 2003, 2002 and 2001 for Holding should
be read in conjunction with the consolidated financial statements and notes
thereto.

BALANCE SHEETS

June 30,
----------------------------
2003 2002
---- ----

Assets
Investment in subsidiaries........................................ $ 87,385 $ 99,583
Income tax receivable............................................. 3,155 46
Deferred charges.................................................. - 422
Deferred income taxes............................................. - 1,923
---------- ----------
Total assets.................................................... $ 90,540 $ 101,974
========== ==========

Liabilities
Senior discount debentures........................................ $ - $ 15,901
---------- ----------
Total liabilities............................................... - 15,901
---------- ----------

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 93,656
Accumulated deficit............................................... (3,116) (7,583)
---------- ----------
Total stockholder's equity...................................... 90,540 86,073
---------- ----------

Total liabilities and stockholder's equity...................... $ 90,540 $ 101,974
========== ==========

F-21

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)

STATEMENTS OF OPERATIONS

Year Ended June 30,
------------------------------------------
2003 2002 2001
---- ---- ----

Equity in net income of subsidiaries......................... $ 5,833 $ 4,151 $ 2,439
Interest expense, net........................................ (1,681) (3,105) (3,699)
Gain (loss) from early retirement of debt.................... (871) 3,941 2,554
---------- ---------- ----------

Income before income taxes................................. 3,281 4,987 1,294

Income tax expense (benefit)................................. (1,186) 250 (215)
---------- ---------- ----------

Net income............................................... $ 4,467 $ 4,737 $ 1,509
========== ========== ==========

STATEMENT OF STOCKHOLDER'S EQUITY

Additional
Common Stock Paid-in Accumulated
Shares Amount Capital Deficit Total
------ ------ ------- ------- -----

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
Net income....................... - - - 4,737 4,737
------- ------- ----------- ---------- -----------

Balances, June 30, 2002.......... 1,000 - 93,656 (7,583) 86,073
Net income....................... - - - 4,467 4,467
------- ------- ----------- ---------- -----------

Balances, June 30, 2003.......... 1,000 $ - $ 93,656 $ (3,116) $ 90,540
======= ======= =========== ========== ===========

F-22

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)

STATEMENTS OF CASH FLOWS

Year Ended June 30,
------------------------------------
2003 2002 2001
---- ---- ----

Cash flows from operating activities:
Net income........................................................ $ 4,467 $ 4,737 $ 1,509
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Net change in investment in subsidiaries........................ (5,833) (4,151) (2,439)
Amortization of original issuance discount...................... 1,640 3,029 3,610
Amortization of loan closing costs.............................. 41 76 89
Deferred income taxes........................................... 1,923 415 (325)
(Gain) loss from early retirement of debt....................... 871 (3,941) (2,554)
Changes in operating assets and liabilities:
Income taxes.................................................. (3,109) (165) 110
--------- --------- --------
Net cash provided by (used in) operating activities........ - - -
--------- --------- --------

Cash flows from financing activities:
Repayments of long-term debt...................................... (18,031) (6,805) -
Distribution from subsidiary...................................... 18,031 6,805 -
--------- --------- --------
Net cash provided by (used in) financing activities............. - - -
--------- --------- --------

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

19. UNAUDITED QUARTERLY RESULTS OF OPERATIONS

The following is a summary of the unaudited quarterly results of
operations for Fiscal 2003 and Fiscal 2002.

Quarter Ended Quarter Ended Quarter Ended Quarter Ended
September 30, December 31, March 31, June 30,
Fiscal 2003 2002 2002 2003 2003 Total
---- ---- ---- ---- ------

Net sales................ $ 30,400 $ 31,644 $ 28,954 $ 24,310 $ 115,308
Gross profit............. 11,885 10,940 10,405 8,195 41,425
Income from operations... 6,935 5,914 5,632 3,830 22,311
Interest expense, net.... 3,738 3,675 3,565 3,377 14,355
Net income (loss)........ 1,887 1,491 1,169 (80) 4,467

Quarter Ended Quarter Ended Quarter Ended Quarter Ended
September 30, December 31, March 31, June 30,
Fiscal 2002 2001 2001 2002 2002 Total
---- ---- ---- ---- ------

Net sales................ $ 27,381 $ 22,329 $ 35,472 $ 35,711 $ 120,893
Gross profit............. 10,667 6,400 15,115 14,823 47,005
Income from operations... 5,026 361 8,418 8,798 22,603
Interest expense, net.... 3,871 3,865 4,182 3,715 15,633
Net income (loss)........ 146 (2,697) 2,029 5,259 4,737

F-23

REPORT OF INDEPENDENT AUDITORS

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, 2003 and 2002 and the results of their
operations and their cash flows for each of the three years in the period ended
June 30, 2003in 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.

As discussed in Note 2 to the consolidated financial statements, the
Company changed its accounting policy for goodwill amortization in fiscal 2003.

PricewaterhouseCoopers LLP
Knoxville, Tennessee
August 5, 2003

F-24

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

June 30,
----------------------------
2003 2002
---- ----

ASSETS
Current assets
Cash and cash equivalents.............................................. $ 1,470 $ 1,875
Accounts receivable, net............................................... 20,267 23,537
Inventory, net......................................................... 7,265 8,014
Income tax receivable.................................................. 1,011 -
Prepaid expenses....................................................... 671 667
Deferred income taxes.................................................. 808 977
----------- -----------
Total current assets............................................. 31,492 35,070

Property, plant and equipment, net..................................... 16,584 19,616
Goodwill, net ......................................................... 152,994 153,277
Other intangible assets, net........................................... 11,307 13,142
Deferred charges, net.................................................. 3,032 3,637
Other assets........................................................... 138 164
----------- -----------
Total assets..................................................... $ 215,547 $ 224,906
=========== ===========

LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of long-term debt...................................... $ 1,875 $ 1,375
Accounts payable, trade................................................ 5,444 5,826
Accrued income taxes................................................... - 2,053
Accrued compensation................................................... 4,333 5,338
Accrued interest....................................................... 5,502 5,570
Accrued expenses....................................................... 3,661 3,383
----------- -----------
Total current liabilities........................................ 20,815 23,545

Revolving credit line.................................................. 10,000 2,750
Term loan.............................................................. 6,250 8,125
Senior notes........................................................... 103,510 103,510
Deferred income taxes.................................................. 1,142 1,231
Other non-current liabilities.......................................... 1,740 2,338
----------- -----------
Total liabilities................................................ 143,457 141,499

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............................................. 82,512 100,543
Retained earnings (accumulated deficit)................................ 4,873 (960)
Accumulated other comprehensive income (loss).......................... 435 (446)
Carryover basis adjustment............................................. (15,730) (15,730)
----------- -----------
Total stockholder's equity....................................... 72,090 83,407
----------- -----------

Total liabilities and stockholder's equity....................... $ 215,547 $ 224,906
=========== ===========

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

F-25

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

Year Ended June 30,
----------------------------------------
2003 2002 2001
---- ---- ----

Gross profit............................................... 41,425 47,005 44,059

Selling, general and administrative expenses.................. 17,971 18,943 18,199
Amortization of goodwill...................................... - 4,806 4,806
Amortization of other intangible assets....................... 1,143 1,645 951
Gain from settlement of purchase price dispute, net........... - (992) -
--------- --------- ---------

Income from operations..................................... 22,311 22,603 20,103

Other expenses (income):
Interest expense........................................... 12,674 12,528 13,212
Management fees to affiliate............................... 325 250 250
Gain from early retirement of debt......................... - - (748)
Loss from sale and disposal of fixed assets................ 33 - -
--------- --------- ---------

Income before income taxes............................... 9,279 9,825 7,389

Income tax expense ........................................... 3,446 5,674 4,950
--------- --------- ---------

Net income............................................. $ 5,833 $ 4,151 $ 2,439
========= ========= =========

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

F-25

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

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

Balances, June 30, 2000.......... 1,000 $ - $ 107,348 $ (7,550) $ (542) $ (15,730) $ 83,526
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
Distribution to AKI Holding Corp. - (6,805) - - - (6,805)
Net income....................... - - - 4,151 - - 4,151
Other comprehensive loss, net
of tax:
Foreign currency translation
adjustment.................. - - - - 391 - 391
---------
Comprehensive income............. 4,542
----- ------ --------- ---------- --------- ----------- ---------

Balances, June 30, 2002.......... 1,000 - 100,543 (960) (446) (15,730) 83,407
Distribution to AKI Holding Corp. - (18,031) - - - (18,031)
Net income....................... - - - 5,833 - - 5,833
Other comprehensive loss, net
of tax:
Foreign currency translation
adjustment.................. - - - - 881 - 881
---------
Comprehensive income............. 6,714
----- ------ --------- ---------- --------- ----------- ---------

Balances, June 30, 2003.......... 1,000 $ - $ 82,512 $ 4,873 $ 435 $ (15,730) $ 72,090
===== ====== ========= ========== ========= =========== =========

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

F-27

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

Year Ended June 30,
--------------------------------------------
2003 2002 2001
---- ---- ----

Cash flows from operating activities:
Net income................................................. $ 5,833 $ 4,151 $ 2,439
Adjustment to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization of goodwill and
other intangibles...................................... 7,331 12,096 10,119
Amortization of loan closing costs....................... 605 617 719
Deferred income taxes.................................... 80 (1,333) (387)
Gain from early retirement of debt....................... - - (892)
Other.................................................... 592 472 (84)
Changes in operating assets and liabilities:
Accounts receivable.................................... 3,270 (3,177) 4,364
Inventory.............................................. 749 690 1,427
Prepaid expenses, deferred charges and other assets.... (4) (131) (400)
Accounts payable and accrued expenses.................. (1,177) (118) 1,077
Income taxes........................................... (3,064) 530 1,222
--------- --------- ---------

Net cash provided by operating activities............ 14,215 13,797 19,604
--------- --------- ---------

Net cash used in investing activities................ (2,464) (20,839) (3,152)
--------- --------- ---------

Cash flows from financing activities:
Payments under capital leases for equipment................ - (503) (846)
Repayments of long-term debt............................... - - (3,110)
Net proceeds (repayments) on revolving loan................ 7,250 2,750 (9,000)
Proceeds (repayments) on term loan, net of repayment of
$500 in 2002............................................. (1,375) 9,500 -
Payments of loan closing costs............................. - (679) -
Distribution to parent..................................... (18,031) (6,805) -
--------- --------- ---------

Net cash provided by (used in) financing activities.. (12,156) 4,263 (12,956)
--------- --------- ---------

Net increase (decrease) in cash and cash equivalents....... (405) (2,779) 3,496
Cash and cash equivalents, beginning of period............. 1,875 4,654 1,158
--------- --------- ---------
Cash and cash equivalents, end of period................... $ 1,470 $ 1,875 $ 4,654
========= ========= =========

Supplemental information:
Cash paid during the period for:
Interest to stockholder................................ $ 21 $ 14 $ 320
Interest, other........................................ 11,950 11,600 12,233
Income taxes........................................... 6,616 6,857 4,115

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

F-28

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 and Baltimore, Maryland 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

Concentration of Credit Risk

F-29

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)

Concentration of Purchasing

Products accounting for a significant portion of the Company's net
sales utilize specific grades of paper that are produced exclusively for
the Company by one domestic supplier or specific component materials that
are sourced from one qualified supplier. The Company does not have purchase
agreements with their suppliers. 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 and alternative component
materials from multiple suppliers. Until such methods are developed or
alternative sources located, 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

Shipping and Handling Costs

The costs associated with shipping and handling are included as a
component of cost of goods sold.

Inventory

Property, Plant and Equipment

Goodwill

F-30

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)

2003 2002 2001
---- ---- ----

Net income as reported............... $ 5,833 $ 4,151 $ 2,439
Goodwill amortization................ - 4,806 4,806
----------- ----------- -----------

Pro forma net income................. $ 5,833 $ 8,957 $ 7,245
=========== =========== ===========

Management annually tests the carrying value of its goodwill and other
long-lived assets which have resulted in no impairment.

Stock Based Compensation

2003 2002 2001
---- ---- ----

Net income as reported............... $ 5,833 $ 4,151 $ 2,439
Stock based compensation expense..... 35 105 105
----------- ----------- -----------

Pro forma net income................. $ 5,798 $ 4,046 $ 2,334
=========== =========== ===========

Deferred Charges

F-31

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)

Other Intangible Assets

Future amortization of other intangible assets is as follows:

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 $106,098 at June 30, 2003, compared to a carrying value of
$103,510. The carrying value of all other financial instruments
approximated fair value at June 30, 2003.

Foreign Currency Transactions

F-32

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

Income Taxes

Use of Estimates

Recently Issued Accounting Standards

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 was applied at the beginning of our 2003 fiscal year.
The adoption of SFAS 142 eliminated the amortization of goodwill,
approximately $4,800 in fiscal 2002, while requiring annual tests for
impairment of goodwill. The Company completes its initial and first annual
tests of the carrying value of goodwill which resulted in no impairment.

FASB Statement of Financial Accounting Standards No. 145 "Rescission
of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13,
and Technical Corrections" ("SFAS 145") was issued in April 2002. The most
significant aspects of this pronouncement, with respect to the Company, is
the elimination of SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt". As a result of the elimination of SFAS No. 4,
gains and losses from extinguishment of debt are classified as
extraordinary items only if they meet the criteria in APB No. 30,
"Reporting the Results of Operations - Discontinued Events and
Extraordinary Items". SFAS No. 145, which the Company adopted in fiscal
2003, requires early retirement of debt to be included in income from
continuing operations. Gains and losses on early retirement of debt that
were classified

F-33

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)

as extraordinary items in prior periods that do not meet the criteria in
APB No. 30 for classification as an extraordinary items in prior periods
that do not meet the criteria in APB No. 30 for classification as an
extraordinary item were reclassified. In fiscal 2002 the Company reported
an approximate $2.7 million extraordinary gain from early retirement of
debt, net of tax.

FASB Statement of Financial Accounting Standards No. 146 "Accounting
for Costs Associated with Exit or Disposal Activities" ("SFAS 146") was
issued in June 2002. SFAS 146 addresses financial accounting and reporting
for costs associated with exit or disposal activities and nullifies EITF
Issue No. 94-3, Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity. SFAS 146 requires that a
liability for a cost associated with an exit or disposal activity be
recognized and measured initially at fair value only when the liability is
incurred. SFAS 146 is effective for exit or disposal activities that are
initiated after December 31, 2002. The Company does not anticipate that the
provisions of this statement will have a material impact on the Company's
reported results of operations, financial positions or cash flows.

FASB Interpretation No. 45 "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness
of Others" ("FIN 45") was issued in November 2002. FIN 45 elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has
issued. It also requires the guarantor to recognize, at the inception of
the guarantee, a liability for the fair value of obligation undertaken in
issuing the guarantee. The disclosure requirements are effective for
quarters ending after December 15, 2002 and the liability recognition is in
effect for guarantees initiated after December 31, 2002. The Company does
not anticipate that the provisions of this statement will have a material
impact on the Company's reported results of operations, financial positions
or cash flows.

FASB Interpretation No. 46 "Consolidation of Variable Interest
Entities" ("FIN 46") was issued in January 2003. FIN 46 requires an
investor with a majority of the variable interest in a variable interest
entity ("VIE") to consolidate the entity and also requires majority and
significant variable interest investors to provide certain disclosures. A
VIE is an entity in which the equity investor does not have a controlling
interest, or the equity investment risk is insufficient to finance the
entity's activities without receiving additional subordinated financial
support from the other parties. For arrangements entered into with VIEs
created prior to January 31, 2003, the provisions of FIN 46 are required to
be adopted at the beginning of the first interim or annual period beginning
after June 15, 2002. The Company does not anticipate that the provisions of
this interpretation will have a material impact on the Company's reported
results of operations, financial position or cash flows.

3. SIGNIFICANT ACQUISITIONS

F-34

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 (Continued)

value to goodwill totaling $407 which will not be amortized in accordance
with Statement of Financial Accounting Standards (SFAS) No. 142 "Goodwill
and Other Intangible Assets". The following shows the allocation of the
purchase price:

Current liabilities............................ $ 3,179
===========

Patents are being amortized over a ten year period and other
intangible assets are being amortized over periods ranging from one to four
years.

2002 2001
---- ----

(unaudited) (unaudited)

Revenue........................ $ 127,226 $ 129,122
Net income .................... 4,110 3,237

F-35

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)

4. ACCOUNTS RECEIVABLE

The following table details the components of accounts receivable:

June 30,
-------------------------
2003 2002
---- ----

$ 20,267 $ 23,537
========== ==========

5. INVENTORY

The following table details the components of inventory:

Total inventory............................ $ 7,265 $ 8,014
========== ==========

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,
2003 or June 30, 2002.

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 2003 2002
------------ ---- ----

Land....................... $ 258 $ 258
Buildings.................. 7 - 15 years 2,999 2,690
Leasehold improvements..... 1 - 3 years 717 353
Machinery and equipment.... 5 - 7 years 33,240 32,000
Furniture and fixtures..... 3 - 5 years 4,141 3,609
Construction in progress... 31 255
-------- --------
41,386 39,165
Accumulated depreciation... (24,802) (19,549)
-------- --------
$ 16,584 $ 19,616
======== =========

Depreciation expense amounted to $5,360, $5,197 and $4,341 for the
years ended June 30, 2003, 2002 and 2001, respectively.

F-36

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. CREDIT AGREEMENT

2004................ $ 1,875
2005................ 2,125
2006................ 2,625
2007................ 1,500
-----------
$ 8,125
===========

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 $10,000 at such interest rates and due
as agreed upon by the Company and AHC. At June 30, 2003, no amount was
outstanding under the promissory note. Interest paid to AHC in connection
with the promissory note totaled $21, $14 and $320 for the years ended June
30, 2003, 2002 and 2001, respectively.

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

F-37

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)

9. SENIOR NOTES (Continued)

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. 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 of approximately $748. The purchased notes were subsequently retired.

10. INITIAL CAPITALIZATION

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 of cash 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.

F-38

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

Operating Leases

2004......... $ 1,375
2005......... 1,051
2006......... 1,017
2007......... 809
2008......... 656
Thereafter... 2,217
-----------
$ 7,125
===========

Royalty Agreements

Employee Agreements

F-39

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)

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

12. RETIREMENT PLANS

13. INCOME TAXES

F-40

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)

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

Year Ended June 30,
-----------------------------------
2003 2002 2001
---- ---- ----

Income before income taxes:
United States................. $ 7,578 $ 7,683 $ 5,928
Foreign....................... 1,701 2,142 1,461
-------- -------- --------

$ 9,279 $ 9,825 $ 7,389
======== ======== ========

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

Year Ended June 30,
----------------------------------
2003 2002 2001
---- ---- ----

Current expense:
Federal....................... $ 2,408 $ 5,003 $ 4,533
Foreign....................... 613 1,042 526
State......................... 345 962 278
-------- -------- --------
3,366 7,007 5,337
-------- -------- --------

Deferred expense (benefit):
Federal....................... 42 (1,247) (721)
Foreign....................... - - -
State......................... 38 (86) 334
-------- -------- --------
80 (1,333) (387)
-------- -------- --------

$ 3,446 $ 5,674 $ 4,950
======== ======== ========

The significant components of deferred tax assets and (liabilities) at
June 30, 2003 and 2002, were as follows:

June 30,
--------------------------------------------------------
2003 2002
---- ----
Current Noncurrent Current Noncurrent
------- ---------- ------- ----------

Deferred income tax assets:
Accrued expenses........................ $ 376 $ - $ 483 $ -
Allowance for doubtful accounts......... 213 - 216 -
Reserve for inventory obsolescence...... 219 - 278 -
Amortization of intangibles............. - 879 - 773
--------- -------- --------- ---------
808 879 977 773
Deferred income tax liability:
Property, plant and equipment........... - (2,021) - (2,004)
--------- -------- --------- ---------

Deferred tax assets (liabilities).. $ 808 $ (1,142) $ 977 $ (1,231)
========= ======== ========= =========

F-41

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)

Year Ended June 30,
--------------------------------------------
2003 2002 2001
---- ---- ----

Computed tax provision at the
statutory rate................................. $ 3,155 $ 3,439 $ 2,586
State income tax provision, net of
federal effect................................. 253 570 397
Net nondeductible expenses....................... 32 1,373 1,952
Extraterritorial income exclusion................ (86) - -
Other, net....................................... 92 292 15
--------- --------- ---------

$ 3,446 $ 5,674 $ 4,950
========= ========= =========

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. EBITDA is net income or loss plus income taxes, interest
expense, management fees, loss from early retirement of debt, loss from
sale and disposal of fixed assets, depreciation, amortization and
impairment loss of goodwill and amortization of other intangibles less
gains from early retirement of debt and settlement of purchase price
dispute. 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, 2003, 2002 and 2001 follows:

Outstanding, end of year........... 1,532,250 $ 1.00 1,469,050 $ 1.00 1,464,850 $ 1.00
========= ======= ========= ======= ========= =======

Exercisable, end of year........... 1,436,073 $ 1.00 1,106,343 $ 1.00 640,793 $ 1.00
========= ======= ========= ======= ========= =======

Weighted average remaining
contractual life................... 6.7 years 7.5 years 8.5 years

F-42

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)

15. RELATED PARTY TRANSACTIONS

The Company made payments to an affiliate of DLJMBII for management
fees of $325 for the year ended June 30, 2003 and $250 for the years ended
June 30, 2002 and June 30, 2001.

16. GEOGRAPHIC INFORMATION

United
Net sales: States France Total
------ ------ -----

Year ended June 30, 2001............... $ 96,845 $ 18,550 $ 115,395
Year ended June 30, 2002............... 103,138 17,755 120,893
Year ended June 30, 2003............... 99,757 15,551 115,308

Long-lived assets:

Year ended June 30, 2001............... $ 183,042 $ 70 $ 183,112
Year ended June 30, 2002............... 189,754 82 189,836
Year ended June 30, 2003............... 183,949 106 184,055

17. UNAUDITED QUARTERLY RESULTS OF OPERATIONS

The following is a summary of the unaudited quarterly results of operations
for Fiscal 2003 and Fiscal 2002.

Quarter Ended Quarter Ended Quarter Ended Quarter Ended
September 30, December 31, March 31, June 30,
Fiscal 2003 2002 2002 2003 2003 Total
---- ---- ---- ---- -----

Net sales................ $ 30,400 $ 31,644 $ 28,954 $ 24,310 $ 115,308
Gross profit............. 11,885 10,940 10,405 8,195 41,425
Income from operations... 6,935 5,914 5,632 3,830 22,311
Interest expense, net.... 3,188 3,220 3,184 3,082 12,674
Net income (loss)........ 2,257 1,633 1,437 506 5,833

Quarter Ended Quarter Ended Quarter Ended Quarter Ended
September 30, December 31, March 31, June 30,
Fiscal 2002 2001 2001 2002 2002 Total
---- ---- ---- ---- -----

Net sales................ $ 27,381 $ 22,329 $ 35,472 $ 35,711 $ 120,893
Gross profit............. 10,667 6,400 15,115 14,823 47,005
Income from operations... 5,026 361 8,418 8,798 22,603
Interest expense, net.... 3,044 3,038 3,306 3,140 12,528
Net income (loss)........ 702 (2,140) 2,616 2,973 4,151

F-43