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, 2004

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

For the transition period from ___________ to _____________

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

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

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

The aggregate market value of the voting and non-voting stock held by
non-affiliates was zero as of December 31, 2003.

As of August 15, 2004, 1,000 shares of common stock of AKI, Inc., $0.01 par
value, were outstanding.

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

ITEM 1. BUSINESS

General

Our Company is a leading global marketer and manufacturer of multi-sensory
marketing, interactive advertising and sampling systems which utilize various
technologies to 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 15, 2004, 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. The RetCom 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, Liqi-Seal(R) for sampling skin care and foundation
products in a unique clear packette, PowdaScent(TM) for the sampling of
fragrance products and SelectaShade(R) which is a unique beauty tool for shade
selection for foundation.

On July 21, 2004, AHC entered into an Agreement and Plan of Merger (the
"Fusion Merger Agreement") with Fusion Acquisition LLC ("Fusion"), a
newly-formed entity owned by investment funds managed by Kohlberg, Kravis,
Roberts & Co. ("KKR") and AHC Merger, Inc. ("AHC Merger"), a wholly-owned
subsidiary of Fusion formed for the purpose of effecting the Fusion Merger (as
defined below), pursuant to which AHC Merger will merge with and into AHC such
that AHC will be the surviving corporation (the "Fusion Merger") and, at the
effective time of the Fusion Merger, will become a wholly-owned subsidiary of
Fusion. Immediately upon the effectiveness of the Fusion Merger, Fusion will
contribute AHC to Jostens Holding Corp. ("JHC") in exchange for capital stock of
JHC. Following the contribution, JHC intends to contribute AHC to its direct
subsidiary, Jostens IH Corp., and as a result, AHC will be a wholly- owned
subsidiary of Jostens IH Corp.

Pursuant to the Fusion Merger Agreement, each issued and outstanding share
of AHC's common stock will be cancelled and retired and shall cease to exist,
and no consideration shall

be delivered in exchange therefore; and each issued and outstanding share of
AHC's outstanding preferred stock shall be converted into the right to receive
cash merger consideration. The cash merger consideration payable per share of
preferred stock will be determined based upon a total enterprise value of $250.0
million, as adjusted based upon the working capital of our Company at closing.
Upon consummation of the Fusion Merger and the contributions, our Company shall
be a wholly-owned subsidiary of Jostens IH Corp.

The Fusion Merger Agreement and subsequent contribution are subject to
certain conditions to closing including, among others: (i) the consummation of
the Fusion Merger and certain other concurrent transactions, including the
contribution and the merger of Von Hoffmann Holdings Inc. with and into a
subsidiary of Fusion; (ii) the repayment, repurchase or redemption of certain
indebtedness and preferred stock of Jostens, Inc., JHC, Von Hoffmann Holdings
Inc., Von Hoffmann Corporation, AHC and AKI; (iii) that Jostens IH Corp. obtains
financing for such concurrent transactions on the terms and conditions set forth
in the financing commitment provided by an affiliate of Credit Suisse First
Boston LLC, Banc of America Securities LLC and Deustche Bank Securities Inc.;
and (iv) that Marc Reisch, CEO of Fusion, shall have made an investment in the
common stock of JHC.

In connection with the Fusion Merger and subsequent contribution, we will
refinance our existing credit facility. In addition, upon the consummation of
the contribution, we intend to use new financing by Jostens IH Corp. to fund
certain tender payments due to holders of AKI, Inc.'s 10 1/2% Senior Notes due
2008 who elect to tender their notes pursuant to the tender offer and consent
solicitation commenced on August 19, 2004. It is a condition to the closing of
the Fusion Merger and the contribution and new financing described above that
the notes be repurchased or redeemed.

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 ("USPS") 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, MicroDot(TM) 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(R) 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.

o AromaWindow (TM): A proprietary technology in which Microfragrance(R)
capsules are applied to a clear polyester film label, delivering an
accurate aroma rendition of any product, where scent is part of the
message, when scratched. This label technology is very effective for
application on packaging surfaces. The advantage of this

technology is that the clarity of the label does not obscure the
graphics of the packaging as does a more traditional opaque label.

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
both in the fine fragrance and many other consumer products categories
including 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 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 USPS approval for
subscription magazine periodical rates.

o BeautiSeal(R): A proprietary, patented technology, BeautiSeal(R) is a
sampling system for depositing quality renditions of creams, lotion or
gel products 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 USPS 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 Liqi-Seal(R): 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 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 USPS
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. Also very effective for sampling other
personal care powder products such as baby powder and foot care
powder.

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. BeautiTouch(R) is also available in a stand alone
triple chamber format which is very effective as handouts or as a
sample at point of sale.

o SelectaShade(R): 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(R) 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 USPS 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),
Liqi-Seal(R), 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.

Company-Sponsored Research and Development Activities

We engage in various company-sponsored research and development activities.
Research and development expenditures consist of salaries and benefits,
occupancy costs, and test materials and related production costs, and are
charged to selling, general and administrative expenses in the period incurred.
Research and development expenses totaled approximately $2.2 million, $2.1
million and $2.1 million for the years ended June 30, 2004, 2003 and 2002,
respectively, including expenditures related to the improvement of existing
products, services and techniques totaled approximately $1.8 million, $1.7
million and $1.7 million, respectively.

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 76% of sales in fiscal 2004. Estee Lauder, L'Oreal and Mary Kay
were the only customers that accounted for 10% or more of net sales in fiscal
2004. 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.

Geographic Revenues

Revenues generated from customers in the United States for the years ended
June 30, 2004, 2003 and 2002 were approximately $101.4 million, $87.6 million
and $95.5 million, respectively. Revenues including export shipments from the
United States, generated by foreign customers, principally in Europe, for the
years ended June 30, 2004, 2003 and 2002 were approximately $32.0 million, $27.7
million and $25.4 million, respectively.

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 our Company's manufacturing facilities in
Chattanooga, Tennessee with ISO 9001:1994 Registration. In December 2003, these
facilities and a fourth manufacturing facility located in Baltimore, Maryland
were awarded ISO 9001:2000 Registration. These facilities produce many of our
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 of our Company's quality management system which contains
five process groups; each with elements and sub-elements that outline the
requirements for documenting and implementing our Company's overall philosophy
as it pertains to quality, our 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
9001:2000 standard applies to organizations that design, develop and produce
products while assuring and controlling quality through continuous improvement.

Both of 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.

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 Liqi-Seal(R), 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.

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 fragrance and cosmetic sampling
market are the fragrance divisions of Vertis, Inc., Orlandi, Inc., Delta
Graphics, Inc., Nord'est, Marietta Corp., Sampling Dimensions, LLC, Klocke,
Rotakon GmbH, Follmann & Co., 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 July 31, 2004, we employed 490 persons, which included 288 hourly and
202 salaried and management personnel. A substantial number of our hourly
employees are represented by the Graphics Communications International Union
(GCIU) local 197-M. Management considers our relations with the union to be
good. The current union contract was signed March 11, 2004 and will be in effect
through March 31, 2007.

Available Information

We are subject to the informational requirements of the Securities Exchange
Act of 1934. We therefore file periodic reports and other information with the
Securities and Exchange Commission. Since we are not a listed company, we do not
make such annual reports or other information available on our website and do
not provide electronic or paper copies of these reports free of charge. Such
reports may be obtained by visiting the Public Reference Room of the SEC at 450
Fifth Street, NW, Washington, D.C. 20549, or by calling the SEC at
1-800-SEC-0330. In addition, the SEC maintains an internet site
(http://www.sec.gov) that contains reports, proxy and information statements and
other information regarding issuers that file electronically. Our Internet
website address is www.arcadeinc.com. Information contained on our website is
not part of this report.

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, 2004, AKI had total indebtedness of approximately $105.0 million. As of July
31, 2004, AKI had outstanding borrowings of $4.0 million under its revolving
credit agreement with Heller Financial, Inc. In addition, as of such date,
additional borrowings of up to approximately $15.7 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. As of June 30, 2004, we were in compliance with all debt covenants.

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 July 31, 2004, AKI had outstanding
borrowings under the credit agreement consisting of, $4.0 million revolving loan
and could borrow an additional $15.7 million under the revolving loan commitment
of the credit agreement, subject to specified conditions.

Our results of operations could be adversely affected if the USPS reclassifies
our sampling systems or the sampling products of our competitors.

Most of our sampling systems are approved by the USPS for inclusion in
subscription magazines mailed at periodical postage rates. 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 2004. 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 76% of
our net sales in fiscal 2004. None of our customers, other than Estee Lauder,
L'Oreal and Mary Kay, accounted for 10% or more of net sales in fiscal 2004.
Although we have long-established relationships with most of our major
customers, we generally do not have long-term contracts with any of our
customers. We do have an exclusive three year contract, expiring in August 2007,
to provide Mary Kay certain lipstick samples. We may also 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,
L'Oreal 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 fragrance and
cosmetic sampling market are the fragrance division of Vertis, Inc., Orlandi
Inc., Delta Graphics, Inc., Nord'est, Marietta Corp, Sampling Dimensions LLC,
Klocke, Rotakon GmbH, Follmann & Co., Manka Creations 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 2004, 2003 and 2002. 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 2004, 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
27% of our net sales in fiscal 2004, 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 and are subject to
foreign laws and regulations and political and economic events.

Approximately 24% of our net sales, including export shipments from the
United States, in fiscal 2004 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 July 31, 2004, approximately 47% of our employees worked under a
collective bargaining agreement that expires on March 31, 2007. While we believe
that our relations with our employees are good, there can be no assurance that
our collective bargaining agreement will

be renewed in the future. A prolonged labor dispute (which 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 60,000 square feet, and its lease expires in August, 2007 with an
option to purchase the facility for $4.2 million. The warehouse facility at 7525
Perryman Court encloses approximately 13,000 square feet and its lease expires
in January, 2005.

We also lease sales offices in New York, New York, Paris, France and
London, England.

ITEM 3. LEGAL PROCEEDINGS

Other than as discussed below, we do not believe that there are any pending
legal proceedings other than ordinary routine litigation incidental to our
business.

The Beautiful Bouquet Company, Ltd. (the "Licensor") filed suit in
Tennessee state court on October 30, 2003 against our Company alleging breaches
of a Patent and Know-How License agreement, as amended (the "License
Agreement"). Under the License Agreement, our Company licenses certain
intellectual property related to one of our products for which we are obligated
to pay the Licensor a royalty based on sales of the product and a minimum annual
royalty. The Licensor alleges our Company committed a number of breaches,
including a breach of the License Agreement and a breach of fiduciary duty owed
to the Licensor, and is seeking to recover unspecified amounts under the terms
of the License Agreement and all amounts due it because of our Company's alleged
unjust enrichment of the Licensor's intellectual property rights.

We believe that we did not breach any provisions of the License Agreement
and intend to vigorously defend ourself.

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

None.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES

There is no established public trading market for AKI's common stock. As of
August 15, 2004, 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, 2004, 2003, 2002, 2001 and 2000 and the years ended June 30, 2004,
2003, 2002, 2001 and 2000 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) 2004 2003 2002 2001 2000
---- ---- ---- ---- ----

Statement of Operations Data:
Net sales $ 133,372 $ 115,308 $ 120,893 $ 115,395 $ 99,811
Cost of goods sold 85,770 73,883 73,888 71,336 61,552
--------- --------- --------- --------- ---------
Gross profit 47,602 41,425 47,005 44,059 38,259
Selling, general and
administrative expenses 20,795 17,971 18,943 18,199 16,980
Amortization of intangibles
including goodwill 1,143 1,143 6,451 5,757 5,336
Gain from settlement, net - - (992) - (858)
--------- --------- --------- --------- ---------
Income from operations 25,664 22,311 22,603 20,103 16,801
Interest expense, net 12,575 12,674 12,528 13,212 13,668
Management fees 400 325 250 250 250
(Gain) from early
retirement of debt (1) - - - (748) (704)
Other, net (105) 33 - - -
Income tax expense 4,418 3,446 5,674 4,950 3,092
--------- --------- --------- --------- ---------
Net income $ 8,376 $ 5,833 $ 4,151 $ 2,439 $ 495
========= ========= ========= ========= =========

Balance Sheet Data (at end
of period):
Cash and cash equivalents $ 1,369 $ 1,470 $ 1,875 $ 4,654 $ 1,158
Working capital 12,643 10,677 11,525 10,288 14,182
Goodwill, net 152,438 152,994 153,277 157,334 162,472
Total assets 212,203 215,547 224,906 213,378 222,050
Senior notes 103,510 103,510 103,510 103,510 107,510
Total debt 105,010 121,635 115,760 104,013 117,859
Total stockholder's equity 84,225 72,090 83,407 85,670 83,526

Other Data:
Capital expenditures $ 1,349 $ 2,345 $ 1,338 $ 3,015 $ 2,782
Ratio of earnings to fixed
charges (2) 2.0x 1.7x 1.8x 1.6x 1.3x
- ------------

(1) Extraordinary gains in fiscal 2001 and 2000 have been reclassed to conform
with current year presentation, in accordance with the provisions of SFAS
145.
(2) For purposes of calculating the ratio of earnings to fixed charges,
"earnings" represent income (loss) before income taxes plus fixed charges.
"Fixed charges" consist of interest on all indebtedness and amortization of
deferred financing costs.

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 our 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.

Fusion Merger

On July 21, 2004, AHC entered into the Fusion Merger Agreement with Fusion,
a newly-formed entity owned by investment funds managed by KKR, and AHC Merger,
Inc., a wholly-owned subsidiary of Fusion formed for the purpose of effecting
the Fusion Merger, pursuant to which AHC Merger will merge with and into AHC
such that AHC will be the surviving corporation and, at the effective time of
the Fusion Merger, will become a wholly-owned subsidiary of Fusion. Immediately
upon the effectiveness of the Fusion Merger, Fusion will contribute AHC to JHC
in exchange for capital stock of JHC. Following the contribution, JHC intends to
contribute AHC to its direct subsidiary, Jostens IH Corp., and as a result AHC
will be a wholly-owned subsidiary of Jostens IH Corp.

Pursuant to the Fusion Merger Agreement, each issued and outstanding share
of AHC's common stock will be cancelled and retired and shall cease to exist,
and no consideration shall be delivered in exchange therefore; and each issued
and outstanding share of AHC's outstanding preferred stock shall be converted
into the right to receive cash merger consideration. The cash merger
consideration payable per share of preferred stock will be determined based upon
a total enterprise value of $250.0 million, as adjusted based upon the working
capital of our Company at closing. Upon consummation of the Fusion Merger and
the contributions, AHC shall be a wholly-owned subsidiary of Jostens IH Corp.

Holdings Inc., Von Hoffmann Corporation, AHC and AKI; (iii) that Jostens IH
Corp. obtains financing for such concurrent transactions on the terms and
conditions set forth in the financing commitment provided by an affiliate of
Credit Suisse First Boston LLC, Banc of America Securities LLC and Deustche Bank
Securities Inc.; and (iv) that Marc Reisch, CEO of Fusion, shall have made an
investment in the common stock of JHC.

In connection with the Fusion Merger and subsequent contribution, we will
refinance our existing credit facility. In addition, upon the consummation of
the contributions, JHC intends to use new financing by Jostens IH Corp. to fund
certain tender payments due to holders of AKI's 10 1/2% Senior Notes due 2008
who elect to tender their notes pursuant to tender offers and consent
solicitations commenced on August 19, 2004.

Results of Operations

Fiscal Year Ended June 30, 2004 Compared to Fiscal Year Ended June 30, 2003

Net Sales. Net sales for the fiscal year ended June 30, 2004 increased
$18.0 million, or 15.6%, to $133.3 million as compared to $115.3 million for the
fiscal year ended June 30, 2003. The increase in net sales was primarily
attributable to an increase in sales of sampling technologies for advertising
and marketing of domestic fragrance products and international cosmetic products
and favorable foreign exchange rates.

Gross Profit. Gross profit for the fiscal year ended June 30, 2004
increased $6.2 million, or 15.0%, to $47.6 million as compared to $41.4 million
for fiscal year ended June 30, 2003. Gross profit as a percentage of net sales
decreased to 35.7% in the fiscal year ended June 30, 2004, from 35.9% in the
fiscal year ended June 30, 2003. The increase in gross profit is primarily due
to the increase in sales volume and favorable foreign exchange rates. The
decrease in gross profit as a percentage of net sales is primarily due to
changes in product and format mix and the reduction in prices of certain
fragrance sampling products in order to maintain and grow market share.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the fiscal year ended June 30, 2004 increased $2.8
million, or 15.6% to $20.8 million as compared to $18.0 million for the fiscal
year ended June 30, 2003. Selling, general and administrative expenses as a
percent of net sales were 15.6% in the fiscal years ended June 30, 2004 and
2003. The increase in selling, general and administrative expenses is primarily
related to an increase in advisory services related to customs and duties
matters and consulting services related to marketing initiatives, incentive
compensation expense, and the impact of foreign exchange rates.

Income from Operations. Income from operations for the fiscal year ended
June 30, 2004 increased $3.4 million, or 15.2%, to $25.7 million as compared to
$22.3 million for the fiscal year ended June 30, 2003. Income from operations as
a percentage of net sales was 19.3% in the fiscal years ended June 30, 2004 and
2003. The increase in income from operations is principally the result of the
factors described above.

Interest Expense. Interest expense for the fiscal year ended June 30, 2004
decreased $0.1 million, or 0.8%, to $12.6 million, as compared to $12.7 million
for the fiscal year ended June 30, 2003. Interest expense as a percentage of net
sales decreased to 9.5% in the fiscal year ended June 30, 2004 from 11.0% in the
fiscal year ended June 30, 2003. The decrease in interest expense, including the
amortization of deferred financing costs, is primarily due to the repayment of
the term loan.

Income Tax Expense. The income tax expense for the fiscal year ended June
30, 2004 increased $1.0 million to $4.4 million as compared to $3.4 million for
the fiscal year ended June 30, 2003. The increase is due to the increase in
income before income taxes and non-deductible expenses principally as a result
of the factors described above.

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 services related to a patent infringement lawsuit
initiated by our Company 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
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.

Income Tax Expense. Income tax expense 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.

Liquidity and Capital Resources

We have substantial indebtedness and significant debt service obligations.
As of June 30, 2004, we had indebtedness in an aggregate amount of $105.0
million (excluding trade payables, accrued liabilities and deferred taxes),
which is a direct obligation of AKI relating to its notes and revolving credit
line. At June 30, 2004, AKI had $23.0 million in accrued liabilities (including
trade payables, accrued liabilities, deferred taxes and other liabilities). As
of July 31, 2004, AKI had outstanding borrowings of $4.0 million under the
revolving loan commitment of the credit agreement.

Borrowings under the revolving credit line are limited to a maximum amount
equal to $20.0 million. At June 30, 2004 and July 31, 2004, AKI had borrowing
availability of approximately $18.2 million and $15.7 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 certain formulas set forth in the credit agreement, 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: (1) pay dividends or make certain restricted payments; (2)
incur additional indebtedness and issue preferred stock; (3) create liens; (4)
incur dividend and other payment restrictions affecting subsidiaries; (5) enter
into mergers, consolidations or sales of all or substantially all of the assets
of our company; (6) enter into certain transactions with affiliates; and (7)
sell certain assets. We were in compliance with all such covenants as of June
30, 2004.

In connection with the Fusion Merger and subsequent contribution, we will
refinance our existing credit facility. In addition, upon the consummation of
the contribution, we intend to use new financing by Jostens IH Corp. to fund
certain tender payments due to holders of AKI's 10 1/2% Senior Notes due 2008
who tender their notes pursuant to the tender offer and consent solicitation
commenced on August 19, 2004. It is a condition to the closing of the Fusion
Merger and the contribution and new financing described above that the notes be
repurchased or redeemed.

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 $14.7 million and $14.2 million for fiscal 2004 and 2003,
respectively, together with borrowings under revolving credit facilities. Net
cash provided by operating activities during fiscal 2004 resulted primarily from
net income before depreciation and amortization and an increase in accounts
payable and accrued expenses, partially offset by increases in accounts
receivable and inventories.

We define Adjusted EBITDA (also referred to as EBITDA in our credit
agreement) as net income or loss plus income and franchise 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 and sale and disposal of fixed assets plus non-
capitalized acquisitions costs. Adjusted EBITDA is not a measure of financial or
operating performance, cash flow or liquidity under accounting principles
generally accepted in the United States 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, 2004, 2003
and 2002 is as follows (dollars in millions):

2004 2003 2002
---- ---- ----

Net income........................ $ 8.4 $ 5.8 $ 4.1

Income and franchise tax
expense......................... 4.7 3.7 5.9
Interest expense.................. 12.6 12.7 12.5
Depreciation and amortization
of goodwill and other
intangibles..................... 7.1 7.3 12.1
Gain from sale and disposal of
fixed assets.................... (0.1) - -
Non-capitalized acquisitions
costs........................... - - 0.2
-------- -------- --------

Adjusted EBITDA................... $ 32.7 $ 29.5 $ 34.8
======== ======== ========

In fiscal 2004 and fiscal 2003, we had capital expenditures of
approximately $1.3 million and $2.3 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, 2004, AHC had outstanding $73.4 million of notes payable to
stockholders which bear interest at approximately 16% per annum and mature on
December 15, 2009, and approximately $133.0 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 outstanding no Debentures 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, 2005 are budgeted
to be approximately $3.0 million. Based on borrowings outstanding (other than
pursuant to the revolving credit agreement) as of June 30, 2004 and borrowings
outstanding under the revolving credit agreement as of July 31, 2004, we expect
total cash payments for debt service in fiscal 2005 to be approximately $11.3
million, consisting of $10.9 million in interest payments on the notes and $0.4
million in interest and fees under the credit agreement. We also expect to make
royalty payments of approximately $1.2 million during fiscal 2005.

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 2005. 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, 2004, AKI's consolidated cash and cash equivalents and net
working capital were $1.4 million and $12.6 million, respectively, representing
a decrease in cash and cash equivalents of $0.1 million and an increase in net
working capital of $2.0 million from June 30, 2003. Account receivables, net, at
June 30, 2004 increased 9.4% or $1.9 million over the June 30, 2003 amount,
primarily due to an increase in fourth quarter sales.

The following table summarizes our contractual obligations and other
contingencies as of June 30, 2004 (dollars in thousands):

Payments due by fiscal year
--------------------------------------------------------------------------------
2005 2006 2007 2008 2009 Thereafter Total
---- ---- ---- ---- ---- ---------- -----

Debt obligations:
Principal................. $ - $ - $ 1,500 $ - $ 103,510 $ - $ 105,010
Interest*................. 11,169 11,169 11,019 10,869 5,435 - 49,661
Standby letter of credit...... - - 87 - - 291 378
Operating leases.............. 1,506 1,502 1,291 756 683 1,728 7,466
Minimum royalties**........... 1,200 1,200 1,200 1,200 1,200 3,206 9,206
Unconditional raw material
purchase obligations.......... 5,804 - - - - - 5,804
Other long-term obligations... 750 - - - - - 750
----------- ----------- ----------- ----------- ----------- ---------- -----------

Total................... $ 20,429 $ 13,871 $ 15,097 $ 12,825 $ 110,828 $ 5,225 $ 178,275
=========== =========== =========== =========== =========== ========== ===========

* Interest for floating rate obligations has been calculated using the
rates in effect as of June 30, 2004.
** Minimum royalties which are subject to consumer price index ("CPI")
adjustment have been calculated based on the CPI as of June 30, 2004.

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.

Off-Balance Sheet Arrangements

As of June 30, 2004 we did not have any significant off-balance sheet
arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.

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 year 2002, while requiring annual tests for impairment of
goodwill. We completed our initial and annual tests of the carrying value of
goodwill all of which resulted in no impairment.

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. We do not anticipate that the provisions of this statement
will have a material impact on our 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 December 15, 2003. Provisions of this
interpretation did not have any material impact on our reported results of
operations, financial position or cash flows.

FASB Statement of Financial Accounting Standards No. 150 "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity" ("SFAS 150") was issued in May 2003. SFAS 150 established guidance for
how certain financial instruments with characteristics of both liabilities and
equity are classified and requires that a financial instrument that is within
its scope be classified as a liability (or as an asset in some circumstances).
SFAS 150 is effective for fiscal years beginning after June 15, 2003. Our
Company has adopted SFAS 150, and it did not have a material impact on our
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 accounting
principles generally accepted in the United States 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. Products are produced to customer specifications
based on purchase orders or signed quotations which include agreed
upon pricing. Product sales, net of estimated discounts and rebates,
are recognized at the time title and risk of ownership transfers upon
delivery to the customer. Products are shipped F.O.B. shipping point
and are not subject to any contractual right of return provisions.

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;
and (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.

We are exposed to market risks from changes in foreign exchange rates. In
fiscal 2004, we generated approximately 24% of our sales, including export
shipments from the United States, 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, 2004, there were no forward
exchange contracts outstanding.

We are exposed to market risk from changes in interest rates. At June 30,
2004 we had $1.5 million outstanding in borrowings under our credit agreement at
variable rates. All of our remaining long-term debt is at fixed interest rates.
We believe that the effect, if any, of reasonably possible near term changes in
interest rates on our consolidated financial position, results of operations or
cash flows would not be significant.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Reference is made to the Consolidated Financial Statements of AKI, the
related notes and the Report of Independent Registered Public Accounting Firm
for 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 AKI as of August 1, 2004.

Name Age Position
- ---- --- --------
William J. Fox * 47 President, Chief Executive Officer, Chairman of
the Board and Director
Kenneth A. Budde 55 Senior Vice President, Chief Financial Officer and
Secretary
A. Bruce Prashker 42 Senior Vice President and Assistant Secretary
David A. Durkin * 35 Director
Douglas B. Fox 56 Director
Hugh R. Kirkpatrick 67 Director
David M. Wittels * 40 Director

* Member of Executive Committee

William J. Fox has served as Chairman, President and Chief Executive
Officer and a Director of AKI 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 LQ Corporation Inc. and a Director nominee of Nephros, Inc. He also serves on
the Advisory Board of Barrington Companies Investors, LLC.

Kenneth A. Budde has served as Chief Financial Officer of AKI 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 AKI since April
2000. Prior to joining our 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.

David A. Durkin has served as a director of AKI since May 2002. Mr. Durkin
has been a Partner of DLJ Merchant Banking since July 2004 and a Principal since
March 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
Merrill Corporation/Merrill Communications LLC, Prometheus Laboratories, Inc.
and Seabulk International, Inc.

Douglas B. Fox has served as a director of the Corporation and as a
director of AKI 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., The Oreck Company and Advanstar
Communications Inc.

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

David M. Wittels has served as a Director of AKI since December 1997. Mr.
Wittels was a Managing Director of DLJ Merchant Banking from January 2001 to
June 2004 and has served in various capacities with DLJ Merchant Banking during
the past six years. Mr. Wittels also serves as a director of Ziff Davis
Holdings, 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 in
fiscal 2000.

Audit Committee and Audit Committee Financial Expert

Since we are not a listed issuer, as defined in Item 401(i) of Regulation
S-K, we do not have an audit committee; our board of directors performs the
functions of an audit committee. For this reason, we have not designated an
audit committee financial expert, as that term is defined by Item 401(h) of
Regulation S-K.

Code of Ethics

We have adopted a conflict of interest policy that applies to all of our
employees, including our senior management and financial officers. For this
reason, we have not adopted a separate code of ethics within the meaning of Item
406 of Regulation S-K.

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 2004 $ 810,000 $ 887,355 -- 10,360
President, Chief Executive Officer, 2003 788,175 491,217 -- 11,091
Chairman of the Board and 2002 775,000 1,190,724 -- 8,545
Director

Kenneth A. Budde 2004 230,000 143,635 -- 8,000
Senior Vice President, Chief 2003 220,500 90,074 8,000 8,000
Financial Officer and Secretary 2002 210,000 121,653 -- 6,800

A. Bruce Prashker 2004 230,000 119,324 -- 8,000
Senior Vice President and Assistant 2003 215,300 75,000 -- 8,000
Secretary 2002 205,000 77,613 -- 6,800

(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

There were no stock options granted during fiscal 2004 to any of the named
executive officers.

Fiscal Year End Option Values

The following table sets forth information about the number and value of
options to purchase AHC common stock held by the named executive officers as of
June 30, 2004. The values of the in-the-money options have been calculated on
the basis of $100 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, 2004 money options at June 30, 2004
------------------------ ------------------------------

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

William J. Fox 8,880 -- -- --
President, Chief Executive Officer,
Chairman of the Board and Director

Kenneth A. Budde 1,640 40 -- --
Senior Vice President, Chief
Financial Officer and Secretary

A. Bruce Prashker 500 -- -- --
Senior Vice President and Assistant
Secretary

Equity-Based Compensation

AHC adopted the 1998 Stock Option Plan for employees and directors of AHC
and any parent or subsidiary 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 16,500
shares of common stock of AHC. The option plan is administered by the Board of
Directors of AHC or a compensation committee to be designated by the Board of
Directors of AHC. 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 $100 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 did not grant any options for shares of capital stock in fiscal 2004
and no options for shares of capital stock of AHC were exercised in fiscal 2004.

In connection with the Fusion Merger, each AHC Stock Option, granted under
the Option Plan, outstanding shall be cancelled and extinguished and no
consideration will be paid thereon.

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 August 1, 2004 the agreement ends on August 1, 2006.

Mr. Fox's base salary is $850,500, 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 $239,775 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, 2005, 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 $241,500. 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
2004. 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, 2004. 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, 2004, 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: (1) base salary which reflects individual performance and expertise,
(2) variable bonus award payable in cash and tie to the achievement of certain
performance goals that the board establishes from time to time and (3) long-term
stock-based incentive award which is designed to strengthen the mutuality of
interests between such executive officer 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 our 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 $100) 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 2004 rose to $810,000 from $788,715 in 2003.
We paid Mr. Fox a cash bonus of $887,355 for fiscal 2004, in comparison to a
cash bonus of $491,217 for fiscal 2003.

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 August 13, 2004 with respect to the
beneficial ownership of AHC common stock by (1) owners of more than 5% of such
AHC common stock, (2) each director and named executive officer of Holding and
(3) all directors and executive officers of Holding, as a group.

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

DLJ Merchant Banking Partners, II, L.P. and affiliated entities (1) 159,211.11 98.8%
William J. Fox (2) 8,880.00 5.2%
Hugh R. Kirkpatrick (2) 50.00 *
David A. Durkin (3) - -
David M. Wittels (4) - -
Douglas B. Fox - -
Kenneth A. Budde (2) 1,640.00 1.0%
A. Bruce Prashker (2) 500.00 *
All directors and executive officers as a group (2) 11,070.00 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 August 5, 2004.

(3) Mr. Durkin 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 Mr. Durkin is Eleven
Madison Avenue, New York, New York 10010.

(4) Mr. Wittels was an officer of DLJ Merchant Banking an affiliate of
DLJMBII.

Equity Compensation Plan Information

The table below sets forth information relating to our compensation plans
as of June 30, 2004:

Number of securities
remaining available
Number of securities for future issuance
to be issued upon Weighted-average under equity
exercises of exercise 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............ 15,272.50 $ 100 1,227.50
Total............................. 15,272.50 100 1,227.50

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

Transactions with DLJMBII and their Affiliates

Mr. Durkin, who is a director of AKI and an officer and director of Holding
and AHC, is an officer of DLJ Merchant Banking. Mr. Wittels, who is a director
of AKI and an officer and director of Holding and AHC, was 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, 2004. This agreement will be extended
automatically for successive terms of one year unless otherwise terminated by
either party within 60 days prior to its expiration. Our Company has agreed to
indemnify CSFB in connection with its actions as our financial advisor.

In connection with the execution of the Fusion Merger Agreement, AHC
entered into a financial advisory fee agreement with DLJMBII pursuant to which
AHC agreed to pay DLJMBII a financial advisory fee of $2,000,000.

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
our Company and AHC. Interest paid to AHC in connection with the promissory note
totaled approximately $21,000, $21,000 and $14,000 for the years ended June 30,
2004, 2003 and 2002, respectively.

Fusion Merger Agreement

On July 21, 2004, AHC entered into the Fusion Merger Agreement with Fusion,
a newly-formed entity owned by investment funds managed by KKR, and AHC Merger,
a wholly-owned subsidiary of Fusion formed for the purpose of effecting the
Fusion Merger, pursuant to which AHC Merger will merger with and into AHC such
that AHC will be the surviving corporation in the Fusion Merger and, at the
effective time of the Fusion Merger, Fusion will contribute AHC to JHC in
exchange for capital stock of JHC. JHC is controlled by DLJ Merchant Banking
III, L.P. and certain of its affiliated funds, each of which is affiliated with
DLJ Merchant Banking Partners II, Inc. and DLJMBII.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Audit Fees

We retained PricewaterhouseCoopers LLP ("PwC") to audit our consolidated
financial statements for fiscal 2004. 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
our 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 PwC during fiscal
2004 and fiscal 2003 for the following services (dollars in thousands):

2004 2003
---- ----

Audit fees................... $ 142 $ 144
Audit-related fees........... - 1
Tax fees..................... 148 178
----------- -----------

Total........................ $ 290 $ 323
=========== ===========

In the above table, in accordance with new SEC definitions and rules,
"audit fees" are fees our 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) Documents filed as a part of the report.

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 Schedules.

The following consolidated financial statement schedule is included
herein:

Schedule II - Valuation and qualifying accounts

(b) Reports on Form 8-K

On July 23, 2004, we filed a Current Report on Form 8-K, including a
press release announcing the execution of the Agreement and Plan of
Merger with Fusion Acquisition LLC.

On August 20, 2004, we filed a Current Report on Form 8-K, including a
press release announcing the Tender Offer and Consent Solicitation for
our 10 1/2% Senior Notes.

2.1 Agreement and Plan of Merger dated as of July 21, 2004 among
Fusion Acquisition LLC, AHC Merger, Inc. and AHC I Acquisition
Corp.
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 between 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 between the Company and Heller Financial, Inc. (7)
10.9 Financial Advisory Agreement dated as of December 12, 1997
between AHC and DLJ. (1)
10.10 Assignment, dated April 27, 2004 from Credit Suisse First Boston
LLC to DLJ Merchant Banking II, Inc. of the Financial Advisory
Agreement dated December 12, 1997.
10.11 Financial Advisory Fee Letter Agreement, dated July 20, 2004 by
and between AHC I Acquisition Corp. and DLJ Merchant Banking II,
Inc.
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. *
32.1 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

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 31st day of August,
2004.

AKI, INC.

(Registrant)

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

Each person whose signature appears below hereby appoints William J. Fox
and Kenneth 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 31st day of August, 2004.

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.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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 income, stockholder's equity and cash flows
and the financial statement schedule listed in the index appearing under Item
15(a)(2) present fairly, in all material respects, the financial position of
AKI, Inc. and Subsidiaries at June 30, 2004 and 2003 and the results of their
operations and their cash flows for each of the three years in the period ended
June 30, 2004 in conformity with accounting principles generally accepted in the
United States of America. In addition, in our opinion, the financial statement
schedule listed in the index appearing under Item 15(a)(2) presents fairly, in
all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. These financial
statements and the financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and the financial statement schedule based on our audits.
We conducted our audits of these statements in accordance with the standards of
the Public Company Accounting Oversight Board (United States). These standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, 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 adopted the provisions of FASB Statement No. 142 "Goodwill and Other
Intangible Assets" in fiscal 2003.

PricewaterhouseCoopers LLP
Knoxville, Tennessee
August 4, 2004

F-1

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,
------------------------------
2004 2003
---- ----

ASSETS
Current assets
Cash and cash equivalents.............................................. $ 1,369 $ 1,470
Accounts receivable, net............................................... 22,169 20,267
Inventory, net......................................................... 9,810 7,265
Income tax receivable.................................................. - 1,011
Prepaid expenses....................................................... 812 671
Deferred income taxes.................................................. 1,004 808
---------- ----------
Total current assets............................................. 35,164 31,492

Property, plant and equipment, net..................................... 12,539 16,584
Goodwill, net ......................................................... 152,438 152,994
Other intangible assets, net........................................... 9,514 11,307
Deferred charges, net.................................................. 2,400 3,032
Other assets........................................................... 148 138
---------- ----------
Total assets..................................................... $ 212,203 $ 215,547
========== ==========

LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Current portion of long-term debt...................................... $ - $ 1,875
Accounts payable, trade................................................ 7,187 5,444
Accrued income taxes................................................... 573 -
Accrued compensation................................................... 5,079 4,333
Accrued interest....................................................... 5,464 5,502
Accrued expenses....................................................... 4,218 3,661
---------- ----------
Total current liabilities........................................ 22,521 20,815

Revolving credit line.................................................. 1,500 10,000
Term loan.............................................................. - 6,250
Senior notes........................................................... 103,510 103,510
Deferred income taxes.................................................. 136 1,142
Other non-current liabilities.......................................... 311 1,740
---------- ----------
Total liabilities................................................ 127,978 143,457

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............................................. 85,667 82,512
Retained earnings ..................................................... 13,249 4,873
Accumulated other comprehensive income................................. 1,039 435
Carryover basis adjustment............................................. (15,730) (15,730)
---------- ----------
Total stockholder's equity....................................... 84,225 72,090
---------- ----------

Total liabilities and stockholder's equity....................... $ 212,203 $ 215,547
========== ==========

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

F-2

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

Year Ended June 30,
----------------------------------------
2004 2003 2002
---- ---- ----

Net sales..................................................... $ 133,372 $ 115,308 $ 120,893
Cost of goods sold............................................ 85,770 73,883 73,888
--------- --------- ---------

Gross profit............................................... 47,602 41,425 47,005

Selling, general and administrative expenses.................. 20,795 17,971 18,943
Amortization of goodwill...................................... - - 4,806
Amortization of other intangible assets....................... 1,143 1,143 1,645
Gain from settlement of purchase price dispute, net........... - - (992)
--------- --------- ---------

Income from operations..................................... 25,664 22,311 22,603

Other expenses (income):
Interest expense........................................... 12,575 12,674 12,528
Management fees to affiliate............................... 400 325 250
(Gain) loss from sale and disposal of fixed assets......... (105) 33 -
--------- --------- ---------

Income before income taxes............................... 12,794 9,279 9,825

Income tax expense ........................................... 4,418 3,446 5,674
--------- --------- ---------

Net income............................................. $ 8,376 $ 5,833 $ 4,151
========= ========= =========

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

F-3

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

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

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 income:
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 income:
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

Capital contribution from
AKI Holding Corp.................. - - 3,155 - - - 3,155
Net income........................... - - - 8,376 - - 8,376
Other comprehensive income:
Foreign currency translation
adjustment...................... - - - - 604 - 604
---------
Comprehensive income................. 8,980
----- ------ --------- --------- --------- ----------- ---------

Balances, June 30, 2004.............. 1,000 $ - $ 85,667 $ 13,249 $ 1,039 $ (15,730) $ 84,225
===== ====== ========= ========= ========= =========== =========

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

F-4

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

Year Ended June 30,
---------------------------------------------
2004 2003 2002
---- ---- ----

Cash flows from operating activities:
Net income............................................................. $ 8,376 $ 5,833 $ 4,151
Adjustment to reconcile net income to net cash provided by
operating activities:
Depreciation ...................................................... 5,159 5,377 5,197
Amortization of goodwill and other intangibles..................... 1,952 1,954 6,899
Amortization of loan closing costs................................. 659 605 617
Deferred income taxes.............................................. (1,202) 80 (1,333)
Gain from sale and disposal of equipment........................... (105) - -
Other.............................................................. (279) 592 472
Changes in operating assets and liabilities:
Accounts receivable.............................................. (1,902) 3,270 (3,177)
Inventory........................................................ (2,545) 749 690
Prepaid expenses, deferred charges and other assets.............. (141) (4) (131)
Accounts payable and accrued expenses............................ 3,008 (1,177) (118)
Income taxes..................................................... 1,584 (3,064) 530
--------- --------- ---------

Net cash provided by operating activities.......................... 14,564 14,215 13,797
--------- --------- ---------

Cash flows from investing activities:
Purchases of equipment................................................. (1,349) (2,345) (1,338)
Proceeds from sale of equipment........................................ 340 - -
Payments for acquisitions, net of cash acquired........................ - - (19,422)
Patents................................................................ (159) (119) (79)
--------- --------- ---------

Net cash used in investing activities.............................. (1,168) (2,464) (20,839)
--------- --------- ---------

Cash flows from financing activities:
Payments under capital leases for equipment............................ - - (503)
Net proceeds (repayments) on revolving loan............................ (8,500) 7,250 2,750
Proceeds (repayments) on term loan, net of repayment of $500 in 2002... (8,125) (1,375) 9,500
Payments of loan closing costs......................................... (27) - (679)
Distribution to parent................................................. - (18,031) (6,805)
Capital contribution from parent....................................... 3,155 - -
---------- --------- ---------

Net cash provided by (used in) financing activities................ (13,497) (12,156) 4,263
---------- --------- ---------

Net decrease in cash and cash equivalents................................ (101) (405) (2,779)
Cash and cash equivalents, beginning of period........................... 1,470 1,875 4,654
---------- --------- ---------
Cash and cash equivalents, end of period................................. $ 1,369 $ 1,470 $ 1,875
========= ========= =========

Supplemental information:
Cash paid during the period for:
Interest to stockholder.............................................. $ 21 $ 21 $ 14
Interest, other...................................................... 11,831 11,950 11,600
Income taxes......................................................... 4,407 6,616 6,857

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

F-5

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, which ends on 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.

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.

Three customers accounted for 41.9% (16.3%, 15.5% and 10.1%) of net
sales during the year ended June 30, 2004. Two customers accounted for
29.7% (15.0% and 14.7%) and 31.3% (18.4% and 12.9%) of net sales during the
years ended June 30, 2003 and June 30, 2002, respectively.

F-6

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 its suppliers. The Company's 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

Products are produced to customer specifications based on purchase
orders or signed quotations which include agreed upon pricing. Product
sales, net of estimated discounts and rebates, are recognized at the time
title and risk of ownership transfers upon delivery to the customer.
Products are shipped F.O.B. shipping point and are not subject to any
contractual right of return provisions. The Company provides for allowances
for doubtful accounts based on its assessment of balances on a specific
basis as well as historical costs.

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.

F-7

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Goodwill

The aggregate purchase price of business acquisitions was allocated to
the assets and liabilities of the acquired companies based on their
respective fair values as of the acquisition dates. Goodwill represents the
excess purchase price paid over the fair value of net identifiable assets
acquired. The cost and accumulated amortization of goodwill was $172,597
and $20,159 at June 30, 2004 and $173,153 and $20,159 at June 30, 2003,
respectively. In accordance with SFAS 142 goodwill is no longer being
amortized effective July 1, 2003. The following pro forma amounts reflect
goodwill amortization and net income had SFAS 142 been implemented at the
beginning of fiscal 2002:

2004 2003 2002
---- ---- ----

Net income as reported....... $ 8,376 $ 5,833 $ 4,151
Goodwill amortization........ - - 4,806
--------- --------- ---------

Pro forma net income......... $ 8,376 $ 5,833 $ 8,957
========= ========= =========

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 set forth in APB 25 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, 2004, 2003 and 2002 would
have been as follows:

2004 2003 2002
---- ---- ----

Net income as reported............ $ 8,376 $ 5,833 $ 4,151
Stock based compensation expense.. 31 35 105
--------- --------- ---------

Pro forma net income.............. $ 8,345 $ 5,798 $ 4,046
========= ========= =========

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-8

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

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,
------------------------------------------------------------------------------------
2004 2003
---------------------------------------- ----------------------------------------
Accumulated Accumulated
Costs Amortization Net Costs Amortization Net
----- ------------ --- ----- ------------ ---

Patents................... $ 8,592 $ 2,096 $ 6,496 $ 8,433 $ 1,286 $ 7,147
Customer lists............ 7,289 4,373 2,916 7,289 3,645 3,644
Covenants not to compete.. 1,375 1,285 90 1,375 1,010 365
Other..................... 694 682 12 694 543 151
-------- --------- --------- -------- --------- ---------
$ 17,950 $ 8,436 $ 9,514 $ 17,791 $ 6,484 $ 11,307
========= ========= ========= ========= ========= =========

Future amortization of other intangible assets is as follows:

2005.................... $ 1,603
2006.................... 1,563
2007.................... 1,551
2008.................... 1,537
2009.................... 809
Thereafter.............. 2,451
---------
$ 9,514
=========

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 $106,357 at June 30, 2004, compared to a carrying value of
$103,510. The carrying value of all other financial instruments
approximated fair value at June 30, 2004.

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
($84), ($44) and $301 for the years ended June 30, 2004, 2003 and 2002,
respectively.

F-9

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Research and Development Expenses

Research and development expenditures consist of salaries and
benefits, occupancy costs, and test materials and related production costs,
and are charged to selling, general and administrative expenses in the
period incurred. Research and development expenses totaled $2,244, $2,137
and $2,061 for the years ended June 30, 2004, 2003 and 2002, 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 its annual
tests of the carrying value of goodwill all of which resulted in no
impairment.

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 obligations undertaken in
issuing the guarantee. The disclosure requirements are effective for
quarters ending after December 15, 2002 and the liability recognition is

F-10

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)

in effect for guarantees initiated after December 31, 2002. Provisions of
this statement did not 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 December 15, 2003. Provisions of this interpretation did not have any
material impact on the Company's reported results of operations, financial
position or cash flows.

FASB Statement of Financial Accounting Standards No. 150 "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities
and Equity" ("SFAS 150") was issued in May 2003. SFAS 150 establishes
guidance for how certain financial instruments with characteristics of both
liabilities and equity are classified and requires that a financial
instrument that is within its scope be classified as a liability (or as an
asset in some circumstances). SFAS 150 is effective for fiscal years
beginning after June 15, 2003. The Company has adopted SFAS 150 and it did
not have a material impact on the Company's reported results of operations,
financial position or cash flows.

3. 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
is not 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:

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
===========

F-11

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)

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.

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,
-------------------------
2004 2003
---- ----

Trade accounts receivable................ $ 22,600 $ 20,633
Allowance for doubtful accounts.......... (573) (557)
---------- ---------
22,027 20,076
Other accounts receivable................ 142 191
---------- ---------

$ 22,169 $ 20,267
========== =========
5. INVENTORY

The following table details the components of inventory:

June 30,
--------------------------
2004 2003
---- ----
Raw materials
Paper.................................. $ 4,003 $ 1,740
Other raw materials. ................. 3,185 2,353
---------- ---------
Total raw materials................. 7,188 4,093
Work in process.......................... 3,517 3,857
Reserve for obsolescence................. (895) (685)
---------- ---------

Total inventory.......................... $ 9,810 $ 7,265
========== =========

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,
2004 or June 30, 2003.

F-12

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

6. PROPERTY, PLANT AND EQUIPMENT

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

Estimated June 30,
Useful Lives 2004 2003
------------ ---- ----

Land............................ $ 258 $ 258
Buildings....................... 7 - 15 years 3,174 2,999
Leasehold improvements.......... 1 - 3 years 754 717
Machinery and equipment......... 5 - 7 years 32,009 33,240
Furniture and fixtures.......... 3 - 5 years 4,554 4,141
Construction in progress........ 337 31
-------- --------
41,086 41,386
Accumulated depreciation........ (28,547) (24,802)
-------- --------
$ 12,539 $ 16,584
======== ========

Depreciation expense amounted to $5,159, $5,377 and $5,197 for the
years ended June 30, 2004, 2003 and 2002, 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 was
to mature 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 accrued at a floating
rate based upon either prime or LIBOR. The term loan was repaid in full in
2004.

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, 2004, the Company's borrowing base was
approximately $26,024. 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% at June 30,
2004 and 2003). The weighted average interest rate on the outstanding
balance under the revolving loan was 5.31%, 6.14% and 6.45% for the years
ended June 30, 2004, 2003 and 2002, 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, 2004. These fees totaled $68,
$76 and $65 for the years ended June 30, 2004, 2003 and 2002, respectively.
The Credit Agreement contains certain financial covenants and other
restrictions including restrictions on additional indebtedness and
restrictions on the payment of dividends.

F-13

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)

8. LOANS PAYABLE TO AHC

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, 2004, no amount was
outstanding under the promissory note. Interest paid to AHC in connection
with the promissory note totaled $21, $21 and $14 for the years ended June
30, 2004, 2003 and 2002, 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 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.

10. INITIAL CAPITALIZATION

In conjunction with the Acquisition, AHC issued $30,000 of Floating
Rate Notes, $50,279 of Mandatorily Redeemable Senior Preferred Stock (the
"Senior Preferred Stock") and $1,111 of its Common Stock. The Floating Rate
Notes were issued with an original issuance discount of $5,389. Interest
was payable quarterly and could be settled through the issuance of
additional Floating Rate Notes through December 15, 2009, the maturity
date, at the discretion of AHC. The original issuance discount of $5,389
was being amortized using the effective interest method over the life of
the Floating Rate Notes. On November 1, 1999 AHC issued Amended and
Restated Notes totaling $35,500 in exchange for the Floating Rate Notes.
The Amended and Restated Notes bear a fixed interest rate of approximately
16% per annum and mature on December 15, 2009 and provide for the payment
of stipulated early redemption premiums. The Senior Preferred Stock
accretes in value at 15% per annum and must be redeemed by December 15,
2012. The Amended and Restated Notes and Senior Preferred Stock are general
unsecured obligations of AHC.

The cash proceeds from the issuance of the Floating Rate Notes, Senior
Preferred Stock and Common Stock of approximately $76,000 and a Senior
Preferred Stock option of $2,363 were contributed by AHC to the Company in
exchange for 1,000 shares of the Company's Common Stock. Subsequent to the
initial capitalization of the Company, AHC contributed $1 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-14

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

Raw Material Purchase Obligations

The Company in the ordinary course of business issues purchase orders
for raw materials with expected delivery ranging from one to three months.
At June 30, 2004 outstanding purchase orders for raw materials totaled
approximately $5.8 million.

Operating Leases

Equipment and office, warehouse and production space under operating
leases expire at various dates. Rent expense was $1,468, $1,293 and $559
for the years ended June 30, 2004, 2003 and 2002, respectively. Future
minimum lease payments under the leases are as follows:

2005......... $ 1,506
2006......... 1,502
2007......... 1,291
2008......... 756
2009......... 683
Thereafter... 1,728
-----------
$ 7,466
===========

Royalty Agreements

Royalty agreements are maintained for certain technologies used in the
manufacture of certain products. Under the terms of one royalty agreement,
payments by the Company 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 $565, $669 and $500 under
this agreement for the years ended June 30, 2004, 2003 and 2002,
respectively. The Company has paid $7,294 in cumulative royalty payments
under this agreement through June 30, 2004.

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, 2004.

Employee Agreements

The Company has employment and salary continuation agreements with
certain executive officers with terms through June 30, 2005 and 2006. Such
agreements provide for base salaries totaling $1,332 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-15

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)

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 date of
change of control.

Litigation

The Beautiful Bouquet Company, Ltd. (the "Licensor") filed suit
against the Company alleging breaches of a Patent and Know-How License
agreement, as amended (the "License Agreement"). Under the License
Agreement, the Company licenses certain intellectual property related to
one of the Company's products for which the Company is obligated to pay the
Licensor a royalty based on sales of the product and a minimum annual
royalty. The Licensor alleges the Company committed a number of breaches,
including a breach of the License Agreement and a breach of fiduciary duty
owed to the Licensor, and is seeking to recover unspecified amounts under
the terms of the License Agreement and all amounts due it under the
Company's unjust enrichment of the Licensor's intellectual property rights.

The Company believes that it did not breach any provision of the
License Agreement and intends to vigorously defend against its claims.

The Company is a party to other 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.

Value Added Tax Assessment

The French tax authorities have asserted that the Company's foreign
subsidiary has failed to properly collect value added taxes ("VAT") from
its French customers. The assertion is based on the classification of the
Company's products as advertising services and not goods, which are taxed
differently. The Company has historically collected VAT from its customers
on the basis of selling goods which classification had previously been
agreed to in audits by the French tax authorities. While the amount of
uncollected VAT would be substantial if a change in classification of such
goods is required, such amounts could be billable and input VAT to our
customers and therefore reclaimable from the tax authorities. An estimate
of this contingent loss, if any, for this asserted claim by the French tax
authorities, is not possible at this time. The Company believes the range
of such claim by the tax authorities, before considering reclaims
available, is approximately $600 to $2,700.

Printing Services Agreement

In connection with the RetCom Holdings, Ltd. ("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, 2004 was approximately $857.

F-16

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

12. RETIREMENT PLANS

A 401(k) defined contribution plan (the "Plan") is maintained for
substantially all full-time salaried employees 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 $418, $424 and $323 for the years ended
June 30, 2004, 2003 and 2002, 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 $258,
$245 and $221 for the years ended June 30, 2004, 2003 and 2002,
respectively.

13. INCOME TAXES

The Company is included in the consolidated federal income tax return
filed by AHC. Income taxes related to the Company are determined on a
separate entity basis. The Company files separate state income tax returns
and calculates its state tax provision on a separate company basis. Any
income taxes payable or receivable by the consolidated group are settled or
received by the Company.

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

Year Ended June 30,
-----------------------------------
2004 2003 2002
---- ---- ----

Income before income taxes:
United States............ $ 10,390 $ 7,578 $ 7,683
Foreign.................. 2,404 1,701 2,142
--------- --------- ---------

$ 12,794 $ 9,279 $ 9,825
========= ========= =========

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

Year Ended June 30,
-----------------------------------
2004 2003 2002
---- ---- ----

Current expense:
Federal..................... $ 4,205 $ 2,408 $ 5,003
Foreign..................... 867 613 1,042
State....................... 548 345 962
--------- --------- ---------
5,620 3,366 7,007
--------- --------- ---------

Deferred expense (benefit):
Federal..................... (1,013) 42 (1,247)
Foreign..................... - - -
State....................... (189) 38 (86)
--------- --------- ---------
(1,202) 80 (1,333)
--------- --------- ---------

$ 4,418 $ 3,446 $ 5,674
========= ========= =========

F-16

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

13. INCOME TAXES (Continued)

The significant components of deferred tax assets and (liabilities) at
June 30, 2004 and 2003, were as follows:

June 30,
-----------------------------------------------------------
2004 2003
--------------------------- --------------------------
Current Noncurrent Current Noncurrent
------- ---------- ------- ----------

Deferred income tax assets:
Accrued expenses..................... $ 450 $ - $ 376 $ -
Allowance for doubtful accounts...... 219 - 213 -
Reserve for inventory obsolescence... 335 - 219 -
Amortization of intangibles.......... - 1,136 - 879
--------- ---------- --------- ----------
1,004 1,136 808 879
Deferred income tax liability:
Property, plant and equipment........ - (1,272) - (2,021)
--------- ---------- --------- ----------

Deferred tax assets (liabilities).. $ 1,004 $ (136) $ 808 $ (1,142)
========= ========== ========= ==========

The income tax provision recognized by the Company for the years ended
June 30, 2004, 2003 and 2002 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,
--------------------------------------------
2004 2003 2002
---- ---- ----

Computed tax provision at the
statutory rate................................. $ 4,350 $ 3,155 $ 3,439
State income tax provision, net of
federal effect................................. 237 253 570
Net nondeductible expenses....................... 21 32 1,373
Extraterritorial income exclusion................ (204) (86) -
Other, net....................................... 14 92 292
--------- --------- ---------

$ 4,418 $ 3,446 $ 5,674
========= ========= =========

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 $100 per share. Options vest over periods ranging from one to eight
years. Certain options are eligible for accelerated vesting based on
targeted EBITDA. Targeted 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.

F-18

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

14. STOCK OPTIONS (Continued)

In 2004 AHC amended its certificate of incorporation which resulted in
a 100 for 1 reverse stock split of its common stock.

A summary of AHC stock option activity and related information for the
years ended June 30, 2004, 2003 and 2002 follows:

2004 2003 2002
------------------------ ------------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------- ----- ------- ----- ------- -----

Outstanding, beginning of year..... 15,322.50 $ 100 1,469,050 $ 1.00 1,464,850 $ 1.00
Granted....................... - 100 96,000 1.00 21,000 1.00
Exercised..................... - - - - - -
Forfeited..................... (50.00) 100 (32,800) 1.00 (16,800) 1.00
------------- ------ --------- ------- --------- -------

Outstanding, end of year........... 15,272.50 $ 100 1,532,250 $ 1.00 1,469,050 $ 1.00
========= ====== ========= ======= ========= =======

Exercisable, end of year........... 14,717.50 $ 100 1,436,073 $ 1.00 1,106,343 $ 1.00
========= ====== ========= ======= ========= =======

Weighted average remaining
contractual life................... 5.7 years 6.7 years 7.5 years

In connection with the Merger described in footnote 18, each AHC Stock
Option, granted under the Option Plan, outstanding shall be cancelled and
extinguished and no consideration will be paid thereon.

15. RELATED PARTY TRANSACTIONS

The Company made payments to an affiliate of DLJMBII for management
fees of $400, $325 and $250 for the years ended June 30, 2004, 2003 and
2002, respectively.

16. GEOGRAPHIC INFORMATION

The Company operates in one segment, the production of interactive
sampling systems for the fragrance, cosmetic, personal care and other
consumer products industries.

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

United
States France Total
------ ------ -----
Net sales:
Year ended June 30, 2002....... $ 103,138 $ 17,755 $ 120,893
Year ended June 30, 2003....... 99,757 15,551 115,308
Year ended June 30, 2004....... 113,131 20,241 133,372

Long-lived assets:
Year ended June 30, 2002....... $ 189,754 $ 82 $ 189,836
Year ended June 30, 2003....... 183,949 106 184,055
Year ended June 30, 2004....... 176,918 121 177,039

F-19

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)

17. UNAUDITED QUARTERLY RESULTS OF OPERATIONS

The following is a summary of the unaudited quarterly results of
operations for Fiscal 2004 and Fiscal 2003.

Quarter Ended Quarter Ended Quarter Ended Quarter Ended
September 30, December 31, March 31, June 30,
Fiscal 2004 2003 2003 2004 2004 Total
---- ---- ---- ---- -----

Net sales................ $ 37,258 $ 32,616 $ 35,803 $ 27,695 $ 133,372
Gross profit............. 13,723 10,333 13,632 9,914 47,602
Income from operations... 8,752 4,668 7,616 4,628 25,664
Interest expense, net.... 3,214 3,238 3,149 2,974 12,575
Net income............... 3,331 827 2,682 1,536 8,376

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............... 2,257 1,633 1,437 506 5,833

18. SUBSEQUENT EVENT

On July 21, 2004, AHC entered into an agreement and plan of merger
(the "Merger Agreement") with Fusion Acquisition LLC ("Fusion"), an entity
affiliated with Kohlberg Kravis Roberts & Co. The Merger Agreement
contemplates that a subsidiary of Fusion will merge with and into AHC (the
"Merger"), and AHC will continue as the surviving entity and will be a
wholly owned subsidiary of Fusion. The completion of the merger is subject
to several conditions including, among other things, the conclusion of
certain other concurrent transactions ("Concurrent Transactions") involving
other companies affiliated with DLJMB, the repayment, repurchase or
redemption of certain indebtedness and preferred stock of AKI, AHC and the
other companies party to the Concurrent Transaction, and an investment in
common stock by the CEO of Fusion. Upon completion of the Concurrent
Transactions DLJMB will indirectly own 45% of AHC.

F-20

AKI, INC. AND SUBSIDIARIES
SCHEDULE II. VALUATION AND QUALIFYING ACCOUNTS
(in thousands)

Charged
Balances at Charged to (Credited) to Balance at
Beginning of Cost and Other End of
Period Expenses Accounts Deductions(1) Period
------ -------- -------- ------------- ------

Allowance for doubtful accounts,
deducted from accounts receivable
in the balance sheet

Year ended June 20, 2004............... $ 557 $ - $ 17 $ 1 $ 573
Year ended June 30, 2003............... 608 - 14 65 557
Year ended June 30, 2002............... 836 180 (11) 397 608

(1) Amounts represent write-off accounts.

Charged
Balances at Charged to (Credited) to Balance at
Beginning of Cost and Other End of
Period Expenses Accounts Deductions Period
------ -------- -------- ---------- ------

Obsolescence reserve, deducted
from inventory in the balance sheet

Year ended June 20, 2004............... $ 685 $ 332 $ - $ 122 $ 895
Year ended June 30, 2003............... 850 157 - 322 685
Year ended June 30, 2002............... 763 37 200 150 850