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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 Form 10-K (Mark One) þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the year ended December 31, 2004oro
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from              
                      to
 Commission file number 333-40076 Knowles Electronics Holdings, Inc. (Exact name of registrant as specified in its charter)
 DELAWARE
    
    36-2270096(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification Number)1151 Maplewood Drive,
    
    60143Itasca, Illinois
    
    (Zip Code)(Address of principal executive offices)
 Registrants telephone number, including area code:
630-250-5100 Securities registered pursuant to Section 12(b) of the Act: Title of Each Class
    
    Name of Each Exchange on Which RegisteredNone
 Securities registered pursuant to Section 12(g) of the Act: Title of Each Class
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. Yes þ No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be
contained, to the best of the 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. o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Act). Yes o No þ There is no voting stock held by non-affiliates of the registrant. This Annual Report is
being filed by the registrant as a result of undertakings made pursuant to Section 15(d) of the
Securities Exchange Act of 1934.




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KNOWLES ELECTRONICS HOLDINGS, INC. FORM 10-K
Year Ended December 31, 2004 CONTENTS Section
    
    PagePART IItem 1 Business
    
    
    3Item 2 Properties
    
    
    10Item 3 Legal Matters
    
    
    10Item 4 Submission of Matters to a Vote of Security Holders
    
    
    10PART IIItem 5 Market for Registrants Common Equity and Related Stockholder Matters
    
    
    11Item 6 Selected Consolidated Financial Data
    
    
    11Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 7A Quantitative and Qualitative Disclosures about Market Risk
    
    
    34Item 8 Financial Statements and Supplementary Data
    
    
    37Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    66Item 9A Control and Procedures
    
    
    66PART IIIItem 10 Directors and Executive Officers
    
    
    67Item 11 Executive Compensation
    
    
    69Item 12 Security Ownership of Certain Beneficial Owners and Management
    
    
    73Item 13 Certain Relationships and Related Transactions
    
    
    75Item 14 Principal Accounting Fees and Services
    
    
    76PART IVItem 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K
    
    
    76Signatures
    
    
    782004 Stock Option PlanAmendment to Credit AgreementCalculation of Ratio of Earnings to Fixed ChargesSubsidiariesCertification of Chief Executive OfficerCertification of Chief Financial Officer
 2




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PART I 
 Item 1.Business Overview We are a leading international manufacturer of technologically advanced products in
micro-acoustics. Since our company was founded in 1946 by Hugh and Josephine Knowles, we have
leveraged our core competency in acoustic technology to build expertise in hearing aid transducers,
electromechanical components, low voltage integrated circuit design, micro-electrical mechanical
systems (MEMS) and precision manufacturing. We have operations around the world with the largest
facilities in the United States, China and Malaysia. During 2003, we sold our SSPI and Ruwido
(Infrared) businesses, and in 2002 we sold Ruf Electronics allowing us to concentrate on our core
Micro-acoustics business. Our 2004 results from continuing operations reflect revenue, operating
income and EBITDA, of $186.0 million, $34 million and $42 million, respectively. We manufacture
and market micro-acoustic products with strong market share positions in several key markets,
including the hearing aid market. In December 2002 we introduced the worlds first silicon
microphone, which gained commercial viability in 2003 and was accepted as an important new
component from a number of major cellphone manufacturers in 2004, reflecting its considerable
opportunity for growth beyond our traditional markets. We believe that we have achieved these
positions in our markets as a result of our strong customer base, technological expertise,
international low cost manufacturing capability and capable management team. Our principal
executive offices are located at 1151 Maplewood Drive, Itasca, Illinois 60143, and our telephone
number is (630) 250-5100. Products Knowles develops, manufactures, and supplies audio communications components, primarily
miniaturized microphones and receivers used in hearing aids, microphones, headsets, and accessories
for the computer and communication industries. The Company is the worlds largest manufacturer of
high quality transducers, which are used for hearing aid and other high quality applications. We
estimate our market share to be above 75% of the worldwide market for these sophisticated products,
and have held a major share of the transducer market for over 30 years. The transducer is the name
given to both the microphone and the receiver in a hearing aid and other acoustic products that
require the accurate and controlled amplification of sound. The microphone converts surrounding
sounds to electronic signals. Circuitry then modifies the signal over the audio frequency spectrum.
These signals are transferred to the receiver, which then converts the signals to sound. Knowles
often customizes transducers to meet the specifications of our customers, and in certain cases
develops transducer designs in partnership with our customers. We have consistently and
successfully maintained our market share over the years due to our long-standing relationships with
a wide range of customers, value-added services and technological leadership. Knowles also provides a number of additional micro-acoustic devices that benefit from the
companys core competency in technology, design and manufacturing of subminiature acoustic products
for applications outside the hearing aid industry. The companys capabilities in MEMS (Micro
Electro Mechanical Systems), software, and high volume electronic components make Knowles uniquely
qualified to provide value added solutions for growth markets such as mobile communications and
consumer electronics. We produce and develop a range of microphones, speakers, software, and custom
acoustic assemblies primarily for sale to original equipment manufacturers in these markets.
Products developed for these markets include the worlds first Silicon Microphones, ECMs (electret
condenser microphones), and Custom microphone assemblies. Knowles also uses its knowledge of the hearing aid market, its engineering strengths and
manufacturing expertise in the production of electromechanical components used in hearing aids
including switches, trimmers, volume controls and telecoils. Competitive Strengths Our strong market position is attributable to the following competitive strengths:  Leading International Market Position and Strong Customer Base  
    We have been a market leader in micro-acoustic transducers for the hearing aid industry
for more than 30 years, and our worldwide market share of high quality transducers for
hearing aid applications is above 75%. We protect our leading market share by maintaining
strong relationships with all of the key manufacturers that require high quality transducers
including 3




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hearing aid manufacturers, pro-audio manufacturers, manufacturers of security products and
medical device manufacturers. We offer transducers for all categories and often customize
models to meet the specifications of manufacturers.  Technological Expertise  
    We believe that we are a technological leader in each of our products. We offer an
advanced transducer product line that covers a variety of technologies, applications and
markets including the most comprehensive product offering to the hearing aid industry and
our recent introduction of a MEMS-based surface mount silicon microphone. The Company has
been setting the standard for both miniaturization and performance as a technology leader in
the transducer market for hearing aids for over 30 years. We are also at the forefront of
the development of MEMS (micro electro mechanical systems) products as a result of our
semiconductor knowledge and our 50 years of experience in acoustics. We believe that we are
the first microphone maker to commercially manufacture a MEMS-based surface mount silicon microphone.  
    To enhance our technological expertise, we emphasize research and development investment.
Our 2004 research and development expenditures were $11.1 million, or 6.0% of net sales. We
have demonstrated leadership in developing new technologies and have the scale to devote
substantial resources toward product development. In addition, we have strategically
established patent protection for our products while creating manufacturing processes that
competitors cannot readily replicate.  International Low Cost Manufacturing Capability  
    Since our founding more than 50 years ago, we have developed an international network of
well-equipped manufacturing facilities. We operate 5 manufacturing facilities in the United
States, Malaysia and China. We have a proven capability of moving manufacturing to lower
cost environments. Our manufacturing facilities are not unionized. In March 2000, we
announced plans to consolidate our worldwide manufacturing operations. The consolidation
plan included outsourcing some activities performed in our U.S. operation and ceasing
production in the United Kingdom and Taiwan. Production from those operations was moved to
China and Malaysia. In December 2003 we announced the closure of our Elgin, Illinois
facility, which was completed in September 2004. The majority of manufacturing activity was
transferred from Elgin to our locations in China and Malaysia, which were expanded to
accommodate the additional volume. Certain high value operations were consolidated into our
headquarters facility in Itasca, Illinois. Our manufacturing operations operate at high
quality levels while maintaining cost effectiveness.  
    The manufacturing life cycles of some transducers, particularly models for less
technologically advanced applications, have been as long as 25 years, reducing our
production development costs and allowing us to improve the efficiency of our manufacturing
processes. In general, we use automated sub-assembly operations and manual final assembly
operations. For low volume products, we employ subcontractors, which provide us with cost
structure flexibility and allow us to change capacity quickly based on product demand. Growth Strategy We set the standard for engineering excellence in our markets. Our principal objective is to
increase revenues, cash flow and profitability by strengthening our leading market positions in our
existing products in this core business and applying our technological expertise to new growth
opportunities in related products and markets. The primary components of our strategy are to:  Capitalize on Growth Opportunities in the Hearing Aid Market Our worldwide share of the hearing aid transducer market is above 75% and we have been a
market leader in transducer technology for over 30 years. We believe we will increase our sales as
the hearing aid industry continues to expand. Hearing aid penetration into the market of potential
users has historically been low, ranging from approximately 22% in the United States to less than
1% in some emerging economies. The hearing aid industry is projected to grow based on the following
trends:  
    Advances in the technology of hearings aids, leading to better customer satisfaction
    Improvement in the cosmetic appearance of hearing aids
    Growth in the elderly population 4




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
    Increases in the sale of binaural hearing aids
    Increases in the international penetration of hearing aids into developing economies Our strategy is designed to capitalize on these trends and develop products designed to expand
the hearing aid and hearing aid component market. For example, we have developed transducers for
directional hearing aids, which provide better performance than single microphone hearing aids and
require three or more, rather than two, transducers per hearing aid. To increase hearing aid market
growth, we also collect market data that identifies consumer needs and work with industry
participants to improve market penetration.  Develop non-hearing aid Markets for transducers In addition to hearing aids, our transducers are used in pro-audio, broadcast and radio
communications, and medical devices. We are expanding our product offering and using our
application engineering expertise to solve customer needs in all of these growing markets that
require high quality micro-acoustic solutions.  Penetrate High Volume Markets with
SiSonic(TM)Silicon Microphone We have introduced and begun to sell the worlds first high volume silicon surface mount
microphone. This microphones environmental robustness enables it to perform in harsh environments
such as automobiles. Since the SiSonic(TM) Silicon Microphone can withstand high temperatures, it
can be mounted to printed circuit boards using pick and place soldering equipment, thereby
eliminating costly manual installations currently required for many microphone applications. It is
ideal for high volume applications like mobile phones.  Leverage Core Acoustic Expertise to Develop Additional Innovative Products for Markets with
High Growth Potential We expect to continue combining our core competency in acoustics with other technologies such
as MEMS and analog and digital electronics to provide technology solutions for high growth markets,
including mobile communications and consumer electronics. We have developed several new
technologies and products for these markets including: Intellisonic(TM)
Far-Field Microphone Software To support emerging markets such as
interactive video on demand and voice over internet protocol (VOIP) via portable devices, we have
developed a signal processing software to enable clear processing of voice signals in a noisy
environment, such as an automobile or within large crowds. This technology will facilitate clear
voice communications and differentiate between audio inputs, an important feature in these growing
markets. Custom Acoustic Assemblies we continue to introduce new acoustic assemblies, built to
customer specification on an OEM basis. Examples of these are headsets produced for call center,
cellular phone accessory, and PC markets.  Strengthen Customer Relationships We have well-established customer relationships. We plan to continue to strengthen our
existing relationships and develop new relationships through the following.  
    Customizing the design of transducer models to meet the specifications of individual
hearing aid manufacturers. We also conduct joint research and product development with
selected customers.
    Continuing to expand our geographical presence around the world in order to better serve
the increasing demand for micro-acoustical products from OEM electronics manufacturers.  Maintain Low Cost and High Quality Manufacturing Leadership We believe that we are the lowest cost producer of hearing aid quality micro-acoustic
transducers due to our significant market share, our relatively large volumes, our effective
sourcing processes and our successful transfer of production to lower cost areas. We have more than
25 years of experience operating on a worldwide scale. During this time, we have developed
manufacturing and management systems that allow us to operate low cost offshore facilities without
compromising either quality or level of service.With the completion of our restructuring efforts
in 2004, nearly all of our manufacturing activity is located in China and Malaysia, which allows us
to benefit from both their lower cost labor markets, and proximity to emerging product markets. 5




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Products Microphones.We have leveraged our microphone technology to create the widest selection of
subminiature microphones that we supply to original equipment manufacturers for a diverse set of
applications. Our offering of microphones include: Silicon microphone, low cost electrets, worlds
smallest microphone, ultra low noise microphones, low vibration microphones, noise canceling
microphones, and waterproof microphones. Applications for our products include hearing aids, mobile
phones, PDAs, tablets, cellular headsets, monitors, military, radio communications, and sensors. Receivers/Speakers.We manufacture the largest offering of balanced armature
receivers/speakers used in hearing aids, pro-audio, broadcast and radio communications, and medical
devices. We are expanding our offering in high-end consumer electronics applications such as high
fidelity MP3 earphones and cellular accessories. Custom Acoustic Assemblies.We manufacture (on an OEM basis) a variety of wired/noise
canceling headsets used in general telephony markets such as mobile accessories and computer
telephony applications, including internet based telephony and voice recognition. The company also
markets boom-mounted microphones for use in conference rooms, helmets, aerospace and civil/military
communications; condenser microphones assemblies for laptop computers, wireless phones and modem
accessories; computer monitor microphones and lapel microphones. Software.We are developing and marketing a broad line of software products to improve the
quality of the speech signal prior to transmission. Software under development includes: acoustic
echo cancellation, noise suppression, interference canceling, and beam forming. These technologies
can be used separately or together with one or more microphones (in an array) to enhance the user
experience in applications where the user is not positioned close to the microphone and competing
noises degrade voice quality. Electromechanical Controls.We have developed a broad line of electromechanical controls for
hearing aid manufacturers including trimmers, switches, volume controls and connectors. Building on
our strong customer relationships in transducers, our engineering capability in hearing aid
components and our strength in low cost manufacturing, we expect these products will provide us
with significant growth. Research and Development Our 2004 research and development expenditures were $11.1 million, or 6.0% of net sales. We
have a team of 107 scientists, engineers and technicians located primarily in Itasca, Illinois,
Taiwan and Suzhou, China. Research and development efforts for transducers, micro-electro
mechanical systems for the production of silicon microphones, signal processing technology and far
field microphone technology are conducted in the United States and China. Custom acoustic assembly
and microphone product development are conducted in Taiwan. In 2004, we focused our research and
development activities in two key areas. First, we are intensely focused on providing the best
technology in the world in high quality transducers for all applications. Secondly, we are carrying
out extensive research and development on producing and expanding our product portfolio in silicon
microphones using the micro machining of silicon (also referred to as micro-electro mechanical
systems), MEMS packaging and integration of additional electronic functionality. We believe that our ability to rapidly develop new transducers with superior performance is
critical to sustaining our market share and margins. Applied research and advanced modeling lead to
new and creative products, which we believe gives us a competitive advantage as manufacturers who
use micro-acoustic technology look to us for improvements in their components. New transducer products and improvements recently introduced include receivers with improved
maximum power output and reduced vibration sensitivity using our unique and innovative Pantograph
design; significantly reduced vibration with magnetic shield outer housing; and screenless damping
using Ferrofluid(R). Microphone improvements that have recently been introduced include a
analog/digital (A/D) signal converter, programmable digitally controlled gain amplifier, conjoined
ultra-thin microphone pairs, noise reduction, improved electrostatic discharge thresholds and
significantly reduced cellular telephone interference. Our research and development focus on the silicon microphone in 2004 allowed us to continue to
transition this highly innovative product from design concept to the production quantities
required from high volume markets such as cellphones and MP3 players. We believe that we have a
leading position in this application of micro-electro mechanical systems. Additional research and
development activities will focus on expanding the functionality of the Sisonic product to meet and
exceed customer requirements and expand the applications to a wider market place. 6




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Manufacturing We operate from five manufacturing facilities in the United States, Malaysia and China. We
believe that our facilities meet our present needs and that our properties are generally well
maintained and suitable for their intended uses. We believe that we generally have sufficient
capacity to satisfy the demand for our products in the foreseeable future. We periodically evaluate
the composition of our various manufacturing facilities in light of current and expected market
conditions and demand. Prior to the closure of our Elgin, Illinois facility at the end of 2004, we
expanded our operations with additional facilities in our Penang, Malaysia and Suzhou, China
locations. These new facilities added approximately 55,000 square feet of assembly capacity and
25,000 square feet of metal fabrication capacity. In
November 2003 we announced the closure of our Elgin,
Illinois facility that was closed in September 2004. Certain high value manufacturing operations
were consolidated from Elgin into our headquarters facility in Itasca, Illinois with the balance of
manufacturing operations transferred to our locations in China and Malaysia, which were expanded to
accommodate the additional activity. Our manufacturing operations operate at the highest quality
levels and we believe our costs are significantly lower than our competitors. After the completion of our restructuring actions, our production space will be approximately
80% utilized. Our transducer manufacturing facilities are ISO 9001:2000 certified. Our
manufacturing processes are comprised of both automated and manual assembly operations. Capacity
can be increased as demand increases. Sales and Marketing Sales and marketing efforts are organized to reflect the different markets of our customers.
We serve the hearing aid industry through the 23 people in our direct sales group, which operates
from offices in Illinois, United Kingdom and Japan. An independent sales representative covers
Australia. Pricing of transducer products are based on a volume/price grid in which volume
discounts are provided based on actual purchases. From time to time, we reduce prices to meet
competition. See Managements Discussion and Analysis of Financial Condition and Results of
Operations. The markets for electro-acoustical products from the military, medical, professional audio,
and OEM electronics manufacturers are sold through a direct sales force of 31 people and
independent sales representatives. This sales force and independent sales representatives are
located in the United States, Mexico, United Kingdom, Germany, France, Japan, Taiwan, China, Korea,
and Australia. Customers We are the principal transducer supplier worldwide to the major hearing aid manufacturers that
include GN Resound, Interton, Oticon, Phonak, Rion, Siemens, Sonic Innovations, Starkey
Laboratories and Widex; medical device manufactures; pro-audio manufacturers; and manufacturers of
micro-acoustic devices. In 2004, we had three customers that each represented more than ten percent
of our consolidated sales. As a group, these three customers represented 47 percent of our
consolidated sales. Competition We have held a major share of the transducer market for hearing aids for over 30 years,
holding an estimated worldwide market share of above 75% in 2004. Our principal competitor is
SonionMicrotronic, which we believe had a significant portion of the remaining market share in
2004. SonionMicrotronic generally prices their products below our pricing levels, but the
difference in prices has moderated with the increase in the value of the Euro compared to the U.S.
Dollar since 2002. The markets for micro-acoustic products outside the hearing aid industry are highly
competitive and in many cases highly fragmented. We compete with many companies using various
technologies in these markets, generally on the basis of technological expertise, price, product
quality, reliability and on-time delivery. These competitors include large consumer electronics,
communications equipment and acoustic component product companies as well as a number of smaller
specialized companies. 7




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Patents, Copyrights and Trademarks Intellectual property is a valuable and important asset to the Company. As a matter of
practice, we follow a program of filing patent applications for all new design and development
concepts as soon as practical, subject to review for patentability, technical and commercial
feasibility. We currently have approximately 170 patents issued in 15 countries around the world.
In addition, we have more than 80 patent applications pending, reflecting our high level of focused
activity on improving key areas of micro-acoustic technology. In addition to patents, we have more approximately 140 trademarks registrations and pending
applications for registration in 25 countries around the world and 8 registered domain names for
Internet web sites. We have five registered copyrights, as well as a number of unregistered copyrights in our
original works of authorship. In addition, we have in excess of 100 unregistered trade names used
to identify our products and a number of trade secret processes used to design and manufacture our
products. There can be no assurance that our patents and other intellectual property rights will protect
us from competition or be of commercial benefit. In addition, patents by their nature are of
limited duration, and several of our patents will expire during the next few years. Employees We had 2,921 employees as of December 31, 2004. Of these, approximately 70% were direct
production employees and 30% were staff. Geographically, 249 of our employees are based in North
America, 27 in Europe and 2,645 are based in Asia. None of our employees belongs to a labor union.
We have good relationships with our employees and turnover is relatively low. Environmental Matters Our facilities, like similar manufacturing facilities, are subject to a range of stringent
environmental laws and regulations, including those relating to air emissions, wastewater
discharges, the handling and disposal of solid and hazardous waste, and the remediation of
contamination associated with the current and historic use of hazardous substances or materials.
Based on the information available to us, environmental laws currently in force and the advice and
assessment of our environmental consultants, we do not consider that we have any material
environmental liabilities or failures to comply with applicable environmental laws. Regulation Hearing aid manufacturers are subject to a variety of regulatory agency requirements in the
United States and in various other countries in which they sell hearing aids. Manufacturers of
hearing aids are subject to the United States Food, Drug, and Cosmetic Act and other federal
statutes and regulations governing, among other things, the design, manufacture, testing, safety,
labeling, storage, record keeping, reporting, approval, advertising and promotion of medical
devices. Sales of hearing aids outside the United States are also subject to regulatory requirements
that vary from country to country. Similar requirements to those in place in the United States are
imposed on hearing aid manufacturers by the European Union. All hearing aid manufacturers are
required to obtain quality assurance certifications for their components to sell their products in
the European Union. Accordingly, we maintain ISO 9001:2000 quality assurance certifications, which
subject our operations to periodic surveillance audits. INDUSTRY We apply our acoustic technology capabilities in several markets including: Hearing Aids Hearing aids have three basic internal components: a microphone, signal processing and
amplification circuitry, and a receiver. The microphone is located at the top of the hearing aid
and converts surrounding sounds to electronic signals. The circuitry then modifies the signal over
the audio frequency spectrum. These signals are transferred to the receiver, which then converts
the signals to sounds in the ear. The transducer is the name given to both the microphone and the
receiver. Transducers are critical to the 8




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performance capabilities of any hearing aid. Without high performance transducers, the
processing capabilities of hearing devices are ineffective. The overall market for hearing aids continued to grow in 2004, continuing the improvement seen
in the second half of 2003. The United States is currently the worlds largest market for hearing
aids. Hearing aid sales increased approximately 4% in the U.S in 2004, with a strong increase in
the first half of the year followed by a more moderate growth in the second half, according to the
Hearing Industries Association, an industry trade group. The increased demand is caused by a
combination of factors, including an improved economic outlook, technological advances in hearing
aids, and a growing population in the target market. In the longer term, a number of significant factors are expected to increase the demand for
hearing aids including:  
    Technological advances.Advances in recent years have increased consumer satisfaction by
decreasing the size and improving the performance of hearing aids. The development of
programmable, digital and multiple microphone devices, greater applicability of computer
software, increased use of high technology circuitry, enhanced performance in noisy
environments and improved hearing aid casings are expected to further improve product
performance and increase consumer satisfaction.
    Fitting and after sales care.Improved fitting of hearing aids, both physically and
audiologically, is an important factor affecting growth of the hearing aid market.
Dispensers are improving after-sales care of patients and their hearing aids, including
personal visits to older clients, which promises to improve customer satisfaction with
hearing aids.
    Improvement in cosmetic appearance.Through technological advances, some higher priced
hearing aids have become so small that they are virtually invisible, although occlusion or
blockage in connection with their use must be managed.
    Growing elderly population.30% of the population over the age of 65 has historically
had a hearing loss problem. The 2000 U.S. Census indicated that 35 million people were age
65 or older. The U.S. Census Bureau also projects that the population age 65 or older will
be 39.7 million people in 2010, and five years later in 2015, 46 million.
    Greater use of binaural hearing aids.Clinical data has demonstrated that the use of
binaural hearing aids (i.e., two hearing aids per user) benefits individuals with a hearing
loss in both ears. Increased use of binaural hearing aids would result in more transducer
sales (four or more per hearing aid user instead of two). The increased use of binaural
hearing aids represents a special opportunity in Europe, where the use of binaural is
significantly lower than in the United States.
    Undiagnosed hearing loss.Approximately 10% of the U.S. population has some form of
hearing loss, and a relatively high proportion of this population is either unaware of their
hearing loss since it has occurred gradually over time or has not sought medical advice.
There are considerable opportunities to increase sales to this group by educating them on
the signs of hearing loss and encouraging them to visit physicians who can diagnose the
hearing loss and recommend purchase of a hearing aid. The development of a systematic program of routine hearing screening could also lead to
significantly more referrals for treatment.  
    International penetration.  -According to industry studies, approximately 10% of the
population could benefit from hearing aids. In developed countries, 20% of the people who
could benefit from hearing aids own them. In developing countries, the percentage of
hearing aid ownership is far lower.Since two-thirds of the worldwide population over 65
will be in developing countries by 2025, there are substantial opportunities for increased
use of hearing aids in developing economies such as China, India and Eastern Europe,
especially as disposable incomes rise. Mobile Communications Mobile communication devices continue to expand in prevalence world wide, with over 600
million mobile phones sold in 2004,with a constant upgrade of features and capabilities driving an
increase in demand. Many of the services have new voice-driven communications applications, thus
requiring vendors with high volume manufacturing, significant acoustic application support and a
broad line of voice input solutions. We are well positioned to capitalize on this market by selling
key products to original equipment manufacturers including Silicon microphones, ECMs, custom
assemblies and software for elimination of ambient noise. 9




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High End Consumer Electronics We manufacture the largest offering of balanced armature receiver/speakers used in pro-audio,
broadcast and radio communications. The market for high fidelity audio continues to expand through
new technology (MP3 players, cellular accessories, etc.) and greater consumer demand for high
fidelity mobile applications. Security Applications We manufacture a variety of high quality boom-mounted microphones and customer acoustic
assemblies for use in helmets, aerospace and civil/military communications that require high
quality audio response. Medical Devices We manufacture a variety of high quality audio products that are successfully used in
manufacturing medical devices that apply high quality micro-acoustic capabilities to several
medical applications. 
 Item 2. Properties PROPERTIES Owned/
    
    
    Lease
    
    
    AreaLocation
    
    Usage
    
    
    Leased
    
    
    Expiration
    
    
    (Square feet)USElgin, IL (1)
    
    Closed
    
    Owned
    
    
    
    
    
    
    71,800Itasca, IL
    
    Hdqtrs.
    
    Owned
    
    
    
    
    
    
    60,900132,700EUROPEBurgess Hill, UK
    
    Sales
    
    Leased
    
    
    3/31/2016
    
    
    
    15,000ASIA (2)Suzhou, China (329 Suhong)
    
    Mfg.
    
    Leased
    
    
    11/30/2014
    
    
    
    83,700Suzhou, China (37 Bldg.)
    
    Mfg.
    
    Leased
    
    
    7/31/2009
    
    
    
    40,200Tokyo, Japan
    
    Sales
    
    Leased
    
    
    3/15/2005
    
    
    
    600Penang, Malaysia (3)
    
    Mfg.
    
    Owned
    
    
    
    
    
    
    57,500Penang, Malaysia
    
    Mfg.
    
    Leased
    
    
    9/30/2006
    
    
    
    35,000Penang, Malaysia
    
    Distrib.
    
    Leased
    
    
    9/30/2007
    
    
    
    7,000Weifang, China (4)
    
    Mfg.
    
    Leased
    
    
    9/30/2005
    
    
    
    32,900Taipei, Taiwan
    
    Sales
    
    Leased
    
    
    11/30/2005
    
    
    
    13,200270,100GRAND TOTAL
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    417,800
   (1)
    
    This facility is closed and for sale.(2)
    
    The Company has signed a prelease agreement for a 170,000 sq.ft. Facility in Suzhou, China for
occupancy in late 2005.(3)
    
    Land lease expires 09/18/2049(4)
    
    The Company has signed a lease on a new 68,000 sq.ft. facility in Wiefang to replace the current
facility. 
 Item 3.Legal Matters The Company has no material pending or threatened litigation. 
 Item 4.Submission of Matters to a Vote of Security Holders Not applicable. 10




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##### Table of Contents



PART II 
 Item 5. Market for
Registrants Common Equity and Related Stockholder Matters Not applicable. 
 Item 6.Selected Consolidated Financial Data 2000 (9)
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004Statement of Operations Data:
    
(restated)Net sales
    
    $
    184,573
    
    
    $
    173,116
    
    
    $
    164,119
    
    
    $
    154,042
    
    
    $
    185,511Costs and expenses:Cost of sales (1)
    
    
    101,553
    
    
    
    90,705
    
    
    
    87,970
    
    
    
    75,594
    
    
    
    100,684Research and development
    
    
    11,753
    
    
    
    12,845
    
    
    
    11,735
    
    
    
    10,225
    
    
    
    11,141Selling and administrative expense
    
    
    28,450
    
    
    
    34,420
    
    
    
    30,981
    
    
    
    29,732
    
    
    
    33,413Impairment of assets held for sale (2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    850Loss on sale of business (3)
    
    
    
    
    
    
    
    
    
    
    16,736
    
    
    
    
    
    
    
    Restructuring expenses (4)
    
    
    14,858
    
    
    
    (179
    )
    
    
    2,112
    
    
    
    1,532
    
    
    
    5,326Operating income
    
    $
    27,959
    
    
    $
    35,325
    
    
    $
    14,585
    
    
    $
    36,959
    
    
    $
    34,097Interest income
    
    
    941
    
    
    
    139
    
    
    
    129
    
    
    
    111
    
    
    
    57Interest expense
    
    
    (43,292
    )
    
    
    (37,666
    )
    
    
    (33,891
    )
    
    
    (34,735
    )
    
    
    (33,790
    )Loss on extinguishment of debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,100
    )
    
    
    (2,256
    )Income (loss) from continuing operations
before income taxes
    
    
    (14,392
    )
    
    
    (2,202
    )
    
    
    (19,177
    )
    
    
    1,235
    
    
    
    (1,892
    )Income tax
expense (benefit)
    
    
    (1,580
    )
    
    
    6,313
    
    
    
    11,744
    
    
    
    491
    
    
    
    2,873Income(loss) from continuing operations
    
    
    (12,812
    )
    
    
    (8,515
    )
    
    
    (30,921
    )
    
    
    744
    
    
    
    (4,765
    )Income (loss) from discontinued operations after income taxes:Loss on sale of Infrared division
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,576
    )
    
    
    Gain on sale of Synchro-Start division
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35,570
    
    
    
    Income (loss) from discontinued operations (5)
    
    
    7,667
    
    
    
    7,036
    
    
    
    6,545
    
    
    
    932
    
    
    
    Income from discontinued operations after income taxes
    
    
    7,667
    
    
    
    7,036
    
    
    
    6,545
    
    
    
    27,926
    
    
    
    Net income (loss)
    
    $
    (5,145
    )
    
    $
    (1,479
    )
    
    $
    (24,376
    )
    
    $
    28,670
    
    
    $
    (4,765
    )Other Financial Data:Depreciation
    
    $
    10,613
    
    
    $
    11,693
    
    
    $
    8,703
    
    
    $
    7,443
    
    
    $
    8,300Capital expenditures
    
    
    16,151
    
    
    
    21,276
    
    
    
    8,427
    
    
    
    14,776
    
    
    
    19,143Cash flows from operating activities (6)
    
    
    22,835
    
    
    
    9,816
    
    
    
    29,679
    
    
    
    11,111
    
    
    
    6,859Cash flows from investing activities
    
    
    (15,488
    )
    
    
    (17,614
    )
    
    
    (4,867
    )
    
    
    30,469
    
    
    
    (17,143
    )Cash flows from financing activities
    
    
    (12,160
    )
    
    
    (6,152
    )
    
    
    (3,563
    )
    
    
    (54,201
    )
    
    
    15,995EBITDA from continuing operations (7)
    
    
    38,572
    
    
    
    47,018
    
    
    
    23,288
    
    
    
    44,402
    
    
    
    42,397Ratio of earnings to fixed charges (8)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.0x
    
    
    
    Balance Sheet Data:Cash and cash equivalents
    
    $
    16,292
    
    
    $
    2,029
    
    
    $
    23,879
    
    
    $
    11,227
    
    
    $
    16,970Total assets
    
    
    193,867
    
    
    
    179,992
    
    
    
    150,839
    
    
    
    112,573
    
    
    
    138,074Long term debt including current maturities
    
    
    348,807
    
    
    
    339,773
    
    
    
    339,622
    
    
    
    288,180
    
    
    
    307,793Preferred stock mandatorily redeemable
in 2019
    
    
    213,675
    
    
    
    235,042
    
    
    
    258,547
    
    
    
    284,401
    
    
    
    312,842Total common stockholders deficit
    
    
    (442,507
    )
    
    
    (465,780
    )
    
    
    (518,151
    )
    
    
    (512,375
    )
    
    
    (546,360
    )
 11




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##### Table of Contents



See accompanying notes.   (1)
    
    During the fourth quarter of 2001, the Company changed its method of determining the cost
of domestic inventories from the LIFO method to the FIFO method. Prior year results have
been restated to reflect the retroactive application of this tax accounting change; 2000
results were decreased by $1,011.(2)
    
    The Impairment of assets held for sale for 2004 is the charge to reduce the carrying
value of the Elgin, Illinois facility to its estimated fair value
less cost to sell. See Consolidated Financial Statement Footnote
11.(3)
    
    In November 2002 the Company sold its Ruf Electronics operations, which were part of the
Automotive Components segment, and recorded a loss of $16,736. The loss includes $1,186
transferred from accumulated other comprehensive income. The proceeds from the sale were not
material.(4)
    
    The Restructuring expenses for the year 2000 through 2002 are related to the
restructuring announced in March 2000. The Company consolidated its worldwide manufacturing
operations by ending production at five manufacturing facilities and either outsourcing
component production or moving final assembly to lower cost locations in Malaysia, China and
Hungary. Through December 2002, these actions reduced our global workforce by about 20%.
The restructuring expense in 2003 and 2004 is primarily related to the closure of our Elgin,
Illinois facility announced in November 2003.(5)
    
    Net income from discontinued operations in 1999 thru 2003 represents the activities of
the Synchro-Start and Infrared businesses sold during 2003. Years 2000 through 2002 have
been restated to reflect these discontinued operations.(6)
    
    Represents total cash flow from continuing and discontinued operations.(7)
    
    EBITDA from continuing operations is defined as earnings before interest, taxes,
depreciation and amortization; and for the years 2004 and 2003 loss on extinguishment of debt and for
the years 2000 through 2003 income from discontinued operations after income taxes. EBITDA
should not be construed as an alternative to operating income, or net income, as determined
in accordance with GAAP, as an indicator of our operating performance, or as an alternative
to cash flows generated by operating, investing and financing activities. EBITDA is
presented solely as a supplemental disclosure because we believe that it is a widely used
measure of operating performance and because of debt covenants based on a defined EBITDA.
Because EBITDA is not calculated under GAAP, it may not be comparable to similarly titled
measures reported by other companies.Reconciliation of net income to EBITDA: 2000(restated)
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004Net income (loss)
    
    $
    (5,145
    )
    
    $
    (1,479
    )
    
    $
    (24,376
    )
    
    $
    28,670
    
    
    $
    (4,765
    )Depreciation
    
    
    10,613
    
    
    
    11,693
    
    
    
    8,703
    
    
    
    7,443
    
    
    
    8,300Interest expense, net
    
    
    42,351
    
    
    
    37,527
    
    
    
    33,762
    
    
    
    34,624
    
    
    
    33,733Income tax
expense (benefit)
    
    
    (1,580
    )
    
    
    6,313
    
    
    
    11,744
    
    
    
    491
    
    
    
    2,873Loss on extinguishment of debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,100
    
    
    
    2,256Income from discontinued
operations after income
taxes
    
    
    (7,667
    )
    
    
    (7,036
    )
    
    
    (6,545
    )
    
    
    (27,926
    )
    
    
    EBITDA from continuing operations
    
    $
    38,572
    
    
    $
    47,018
    
    
    $
    23,288
    
    
    $
    44,402
    
    
    $
    42,397
  (8)
    The ratio of earnings to fixed charges has been computed by dividing earnings available
for fixed charges (income from continuing operations before income taxes and fixed charges)
by fixed charges interest expense plus one-third of rental expense (the portion deemed
representative of the interest factor). Knowles earnings were inadequate to cover fixed
charges for the twelve months ended December 31, 2000, 2001, 2002 and 2004 by approximately
$14.4, $2.2 $19.2 and $1.9 million, respectively. In 2003, the Companys earnings exceeded
fixed charges by $1.2 million. 12




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##### Table of Contents



(9)
    The results for 2000 have been restated to correct an error in the balance of Other
Comprehensive Income resulting from the conversion to a new consolidation system in 2000.
The error incorrectly recorded a translation loss as an adjustment to equity rather than an
adjustment to the income statement and was primarily related to the U.K. entity. The
correction increased cost of sales in 2000 by $1,578. Appropriate balance sheet accounts
have also been restated. See Consolidated Financial Statement Footnote 2. 
 Item 7.Managements Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the Selected Consolidated
Financial Data and our consolidated financial statements and the related notes included elsewhere
in this report on Form 10-K. Overview We are a leading international manufacturer of technologically advanced microacoustic
products. Since we were founded in 1946, we have leveraged our core competence in acoustic
technology to build expertise in hearing aid transducer and low voltage integrated circuit design,
electronic controls and precision manufacturing in the United States and other countries. We have
numerous international operations with our largest facilities in the United States, China and
Malaysia. We are strongly focused on reducing costs while simultaneously increasing quality. See
Part I  Business Description for more details. The Company divested its non-core businesses during 2002 and 2003 and is now focused on its
core microacoustics business. On July 29, 2003 the Company completed the sale of its Ruwido Austria
GmbH subsidiary, whose operations made up the Infrared division, to FM Electronic Holdings. On May
30, 2003 the Company completed the sale of its Synchro-Start division to Woodward Governor Company.
In November 2002 the Company sold Ruf Electronics, a manufacturer of automotive sensors and
controls. The financial statements for the periods through December 31, 2003 have been prepared
with Ruwido and Synchro-Start accounted for as discontinued operations under Generally Accepted
Accounting Principles (GAAP). Accordingly, the Synchro-Start and Ruwido businesses have been
removed from the Companys results of continuing operations for all periods presented through 2003.
The sale of Ruf is not accounted for as a discontinued operation under GAAP, but is included in the
period up to its sale in November 2002 as component of continuing operations. With the sale of
these three business units, the Company has focused its product offering in one business segment 
Microacoustics. For more detail on the divestitures, see Consolidated Financial Statements Footnote
3, Discontinued Operations. The Company is highly leveraged as a result of its 1999 recapitalization. During 2004, the
Company increased its debt by replacing the $35 million of C Facility debt with
$48 million of D Facility debt, at significantly lower interest rates. As of December 2004, the
Company had $9 million of short-term debt and notes payable of $299 million. On December 20, 2004
the Company entered into a new unsecured credit agreement with Xerion Partners II Master Fund
Limited (Xerion) and other lenders for additional borrowings for up to $10 million. No borrowing
was outstanding under this agreement as of December 31, 2004. No principal payments are due in the
next twelve months. The Company is required to maintain certain leverage and interest coverage
ratios in order to be in compliance with its Credit Agreement covenants and to access its revolving
credit facility. The Company was in compliance with its leverage and interest coverage ratios and
its other covenant requirements as of December 31, 2004 and expects to be in compliance through
December 31, 2005. For more detail, see the Liquidity and Capital resources section below. Our 2004 revenue, operating income and EBITDA were $185.5 million, $34.1 million and $42.4
million, respectively. Our 2003 EBITDA (defined in Item 6. Selected Consolidated Financial Data,
Footnote 7) was $44.4 million. Sales increased by $31.5 million in the twelve months ending December 31, 2004 because of
increases in the sale of transducers in both the hearing aid and non hearing aid applications,
including increases in the sale of the Sisonic microphone, and increases in the sale of
electromechanical components to the hearing aid industry. Gross margin rates declined by 5.2
percentage points in 2004 primarily due to the costs of establishing production of the Sisonic
microphone. Operating expenses increased by $4.7 million primarily due to the increased research
and development and sales and marketing expenses associated with Sisonic. The Company reported
restructuring expenses of $5.3 million in 2004 and $1.5 million in 2003, primarily costs related to
the closure of our Elgin, Illinois facility. Operating income decreased by $2.9 million in 2004,
due to the increased restructuring expenses. The Company reported a $2.3 million loss on the
extinguishment of debt in 2004, due to expenses related to the extinguishment of the C Facility
debt. The Companys key performance indicator is EBITDA, which decreased by $2.0 million in 2004
due to the increased restructuring expenses. For more detail, see the Consolidated Results from
Operations, below. 13




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##### Table of Contents



Key Line Items in the Income statement Net sales.We recognize sales when title to the products transfers to the customer, which
typically is upon the shipment of products to the customers, and when collectability is reasonably
assured. Growth in net sales for transducers is generally driven by growth in the market for hearing
aids and to a lesser extent by the market for high quality micro-acoustic products in the security,
medical and professional audio markets. There has been growing price competition in the market for
hearing aid components over the last several years. Unit volumes increased significantly in the
worldwide market for hearing aids in the second half of 2003 and the first half of 2004. Net sales for microacoustic devices other than transducers have been driven by the emergence
of new markets for acoustic technologies and our penetration of those markets. These markets have
been growing substantially due to technological advances in and increased penetration of mobile
communication devices, high-end consumer electronics, security applications, medical device
manufacturers and a variety of specialty applications that require high performance acoustic
performance. We realized a major milestone in December, 2002 with what we believe was the first
commercial shipment of the worlds first surface mount microphone, based on semiconductor
technology. In 2003 we refined this innovative product and developed manufacturing methods that
allowed us to ship the Silicon Microphone into markets such as cell phones in commercial
quantities. In 2004, we moved production of the Silicon Microphone to China, and successfully
produced and shipped more than 25 million microphones, primarily for cellphone applications. Cost of sales.Our cost of sales consists mainly of materials, direct and indirect labor
costs and other overhead. Other overhead includes depreciation, equipment and tooling maintenance,
shipping and manufacturing supplies. Indirect labor payroll expense and production overhead expense
make up the largest component of cost of sales. Materials makes up the next largest and direct
labor payroll expense is the smallest component of cost of sales. Depreciation is included as an
expense in the line item that corresponds to the asset being depreciated (i.e.manufacturing
facilities are depreciated in cost of sales, headquarter facilities are depreciated in general and
administrative expense).About 63% of our depreciation expense in 2004 and 57% of depreciation
expense in 2003 is reflected in cost of sales. A semi-skilled workforce performs most of our direct labor. Therefore, we have emphasized
moving manufacturing to lower wage locations, including China and Malaysia. In March 2000, we
announced plans, which we executed in 2000 and 2001 to consolidate our worldwide manufacturing
operations, with a strong focus on Asia. We outsourced manufacturing activities previously
performed at our Itasca and Rolling Meadows, Illinois facilities and ceased production at our
manufacturing facilities in the United Kingdom and Taiwan. During 2004, we transferred most of the
manufacturing activity from our Elgin, Illinois facility to our locations in China and Malaysia.
The Elgin facility was closed at the end of September 2004. Our material costs primarily relate to unprocessed materials, including steel, copper wire,
and magnet bar stock. We purchase certain integrated circuits, magnets and diaphragm assemblies
customized specifically for its products from outside suppliers, some of which are single sourced.
Our materials costs generally relate to similar unprocessed materials or commodities. Research and development.Research and development costs consist mainly of personnel cost,
facilities and contract costs. The principal purpose of our research and development efforts is to
strengthen our product offering, provide technical expertise to our customers and to provide new
products for growth markets. Sales and marketing expense.Our sales and marketing expenses consist of personnel costs,
advertising, market research and occupancy expenses. Our selling expenses have not been a
significant portion of our period expenses, but are increasing due to our expansion in markets
beyond the hearing aid industry, which requires additional sales and product management
infrastructure to support future growth. We sell most of our products to original equipment
manufacturers and distributors, through internal sales forces and outside sales agents. General and administrative expense.Our general and administrative expenses consist of
personnel costs, legal, accounting and other professional costs, management information systems and
rent. We have replaced certain management information systems, requiring expenditures of
approximately $11 million from 2000 through 2003. All locations now are integrated into the Companys ERP system. 14




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##### Table of Contents



Other income (expense).Other income (expense) consists of interest income, interest
expense and loss on extinguishment of debt. Due to our recapitalization, interest expense was $33.8 million
in 2004, $34.7 million in 2003 and $33.9 million in 2002.
We recorded a loss on extinguishment of debt in 2004 of $2.3 million, including a
write-off of deferred finance charges and prepayment penalty, and in
2003 of $1.1 million to write-off deferred finance charges. Income taxes.Effective June 30, 1999, Knowles became a C corporation and subsequently, has
been subject to federal income taxes. In 2002 the Company provided for $11.7 million of taxes
despite a pre-tax loss of $19.2 million primarily due to providing a valuation allowance against
the net U.S. deferred income tax assets. The valuation allowance was recorded due to the
uncertainty of realizing the benefit of deferred tax assets as a result of continued U.S. losses
created by the significant interest expense associated with the Companys debt. Income taxes in
2003 were an expense of $0.5 million, with taxes on profitable foreign operations partially offset
by a favorable adjustment to the valuation adjustment against the U.S. deferred tax asset. In 2004,
the taxes were an expense of $2.9 million, primarily due to the taxes on profitable foreign
operations. Foreign exchange exposure.Our revenues are primarily denominated in the U.S. dollar. To a
much lesser degree we also have revenues billed in the Japanese Yen and the British Pound. Our
expenses are principally denominated in those currencies, but are also denominated in the local
currencies of China, Malaysia, and Taiwan. We do not hedge our foreign exchange exposure, since we
generally incur significant costs in the same currencies in which we have sales. China has had a
managed floating exchange rate since 1994 and the exchange rate to the U.S. Dollar has been
effectively fixed since 1996. Malaysia has practiced a fixed exchange rate regime since 1998 and
the exchange rate to the U.S. Dollar has been effectively fixed since then. An increase in the
value of the Chinese or Malaysia currency relative to the U.S. Dollar would have an adverse effect
on the Companys cost of sales. Consolidated Results of
Operations The table below shows the principal line items from our historical consolidated income statements.
For the twelve months ending December 31, 2002 and the consolidated results are shown with and
without the Ruf business, which was sold in November 2002. 12 months
    
    
    12 months
    
    
    12 monthsending
    
    
    ending
    
    
    ending12/31/04
    
    
    12/31/03
    
    
    12/31/02
    
    
    12/31/02
    
    
    12/31/02Consolidated$millions
    
    Consolidated
    
    
    Consolidated
    
    
    Consolidated
    
    
    Ruf
    
    excluding RufSales
    
    $
    185.5
    
    
    $
    154.0
    
    
    $
    164.1
    
    
    $
    14.2
    
    
    $
    149.9Cost of sales
    
    
    100.7
    
    
    
    75.6
    
    
    
    88.0
    
    
    
    10.6
    
    
    
    77.4Gross margin
    
    
    84.8
    
    
    
    78.4
    
    
    
    76.1
    
    
    
    3.6
    
    
    
    72.5Gross margin %
    
    
    45.7
    %
    
    
    50.9
    %
    
    
    46.4
    %
    
    
    25.4
    %
    
    
    48.4
    %Research and development
    
    
    11.1
    
    
    
    10.2
    
    
    
    11.7
    
    
    
    1.7
    
    
    
    10.0Sales and marketing
    
    
    12.0
    
    
    
    9.2
    
    
    
    9.5
    
    
    
    1.0
    
    
    
    8.5General and administrative
    
    
    21.5
    
    
    
    20.5
    
    
    
    21.5
    
    
    
    2.2
    
    
    
    19.3Loss on sale of business
    
    
    
    
    
    
    
    
    
    
    16.7
    
    
    
    16.7
    
    
    
    Restructuring expenses
    
    
    5.3
    
    
    
    1.5
    
    
    
    2.1
    
    
    
    
    
    
    
    2.1Impairment of assets held for sale
    
    
    0.8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating income (loss) from continuing operations
    
    $
    34.1
    
    
    $
    37.0
    
    
    $
    14.6
    
    
    $
    (18.0
    )
    
    $
    32.6Interest expense, net
    
    
    33.7
    
    
    
    34.7
    
    
    
    33.8
    
    
    
    
    
    
    
    33.8Loss on extinguishment of debt
    
    
    2.3
    
    
    
    1.1
    
    
    
    
    
    
    
    
    
    
    
    Income (loss) from continuing operations, before tax
    
    $
    (1.9
    )
    
    $
    1.2
    
    
    $
    (19.2
    )
    
    $
    (18.0
    )
    
    $
    (1.2
    )EBITDA from continuing operations
    
    $
    42.4
    
    
    $
    44.4
    
    
    $
    23.3
    
    
    $
    (17.5
    )
    
    $
    40.8
 15




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##### Table of Contents



Key Changes in 2004 Sales increased by $31.5 million in 2004 compared to the year earlier due to increases in sale
of transducers for hearing aid and pro-audio applications, increased sales of the silicon
microphone and increased sales of electromechanical devices to the hearing aid market. Gross margins as a percentage of revenue in 2004 decreased by 5.2 percentage points due to the
start-up and production costs associated with the silicon microphone. Restructuring expenses of $5.3 million in 2004 and $1.5 million in 2003 were expenses related
to the Companys transfer of manufacturing from its Elgin Illinois facility to facilities in China
and Malaysia. The Elgin facility was closed at the end of September, 2004. Restructuring expenses
in 2002 of $2.1 million included a $1.2 million loss on the sale of a facility in Taiwan and
severance expenses. Operating income decreased by $2.9 million in 2004, due to the increased restructuring
expenses and increased marketing expenses associated with the silicon
microphone, partially offset by a higher gross margin. Interest expense decreased by $0.9 million in 2004, primarily due to lower interest rates
partially offset by increased borrowing levels. The Company recorded a loss on extinguishment of debt of $2.3 million in 2004 related to
prepayment fees and the write-off of deferred charges associated with the C Facility debt, as the
$35 million in C Facility debt was replaced with $48 million in D Facility debt at more favorable
interest rates. Income from continuing operations before tax decreased by $3.1 million, due to the loss on the
extinguishment of debt and the increased restructuring expenses. EBITDA
deceased from $44.4 million in 2003 to $42.4 in 2004 primarily due to the increased restructuring
expenses. For more detail on results of operations, see the section below, Year Ended December 31, 2004
Compared to Year Ended December 31, 2003. 16




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##### Table of Contents



12 months
    
    
    12 months
    
    
    12 monthsending
    
    
    ending
    
    
    ending12/31/04
    
    
    12/31/03
    
    
    12/31/02
    
    
    12/31/02
    
    
    12/31/02Consolidated% of revenue
    
    Consolidated
    
    
    Consolidated
    
    
    Consolidated
    
    
    Ruf
    
    
    excluding RufSales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    54.3
    %
    
    
    49.1
    %
    
    
    53.6
    %
    
    
    74.6
    %
    
    
    51.6
    %Gross margin
    
    
    45.7
    %
    
    
    50.9
    %
    
    
    46.4
    %
    
    
    25.4
    %
    
    
    48.4
    %Research and development
    
    
    6.0
    %
    
    
    6.6
    %
    
    
    7.1
    %
    
    
    12.0
    %
    
    
    6.7
    %Sales and marketing
    
    
    6.4
    %
    
    
    6.0
    %
    
    
    5.8
    %
    
    
    7.0
    %
    
    
    5.7
    %General and administrative
    
    
    11.6
    %
    
    
    13.3
    %
    
    
    13.1
    %
    
    
    15.5
    %
    
    
    12.9
    %Loss on sale of business
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    10.2
    %
    
    
    117.6
    %
    
    
    0.0
    %Restructuring expenses
    
    
    2.9
    %
    
    
    1.0
    %
    
    
    1.3
    %
    
    
    0.0
    %
    
    
    1.4
    %Impairment of assets held for sale
    
    
    0.4
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Operating income (loss) from continuing operations
    
    
    18.4
    %
    
    
    24.0
    %
    
    
    8.9
    %
    
    
    -126.8
    %
    
    
    21.7
    %Interest expense, net
    
    
    18.2
    %
    
    
    22.5
    %
    
    
    20.6
    %
    
    
    0.0
    %
    
    
    22.5
    %Loss on extinguishment of debt
    
    
    1.2
    %
    
    
    0.7
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Income (loss) from continuing operations, before tax
    
    
    -1.0
    %
    
    
    0.8
    %
    
    
    -11.7
    %
    
    
    -126.8
    %
    
    
    -0.8
    %EBITDA from continuing operations
    
    
    22.9
    %
    
    
    28.8
    %
    
    
    14.2
    %
    
    
    -123.2
    %
    
    
    27.2
    %
 Operating income was 18.4% in 2004 compared to 24.0% in 2003 and 21.7% in 2002 excluding Ruf.
EBITDA was 22.9% in 2004 compared to 28.8% in 2003 and 27.2% in 2002 excluding Ruf. The decline in profitability as a percentage of sales in 2004 was due to the startup costs and
manufacturing costs associated with the silicon microphone and the increased restructuring
expenses. The increase in 2003 over the prior year was due to increased sales of transducers and
electromechanical products; improved gross margin rates created by improved manufacturing
efficiencies; improved inventory controls and reduced costs of warranty. Year Ended December 31, 2004 Compared to Year Ended December 31, 2003 12 month sending
    
    
    $ change
    
    
    % changefrom prior
    
    
    from prior$ millions
    
    12/31/2004
    
    
    12/31/2003
    
    
    year
    
    
    yearConsolidated sales
    
    $
    185.5
    
    
    $
    154.0
    
    
    $
    31.5
    
    
    
    20.5
    %
 Consolidated net sales increased by 20.5% in 2004 compared to 2003 due to the increase in
sales of transducers to the hearing aid industry, the increase in sales of transducers to
non-hearing aid manufacturers, the increase in sales of the silicon microphone. and the increase in
sales of Deltek brand electromechanical components. 17




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##### Table of Contents



The following table sets forth cost of sales and cost of sales as a percent of net sales. $ change
    
    
    % change12 months ending
    
    
    from prior
    
    
    from prior$ millions
    
    12/31/2004
    
    
    12/31/2003
    
    
    year
    
    
    yearConsolidated cost of sales
    
    $
    100.7
    
    
    $
    75.6
    
    
    $
    25.1
    
    
    
    33.2
    %% of net sales
    
    
    54.3
    %
    
    
    49.1
    %
 Consolidated cost of sales as a percentage of net sales increased by 5.2 percentage
points due to the startup and manufacturing costs associated with the silicon microphone. 18




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##### Table of Contents



The following table sets forth net income for the twelve months ending 2004 compared to the
year earlier period: 12 months
    
    
    12 monthsending
    
    
    ending12/31/04
    
    
    12/31/03
    
    
    Increase/(decrease)$millions
    
    Consolidated
    
    
    Consolidated
    
    
    $s
    
    
    %Sales
    
    $
    185.5
    
    
    $
    154.0
    
    
    $
    31.5
    
    
    
    20.5
    %Cost of sales
    
    
    100.7
    
    
    
    75.6
    
    
    
    25.1
    
    
    
    33.2
    %Gross margin
    
    
    84.8
    
    
    
    78.4
    
    
    
    6.4
    
    
    
    0.1Gross margin %
    
    
    45.7
    %
    
    
    50.9
    %Research and development
    
    
    11.1
    
    
    
    10.2
    
    
    
    0.9
    
    
    
    0.1Sales and marketing
    
    
    12.0
    
    
    
    9.2
    
    
    
    2.8
    
    
    
    0.3General and administrative
    
    
    21.5
    
    
    
    20.5
    
    
    
    1.0
    
    
    
    0.0Restructuring expenses
    
    
    5.3
    
    
    
    1.5
    
    
    
    3.8
    
    
    
    2.5Impairment of assets held for sale
    
    
    0.8
    
    
    
    
    
    
    
    0.8
    
    
    nmOperating income from continuing operations
    
    
    34.1
    
    
    
    37.0
    
    
    
    (2.9
    )
    
    
    -7.8
    %Interest expense, net
    
    
    33.7
    
    
    
    34.7
    
    
    
    (1.0
    )
    
    
    (0.0
    )Loss on extinguishment of debt
    
    
    2.3
    
    
    
    1.1
    
    
    
    1.2
    
    
    nmIncome (loss) from continuing operations, before tax
    
    
    (1.9
    )
    
    
    1.2
    
    
    
    (3.1
    )
    
    
    -258.3
    %Tax provision (benefit)
    
    
    2.9
    
    
    
    0.5
    
    
    
    2.4
    
    
    
    580.0
    %Income (loss) from continuing operations, after tax
    
    
    (4.8
    )
    
    
    0.8
    
    
    
    (5.6
    )
    
    nmGain on sale of businesses, after tax
    
    
    
    
    
    
    27.0
    
    
    
    (27.0
    )
    
    
    -100.0
    %Income from discontinued operations, after tax
    
    
    
    
    
    
    0.9
    
    
    
    (0.9
    )
    
    
    -100.0
    %Net income (loss)
    
    $
    (4.8
    )
    
    $
    28.7
    
    
    $
    (33.5
    )
    
    nmEBITDA from continuing operations
    
    $
    42.4
    
    
    $
    44.4
    
    
    $
    (2.0
    )
    
    
    -4.5
    %nm  not meaningful
 Research and development spending
increased by $0.9 million or 8.8% due to increased spending on product development, including the
Ferrofluid receiver, the Pantograph receiver, the Business Class Microphone, the Silicon Microphone
and the expanded offering of Deltek electromechanical controls. Sales and marketing expenses
increased by $2.8 million or 30.4% primarily due to expanded sales support of the Silicon
Microphone worldwide and higher sales in all product lines. General and administrative expenses
increased by $1.0 million or 4.9%, primarily due to increased costs related to the Itasca
headquarters. Operating income of $34.1 million in the twelve months ending December, 2004 decreased by $2.9
million from the prior year, due to the $3.8 million increase in restructuring expenses partially
offset by increased gross margins from increased sales. Restructuring expenses of $5.3 million in 2004 and $1.5 million in 2003 were costs related to
the Companys transfer of production from of its Elgin, Illinois manufacturing facility in 2004 to
its facilities in Malaysia and China. Interest expenses of $33.7 million in 2004 and $35.8 million in 2003 reflect the debt incurred
by the Company in association with its recapitalization in 1999. See Liquidity and Capital
Resources below. Loss from continuing operations before tax was a $1.9 million in 2004 compared to income of
$1.2 million in 2003. The decline of $3.1 million is due to the increase in restructuring expense
and the $2.3 million loss on extinguishment of debt partially
offset by a higher gross margin. 19




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##### Table of Contents



The key measurement used by management to gauge the profitability of the business is EBITDA,
which decreased from $44.4 million in 2003 to $42.4 million in 2004. The decrease of $2.0 million
was caused by the increased restructuring expenses. The tax provision in 2004 reflects taxes on profitable foreign operations. In 2003 the taxes
on profitable foreign operations was partly offset by a reduction in the valuation allowance
against the net U.S. deferred tax income tax asset. The company sold Syncho-Start in May 2003 for $49.7 million. The Company retained pension
liabilities of $3.5 million associated with the SSPI pension plan covering U.S. employees. The
Company recorded a gain of $35.6 million on the sale of Synchro-Start, which is net of $0.7 million
of tax expense on the gain. The Company sold the Infrared business for $0.1 million in July 2003
with the buyer assuming $4.0 million of debt. The Company recorded an $8.6 million loss on the
sale. Income from discontinued operations, after tax of $0.9 million in 2003 reflects the after-tax
results of the Synchro-Start and the Ruwido businesses in 2003 prior to their sale. Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 12 Months Ending
    
    
    $ Change
    
    
    % Change12/31/2003
    
    
    12/31/2002
    
    
    From Prior Year
    
    
    From Prior Year$ millionsConsolidated sales
    
    $
    154.0
    
    
    $
    164.1
    
    
    $
    (10.1
    )
    
    
    6.2
    %Sales from Ruf
    
    
    
    
    
    
    14.2
    
    
    
    (14.2
    )
    
    
    100.0
    %Consolidated sales, excluding Ruf
    
    $
    154.0
    
    
    $
    149.9
    
    
    $
    4.1
    
    
    
    2.7
    %
 Consolidated net sales decreased by 6.2% in 2003 compared to 2002, due to the November 2002
sale of Ruf Electronics. Excluding the sales of Ruf in 2002, sales increased by 2.7 % in 2003 over
2002. The increase was caused by an increase in sales of transducers to the hearing aid industry
and to security and medical applications, increased sales of the Silicon Microphone and increased
sales of Deltek brand electromechanical components. The following table sets forth cost of sales and cost of sales as a percent of net sales. 12 Months Ending
    
    
    $ Change
    
    
    % Change12/31/2003

    
    
    12/31/2002
    
    
    From Prior Year
    
    
    From Prior Year$ millionsConsolidated cost of sales
    
    $
    75.6
    
    
    $
    88.0
    
    
    $
    (12.4
    )
    
    
    14.1
    %Cost of sales from Ruf
    
    
    
    
    
    
    10.6
    
    
    
    (10.6
    )
    
    
    100.0
    %Consolidated cost of sales, excluding Ruf
    
    $
    75.6
    
    
    $
    77.4
    
    
    $
    (1.8
    )
    
    
    2.3
    %% of Net Sales
    
    
    49.1
    %
    
    
    51.6
    %
 Consolidated cost of sales as a percentage of net sales decreased by 4.5 percentage points,
with approximately half of the decrease due to the sale of the low-margin Ruf business. The
remaining decrease was primarily due to improved manufacturing efficiencies, including lower
production costs, improved inventory controls and reduced costs of warranty. 20




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##### Table of Contents



The following table sets forth income from continuing operations for the twelve months ending
2003 compared to the year earlier period: 12 Months
    
    
    12 Months EndingEnding
    
    
    
    
    
    
    
    
    
    
    12/31/02
    
    
    Change12/31/03
    
    
    12/31/02
    
    
    12/31/02
    
    
    Consolidated
    
    
    Excluding RUFConsolidated
    
    
    Consolidated
    
    
    Ruf
    
    
    Excl Ruf
    
    
    $s
    
    
    %$ millionsSales
    
    $
    154.0
    
    
    $
    164.1
    
    
    $
    14.2
    
    
    $
    149.9
    
    
    
    4.1
    
    
    
    2.7
    %Gross margin
    
    
    78.4
    
    
    
    76.1
    
    
    
    3.6
    
    
    
    72.5
    
    
    
    5.9
    
    
    
    8.1
    %Gross margin %
    
    
    50.9
    %
    
    
    46.4
    %
    
    
    25.4
    %
    
    
    48.4
    %Research & development
    
    
    10.2
    
    
    
    11.7
    
    
    
    1.7
    
    
    
    10.0
    
    
    
    0.2
    
    
    
    2.0
    %Sales and marketing
    
    
    9.2
    
    
    
    9.5
    
    
    
    1.0
    
    
    
    8.5
    
    
    
    0.7
    
    
    
    8.2
    %General and administrative
    
    
    20.5
    
    
    
    21.5
    
    
    
    2.2
    
    
    
    19.3
    
    
    
    1.2
    
    
    
    6.2
    %Loss on sale of business
    
    
    
    
    
    
    16.7
    
    
    
    16.7
    
    
    
    
    
    
    
    
    
    
    
    Restructuring expenses
    
    
    1.5
    
    
    
    2.1
    
    
    
    
    
    
    
    2.1
    
    
    
    (0.6
    )
    
    
    28.6
    %Operating income
    
    $
    37.0
    
    
    $
    14.6
    
    
    $
    (18.0
    )
    
    $
    32.6
    
    
    $
    4.4
    
    
    
    13.5
    %Loss on extinguishment of debt
    
    
    1.1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.1
    
    
    
    Interest expense, net
    
    
    34.7
    
    
    
    33.8
    
    
    
    
    
    
    
    33.8
    
    
    
    2.0
    
    
    
    5.9
    %Income from continuing operations, before tax
    
    $
    1.2
    
    
    $
    (19.2
    )
    
    $
    (18.0
    )
    
    $
    (1.2
    )
    
    
    2.4
    
    
    
    200.0
    %EBITDA from continuing operations
    
    $
    44.4
    
    
    
    
    
    
    
    
    
    
    $
    40.8
    
    
    
    3.6
    
    
    
    8.8
    %
 Research and development spending (excluding Ruf) increased by $0.2 million or 2% due to increased spending on product
development, including the Ferrofluid receiver, the Pantograph receiver, and the Silicon
Microphone. Sales and marketing expenses excluding Ruf increased by $0.7 million or 8.2% primarily
due to expanded sales support of the Silicon Microphone worldwide. General and administrative
expenses excluding Ruf increased by $1.2 million or 6.2%, primarily due to increased employee and
employee benefit costs, including relocation, pension, medical and other benefit expenses. Operating income of $37.0 million in the twelve months ending December, 2003 increased by
$22.4 million, with $16.7 million of the increase due to the loss in 2002 on the sale of Ruf and
the balance due to improved profitability in ongoing operations due to increased sales and improved
gross margin rates. The Company announced the sale of Ruf in November 2002. Although the proceeds
from the sale were not significant, the sale allowed the Company to exit from a non-core business,
which was not profitable. The net loss from the sale of Ruf in 2002 was $16.7 million. Restructuring expenses of $1.5 million in 2003 were primarily an accrual for expected
severance costs related to the Companys expected closure of its Elgin, Illinois manufacturing
facility in 2004. Restructuring expenses in 2002 of $2.1 million included a $1.2 million loss on
the sale of a facility in Taiwan and severance expenses. Interest expenses of $35.8 million in 2003 reflect the debt incurred by the Company in
association with its recapitalization in 1999. See Liquidity and Capital Resources below. Compared
to 2002, interest expense increased by $2.0 million, primarily due to the refinancing of the $31.7
million of the A Facility portion of the bank debt, which was replaced with $35 million of C
Facility debt. The C Facility debt is at a fixed rate of 18.5% compared to a lower rate of LIBOR
plus 5% for the A Facility debt. Income from continuing operations before tax was $1.2 million in 2003, an improvement of $20.4
million compared to the loss of $19.2 million in 2002. The improvement was due to the 2002 loss on
the sale of Ruf of $16.7 million, the avoidance of the 2002 operating loss from Ruf of $1.3 million
and of improved operating results that were only partially offset by increased interest expense of
$2.0 million. The key measurement used by management to gauge the profitability of the business is EBITDA,
which increased from $40.8 million in 2002 to $44.4 million in 2003. The increase of $3.6 million
was caused by increased sales and improved gross margin rates, only partially offset by increased
operating expenses. 21




---



##### Table of Contents



Key statistics related to income taxes and gains/losses from discontinued operations are as
follows: 12 Months
    
    
    12 Months EndingEnding
    
    
    
    
    
    
    
    
    
    
    12/31/0212/31/03
    
    
    12/31/02
    
    
    12/31/02
    
    
    ConsolidatedConsolidated
    
    
    Consolidated
    
    
    Ruf
    
    
    Excl Ruf$ millionsIncome (loss) from continuing operations, before tax
    
    $
    1.2
    
    
    $
    (19.2
    )
    
    $
    (18.0
    )
    
    $
    (1.2
    )Tax provision
    
    
    0.4
    
    
    
    11.7
    
    
    
    
    
    
    
    11.7Income (loss) from continuing operations, after tax
    
    $
    0.8
    
    
    $
    (30.9
    )
    
    $
    (18.0
    )
    
    $
    (12.9
    )Gain on sale of discontinued businesses, after tax
    
    
    27.0
    
    
    
    
    
    
    
    
    
    
    
    Income from discontinued operations, after tax
    
    
    0.9
    
    
    
    6.5
    
    
    
    
    
    
    
    6.5Net Income (loss)
    
    $
    28.7
    
    
    $
    (24.4
    )
    
    $
    (18.0
    )
    
    $
    (6.4
    )
 The tax provision in 2003 reflects taxes of foreign operations partly offset by a reduction in
the valuation allowance against the net U.S. deferred tax income tax asset. In 2002, the Company
provided for $11.7 million of taxes despite a pre-tax loss primarily due to providing a valuation
allowance against the net U.S. deferred income tax assets. The Company sold Synchro-Start in May 2003 for $49.7 million. The Company retained pension
liabilities of $3.5 million associated with the SSPI pension plan covering U.S. employees. The
Company recorded a gain of $35.6 million on the sale of Synchro-Start, which is net of $0.7 million
of tax expense on the gain. The Company sold the Infrared business for $0.1 million in July 2003
with the buyer assuming $4.0 million of debt. The Company recorded an $8.6 million loss on the
sale. Income from discontinued operations, after tax of $0.9 million in 2003 reflects the after-tax
results of the Synchro-Start and the Ruwido businesses in 2003 prior to their sale. The income from
discontinued operations was significantly lower than the prior year due to the partial year nature
of the results, a decrease in margin rates and an increase in operating expenses. 22




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##### Table of Contents



Seasonality and Quarterly Results of Operations Our sales have been subject to a small degree of seasonality in the past several years. The
fourth quarter has been our strongest quarter primarily due to stronger customer demand. In
addition to the normal seasonality trends, the fourth quarter of 2003 was especially strong due to
improved conditions in the hearing aid market and an increase in shipments of the Silicon
Microphone. The sales of Silicon Microphones continued to increase in each quarter during 2004. The following table sets forth selected financial information by fiscal quarter. SELECTED FINANCIAL INFORMATION BY QUARTER  UNAUDITED March 31,
    
    
    June 30,
    
    
    Sept. 30,
    
    
    Dec. 31,
    
    
    March 31,
    
    
    June 30,
    
    
    Sept. 30,
    
    
    Dec. 31,2003
    
    
    2003
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2004
    
    
    2004
    
    
    2004 (4)Net sales
    
    $
    37.5
    
    
    $
    38.9
    
    
    $
    34.7
    
    
    $
    42.9
    
    
    $
    45.3
    
    
    $
    44.8
    
    
    $
    46.5
    
    
    $
    48.9Cost of sales
    
    
    18.9
    
    
    
    18.9
    
    
    
    17.6
    
    
    
    20.2
    
    
    
    24.0
    
    
    
    25.0
    
    
    
    27.1
    
    
    
    24.6Gross margin
    
    
    18.6
    
    
    
    20.0
    
    
    
    17.1
    
    
    
    22.7
    
    
    
    21.3
    
    
    
    19.8
    
    
    
    19.4
    
    
    
    24.3Research and
development
    
    
    2.3
    
    
    
    2.9
    
    
    
    2.5
    
    
    
    2.5
    
    
    
    2.7
    
    
    
    2.9
    
    
    
    2.9
    
    
    
    2.6Selling and marketing
    
    
    2.1
    
    
    
    2.3
    
    
    
    2.3
    
    
    
    2.5
    
    
    
    2.5
    
    
    
    2.8
    
    
    
    2.9
    
    
    
    3.8General and administrative
    
    
    5.7
    
    
    
    4.8
    
    
    
    4.3
    
    
    
    5.7
    
    
    
    5.3
    
    
    
    6.0
    
    
    
    5.1
    
    
    
    5.1Impairment of assets held for sale (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    .9
    
    
    
    
    
    
    
    Restructuring expense (2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.5
    
    
    
    (.1
    )
    
    
    
    
    
    
    2.3
    
    
    
    3.1Operating income
    
    $
    8.5
    
    
    $
    10.0
    
    
    $
    8.0
    
    
    $
    10.5
    
    
    $
    10.9
    
    
    $
    7.2
    
    
    $
    6.2
    
    
    $
    9.7Income (loss) from continuing
operations after taxes
    
    
    (1.1
    )
    
    
    (0.7
    )
    
    
    (1.2
    )
    
    
    3.7
    
    
    
    1.3
    
    
    
    (3.5
    )
    
    
    (1.8
    )
    
    
    (0.8
    )Income from discontinued operations (3)
    
    
    1.1
    
    
    
    25.6
    
    
    
    1.1
    
    
    
    0.1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    0.0
    
    
    $
    24.9
    
    
    $
    (0.1
    )
    
    $
    3.8
    
    
    $
    1.3
    
    
    $
    (3.5
    )
    
    $
    (1.8
    )
    
    $
    (0.8
    )
   (1)

    The Impairment of assets held for sale for 2004 is the charge to reduce the carrying value
of the Elgin, Illinois facility to its estimated fair value less cost
of sale. See Consolidated Financial Statement Note 11.(2)

    The Restructuring expenses in 2003 and 2004 primarily relate to the closure of the Elgin,
Illinois facility announced in November 2003.(3)

    Income from discontinued operations for the quarter ended June 30, 2003 includes the gain on
sale of the Synchro-Start business and loss on the sale of the Infrared business.(4)

    An adjustment increasing the tax
provision $1.4 million was made in the quarter ending
December 31, 2004. 23




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##### Table of Contents



Liquidity and Capital Resources We have historically used available funds for capital expenditures and working capital
management. These funds have been obtained from operating activities and from lines of credit. In
the future, we will continue to have these needs. We also will have substantial interest expense of
approximately $33 to $38 million each year. We are a holding company. Our subsidiaries conduct substantially all of our consolidated
operations and own substantially all of our consolidated assets. Consequently, our cash flow and
our ability to meet our debt service obligations depends substantially upon the cash flow of our
subsidiaries and the payment of funds by our subsidiaries to us in the form of loans, dividends or
otherwise. In association with its recapitalization on June 30, 1999 the Company borrowed $200 million
under a bank credit agreement in two facilities, an A Facility of $50 million and a B Facility of
$150 million. On June 30, 1999, the Company also borrowed $153.2 million under a senior
subordinated note agreement. The Company borrowed an additional $10 million in Senior Subordinated
Debt in August 2002, as required under the Amendment and Waiver to the Credit Agreement dated May
10, 2002. In the first quarter of 2003, the Company repaid $7.7 million of principal on the B
facility as required under the Excess Cash provision of the Credit Agreement. On March 25, 2003,
the Company entered into the Fifth Amendment of the Credit Agreement, which resulted in the Company
repaying the balance of the A facility ($31.7 million), replacing the original A Facility with a
$35 million C Facility and revising certain terms and conditions of the Credit Agreement. In May
2003 the Company obtained Amendment Number Six and Waiver that approved the sale of Synchro-Start
and Ruwido under certain conditions. The Company completed the sale of the Synchro-Start division
May 30, 2003 and prepaid $42 million of B Facility loans. An additional prepayment of $2.3 million
related to the Synchro-Start sale was made in November 2003. The Company completed the sale of
Ruwido in July and prepaid $1 million of B Facility loans in July 2003. In April, 2004 the Company entered into the Seventh Amendment of the Credit Agreement, which
resulted in the Company repaying the $35 million in C Facility loans and replacing these C Facility
loans with $48 million in D Facility loans at substantially lower interest rates. In December, 2004 the Company entered into a new unsecured credit agreement for up to $10
million in additional financing with Xerion Partners. No amount was outstanding under this
agreement as of December 31, 2004. As of December 31, 2004 the Companys outstanding borrowing and repayment dates were as
follows: Lessthan
    
    
    1 to 3
    
    
    3 to 5
    
    
    After 5Contractual
obligations(1)
    
    Total
    
    
    1 Year
    
    
    Years
    
    
    Years
    
    
    YearsCredit Agreement dated June 28, 1999 and most
recently amended April 8, 2004:B Facility
    
    $
    102,728
    
    
    $
    5,865
    
    
    $
    96,863
    
    
    $
    
    
    
    $
    D Facility
    
    
    59,400
    
    
    
    4,560
    
    
    
    54,840
    
    
    
    
    
    
    
    Revolver
    
    
    11,390
    
    
    
    956
    
    
    
    10,434
    
    
    
    
    
    
    
    Total credit agreement
    
    
    173,518
    
    
    
    11,381
    
    
    
    162,137
    
    
    
    
    
    
    
    13 1/8% Senior Subordinated Notes due
2009
    
    
    253,738
    
    
    
    20,108
    
    
    
    40,215
    
    
    
    193,415
    
    
    
    10% Senior Subordinated Notes due 2009
    
    
    15,000
    
    
    
    1,000
    
    
    
    2,000
    
    
    
    12,000
    
    
    
    Operating leases
    
    
    14,247
    
    
    
    1,976
    
    
    
    3,037
    
    
    
    2,643
    
    
    
    6,591Retention bonus
    
    
    4,370
    
    
    
    
    
    
    
    
    
    
    
    4,370
    
    
    
    Sales
contract payments
    
    
    1,825
    
    
    
    1,825
    
    
    
    
    
    
    
    
    
    
    
    Pension
contributions(2)
    
    
    8,300
    
    
    
    2,028
    
    
    
    6,272
    
    
    
    
    
    
    
    Total
    
    $
    470,998
    
    
    $
    38,318
    
    
    $
    213,661
    
    
    $
    212,428
    
    
    $
    6,591
   (1)

    Debt obligations include interest.(2)

    The pension contribution has not been
estimated beyond 2007. 24




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##### Table of Contents



Under the amended terms of the Credit Agreement, the Company must maintain certain financial
ratios. The two primary ratios the Company must maintain are the leverage ratio, which is total net
debt divided by EBITDA, and the interest coverage ratio, which is EBITDA divided by net cash
interest expense. The Company is required to maintain its leverage ratio below a specified level
and its interest coverage ratio above a specified level. For purposes of calculating the required ratio, under the amended terms of the Credit
Agreement, EBITDA excludes up to $7.5 million in cash charges related to the costs of
restructuring overhead in the three year period 2003 through 2005. These restructuring costs will
be related to the Companys announced closure of its Elgin facility and the increase in
capabilities in our Asian manufacturing facilities. These restructuring costs were $5.3 million in
2004 and $1.2 million in 2003. The required ratios as amended for future years ends are as follows: Required
    
    
    Required InterestLeverage Ratio
    
    
    Coverage RatioDecember 31, 2005
    
    
    6.75
    
    
    
    1.25December 31, 2006
    
    
    6.00
    
    
    
    1.35
 We expect to be able to comply with the required covenants through December 31, 2005. However,
our ability to meet these covenants is highly dependent upon market and competitive conditions. If
future results are lower than planned, the company may be unable to comply with the debt covenants
or make required debt service payments. Such inability could have a material adverse impact on the
Companys financial condition, results of operations or liquidity. The Credit Agreement as amended totals $153 million of credit as of December 31, 2004.
Included is a $15 million Revolving Credit Facility through June 30, 2006, a B Facility of $89.6
million which matures on June 29, 2007 and a D Facility of $48 million which matures on June 29,
2007. The Revolving Credit facility bears interest, at the Companys option, at either (1) one-,
two-, three-, or six month LIBOR plus 4.0% or (2) the greater of the prime rate, a base certificate
of deposit rate plus 1.00% or the federal funds effective rate plus .50 (the Alternate Base Rate)
in each case plus an initial margin of 3%. The B Facility bears interest, at the Companys option,
at either (1) one-, two-, three-, or six month LIBOR plus 5.00% or (2) Alternate Base Rate plus an
initial margin of 4.00%. The D Facility bears interest at a rate of LIBOR plus 7.25%. At December
31, 2004, the weighted average interest rate was 7.2% for the B facility and 9.5% for the D
facility. The Credit Agreement as amended reduced the Revolving Credit
Facility to $15 million. The Sixth Amendment and Waiver and the subsequent sale of Synchro-Start and Ruwido substantially
revised the terms of the amortization of the Credit Agreement. The principal is due and payable in
four quarterly principal payments from September 30, 2006 to June 29, 2007. Under the amended
Credit Agreement, in the event the B Facility is fully prepaid prior to June 30, 2006 the Revolving
Credit Facility will cease to be available to the Company and any amounts outstanding thereunder
shall thereupon become due and payable. The D Facility is payable in full on June 29, 2007. The Seventh Amendment replaced the $35 million C facility with $48 million of borrowing at
substantially lower interest rates. The Fifth and Sixth Amendments modified the Credit Agreement
that was substantially amended on May 10, 2002. On that date, the Company received agreement from
the lenders to revise the terms and conditions of the Credit Agreement. At the end of the first
quarter of 2002, the Company was not in compliance with the terms of the Credit Agreement,
particularly the required leverage and interest coverage ratios. As a result, the Company did not
make the interest payment on its senior subordinated notes scheduled for April 15, 2002. After the
Company obtained the Fourth Amendment and Waiver to the Credit Agreement on May 10, 2002 (the
Fourth Amendment), on May 14, 2002 the Company made the interest payment on our senior
subordinated notes. The Fourth Amendment waived our non-compliance with the required interest
coverage ratio for the period ended March 31, 2002 and the leverage ratio for the period January 1,
2002 through March 31, 2002, and amended these required ratios for subsequent periods through the
first quarter of 2003. In addition the Fourth Amendment required the Company to receive additional funding
of at least $10 million by September 3, 2002, which was required to pay down the outstanding
balance on the revolving credit facility to $8.25 million. As a result of this agreement, the
Company entered into a Senior Subordinated Debt agreement with an affiliate of Doughty Hanson on
August 28, 2002 for $10 million in financing, under terms pari passu to the Senior Subordinated
Debt Agreement of 1999. The proceeds were used to provide funding for working capital and reduced
the balance under the revolving credit agreement to zero. 25




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##### Table of Contents



In December, 2004 the Company entered into a new unsecured credit agreement with Xerion
Partners for up to $10 million in borrowing. No amount was outstanding as of December 31, 2004.  Cash Flows 2004 vs 2003 Cash balances increased by $5.7 million in 2004,
as $6.9 million in cash provided by operating
activities and $16.0 million in cash provided by financing activities were more than the $19.1
million used in purchases of property, plant and equipment. The
Company also received $2.0 million out of escrow from the sale of the
Synchro - Start business. Net cash provided by operating activities was $6.9 million in 2004 compared to $11.1 million
in 2003. The decrease was primarily due to increased investment in inventory partially offset by
higher accounts payable. Net cash used in investing activities in 2004 was $17.1 million, primarily representing the
$19.1 million of capital expenditures required to increase production capacity necessary to serve
the traditional transducer market as well as grow our production capacity for the Silicon
Microphone. Net cash provided by investing activities in 2003 of $30.5 million was due to the $45.2
million in cash generated by the sales of Synchro-Start and Ruwido offset by $14.8 million in
capital equipment purchases. Net cash provided by financing activities in 2004 of $16.0 million represents the increase in
borrowing during the year. The $48.0 million D Facility replaced the C Facility of $35.0 million
plus related deferred fees and expenses. In addition, $9 million in borrowing was made on the
Revolving Facility in December, 2004. Net cash used in financing activities in 2003 was $54.2 million which
primarily represents the $9.5 million payment of principal on the bank debt related to the Excess
Cash provision of the Credit Agreement; the $31.7 million payment of the A Facility portion of the
bank debt; and $45.3 million in payments on the bank debt related to the sale of SSPI and Ruwido
partially offset by the additional borrowing of $35 million of C Facility debt.  Cash Flows 2003 vs 2002 Cash balances decreased by $12.7 million in 2003, as the Company used the $11.1 million of
cash provided by operations and the $45.2 million in proceeds from the sale of SSPI and Ruwido to
pay down debt and to fund capital expenditures. Net cash provided by operating activities was $11.1 million in 2003 compared to $29.7 million
in 2002. Net cash provided by operating activities in 2002 was higher than in 2003 despite lower
income from continuing operations. The 2002 loss included two significant non-cash write-offs  the
$16.6 million non-cash loss on the sale of Ruf and the $6.7 million non-cash loss from adjustments
in deferred tax valuations. The decrease in cash flow reflects cash generated by reductions in
working capital in 2002 that were not repeated in 2003  a reduction in accounts receivable of $6.9
million and a reduction of inventory of $9.4 million. Net cash provided by investing activities in 2003 of $30.5 million represents the $45.2
million in cash generated by the sales of Synchro-Start and Ruwido offset by $14.8 million in
capital equipment purchases. The primary capital expenditures in 2003 were for new product tooling
and production equipment, particularly the equipment required for the new Silicon Microphone. Net
cash used in investing activities of $4.9 million in 2002 was primarily the purchases of new
tooling and production equipment, partially offset by the proceeds from sale of the Taiwan building
for $3.6 million. Net cash used in financing activities in 2003 was $54.2 million which primarily represents the
$9.5 million payment of principal on the bank debt related to the Excess Cash provision of the
Credit Agreement; the $31.7 million payment of the A Facility portion of the bank debt; and $45.3
million in payments on the bank debt related to the sale of SSPI and Ruwido partially offset by the
additional borrowing of $35 million of C Facility debt. Debt payments on the long-term portion of
the Companys Credit Agreement totaled $10.5 million in 2002, with an additional $2.0 million in
payments used to reduce the Companys short-term debt. The Company issued $10 million of 10% Senior
Subordinated Notes dated August 28, 2002. The Recapitalization On June 30, 1999, Key Acquisition, L.L.C. (Key Acquisition), all of whose membership
interests are held by limited partnerships for which Doughty Hanson & Co. Limited or its affiliates
(collectively, Doughty Hanson) act as general partner, acquired control of Knowles Electronics,
Inc. in a recapitalization transaction (Recapitalization). On June 29, 1999, Knowles equipment
financing business, which included certain parcels of real estate, were distributed to our
preexisting stockholders, in redemption of 10% of the stock owned by those stockholders. As part of
the June 30, 1999 recapitalization, we repurchased from our 26




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##### Table of Contents



preexisting stockholders for $505.5 million 90% of our common stock remaining outstanding
after the previous days redemption, and our preexisting stockholders exchanged their remaining
common stock for shares of the newly authorized common stock and preferred stock. In addition, upon
closing of the Recapitalization, certain of our senior officers purchased shares of newly
authorized common stock issued by Knowles. Upon the closing of the recapitalization, Key
Acquisition owned approximately 82.3% of our newly authorized common stock and approximately 88.9%
of our newly authorized preferred stock, certain of our preexisting stockholders owned
approximately 10.3% of our common stock and approximately 11.1% of our preferred stock, and certain
of our senior officers owned approximately 7.4% of our common stock. Ownership of Knowles.Interests in Key Acquisition, which owns approximately 83.6% of our
common stock and 88.9% of our preferred stock are held by the limited partnerships. The general
partner of these limited partnerships is Doughty Hanson & Co. Limited. Holding Company Reorganization.Subsequent to the Recapitalization, we reorganized Knowles
Electronics, Inc. as a holding company. Pursuant to a contribution agreement on August 30, 1999
Knowles Electronics, Inc. contributed substantially all of its assets and liabilities (other than
the capital stock of Knowles Intermediate Holding Company, Inc. and certain foreign subsidiaries
and Knowles Electronics, Inc.s liabilities under the Credit Agreement and Subordinated Bridge
Notes) to Knowles Electronics, LLC, a newly created Delaware limited liability company. As a result
of this reorganization, Knowles Electronics, Inc. is now a holding company that does not conduct
any significant operations. Subsequent to the transaction, Knowles Electronics, Inc. changed its
name to Knowles Electronics Holdings, Inc. The Credit Agreement We entered into the Credit Agreement, dated as of June 28, 1999 and amended and restated as of
July 21, 1999, and amended most recently April 14, 2004 with the Lenders named therein, JP Morgan
Chase Bank (as successor to The Chase Manhattan Bank), as Administrative Agent and Swingline
Lender, Morgan Stanley Senior Funding, Inc., as Syndication Agent, and Chase Securities Inc., as
Lead Arranger and Book Manager. The Credit Agreement, as amended, consists of (i) a $89.6 million
term loan facility (B Facility) due in scheduled principal payments that begin September 30, 2006
and are completed as of June 29, 2007, (ii) a $48 million term loan facility (D Facility) due
June 29, 2007 and (iii) a $15 revolving credit facility due June 30, 2006 (the Revolving
Facility). Under the terms of the Credit Agreement, and in order to provide financing for the
Recapitalization, the A Facility (which was subsequently replaced with C Facility in March, 2003)
and then the D Facility in April 2004) and B Facility were fully drawn on June 30, 1999, the
closing date of the Recapitalization. The Revolving Facility is available for working capital and
general corporate purposes. $9 million in borrowing was outstanding under The Revolving Facility as
of December 31, 2004. In March 2003 we repaid $9.5 million of aggregate principal of the A and B Facilities in
accordance with the excess cash provision of the amended Credit Agreement. In June 2003 we repaid
$42 million in principal of the B Facility in accordance with Amendment No. 6 and the sale of
Syncho-Start. An additional prepayment of $2.3 million related to the Synchro-Start sale was made
in November 2003. A payment of $1 million related to the sale of Ruwido was made in July 2003. In
April, 2004 the C Facility was replaced with a $48 million D Facility at substantially lower
interest rates. 27




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##### Table of Contents



Repayment Dates According to the revised terms of the Amended Credit Agreement, and taking into account the
effect of the three prepayments in 2003, the B Facility will amortize in four quarterly amounts
commencing on September 30, 2006. The D Facility is due and payable upon maturity on June 29, 2007. Amount in $000sB Facility of Credit Agreement to be paid -September 30, 2006
    
    $
    21,950December 31, 2006
    
    
    22,550March 30, 2007
    
    
    22,550June 29, 2007
    
    
    22,551D Facility of Credit Agreement to be paid on June 29, 2007
    
    
    48,000Total Credit Agreement Outstanding as of December 31, 2004
    
    $
    137,601
 The Revolving Facility is available as revolving credit advances or letters of credit.
Pursuant to the Revised Credit Agreement, this facility has no scheduled reduction in availability,
unless the B Facility is fully repaid prior to June 30, 2006, in which case the Revolving Facility
will cease to be available to the Company and any amounts outstanding thereunder shall thereupon
become due and payable. If such earlier maturity does not occur, final repayment is due on all
amounts outstanding under this facility on June 30, 2006. The Credit Agreement provides for certain
limitations governing advances under the Revolving Facility, in particular limits on the amount of
letters of credit and swingline loans outstanding at any one time. Prepayment In addition to the scheduled repayment dates described above, in certain circumstances the
Credit Agreement requires us to make mandatory prepayments of
outstanding amounts under the B Facility
and D Facility, when we or our subsidiaries receive proceeds of certain material dispositions and
insurance claims or issue certain indebtedness or when we have a positive adjusted cash flow in the
prior year. We may voluntarily prepay the B Facility in whole or in part without premium or
penalty. Interest Rate and Fees Amounts outstanding under the Revolving Facility will bear interest, at our option, at either
(1) one-, two-, three- or six-month LIBOR plus an initial interest margin of 4.0% (as amended most
recently April 14, 2004) or (2) the greatest of the prime rate, a base certificate of deposit rate
plus 1.0% or the federal funds effective rate plus 0.50% (Alternate Base Rate), in each case plus
an initial margin of 3%. Amounts outstanding under B Facility will bear interest, at our option, at
either (1) one-, two-, three- or six-month LIBOR plus an initial interest margin of 5.0% (as
amended most recently April 14, 2004) or (2) the Alternate Base Rate plus an initial margin of 4%.
The interest margin may be reduced for advances under the Revolving Facility if we, on a
consolidated basis, meet certain specified leverage ratio targets during a period consisting of the
prior four consecutive fiscal quarters. Amounts outstanding under the
D Facility bear interest at
one, two, three or six month LIBOR plus 6.25%. We will pay a commitment fee on the undrawn portion of the Revolving Facility at a rate of
0.380% to 0.50% per annum, depending upon our leverage ratio. In addition, the Amended Credit
Agreement provides for additional interest to accrue to the B Facility at the rate of approximately
$420,000 per year (subject to a reduction in the event of a
prepayment of the B Facility), to be
paid at the maturity of the facility (or in certain instances, at an earlier date). The requirement
for the additional interest terminated with the prepayment of $42 million resulting from the sale
of the Synchro-Start division. In addition, we will pay certain agency and other fees. On December 20, 2004 the company entered into a new unsecured $10 million credit agreement
with Xerion Partners. Except in certain circumstances, loans under the new unsecured agreement
bear interest at the one, two, three or six month LIBOR rate plus 7.75%. No borrowing was
outstanding under this loan agreement as of December, 31, 2004. Guarantee and Security Our obligations under the Credit Agreement are guaranteed by our U.S. subsidiaries. As
security for our obligations under the Credit Agreement, we have pledged all of the shares of our
U.S. subsidiaries and 65% of the shares of our non-U.S. subsidiaries and have granted the lenders a
security interest in substantially all of our assets and the assets of our U.S. subsidiaries. 28




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##### Table of Contents



Covenants The Amended Credit Agreement contains a number of covenants requiring us to achieve or
maintain specified consolidated financial ratios, including certain interest expense coverage
ratios and certain leverage ratios, which have been described above. The Amended Credit Agreement
also contains general covenants which restrict the incurrence of debt and liens, the payment of
dividends, the incurrence of additional debt, the disposition of assets, the incurrence of capital expenditures above certain levels or
the making of other investments, not to make any acquisitions of another company or business and
certain other activities and transactions. Senior Subordinated Debt  13
    1/8% Senior Subordinated Notes due 2009 We issued Notes under an Indenture, dated October 1, 1999, among us, the Subsidiary Guarantors
and the Bank of New York, as Trustee (the Trustee). The Notes are general unsecured obligations
of the Company, rank subordinate to all Senior Indebtedness of the Company and pari passu or senior
to all other Indebtedness of the Company, and are unconditionally guaranteed on a general unsecured
senior subordinated basis by all of the Companys existing and future domestic Restricted
Subsidiaries and any other Restricted Subsidiaries of the Company that guarantee the Companys
indebtedness under the Credit Agreement.  Principal, Maturity and Interest The Company issued $153,200,000 aggregate principal amount of Notes on October 1, 1999 in
denominations of $1,000 and integral multiples of $1,000. The Notes will mature on October 15,
2009. The Notes will not be entitled to the benefit of any mandatory sinking fund. Subject to the covenants described below under Covenants and applicable law, the Company may
issue additional Notes under the Indenture. The Notes offered hereby and any additional Notes
subsequently issued will be treated as a single class for all purposes under the Indenture. Interest on the Notes will accrue at the rate of 13 1/8% per annum and will be payable
semi-annually in arrears on each April 15 and October 15 (each, an Interest Payment Date),
commencing on April 15, 2000. Payments will be made to the persons who are registered Holders at
the close of business on April 1 and October 1, respectively (each, a Regular Record Date),
immediately preceding the applicable interest payment date. The Company did not make the interest
payment on our senior subordinated notes scheduled for April 15, 2002. We subsequently obtained an
Amendment and Waiver dated as of May 10, 2002 to our Credit Agreement and made the interest payment
on our senior subordinated notes that was scheduled for April 15, 2002 on May 14, 2002.  Guarantees Payment of the principal of, premium, if any, and interest on the Notes will be guaranteed,
jointly and severally, on an unsecured senior subordinated basis by certain Subsidiaries of the
Company (the Subsidiary Guarantors), each of which has guaranteed Indebtedness of the Company
incurred under the Credit Agreement. All current and future Restricted Subsidiaries of the Company
other than Foreign Subsidiaries will be Subsidiary Guarantors. In addition, if any Restricted
Subsidiary which is a Foreign Subsidiary becomes a guarantor of Indebtedness of the Company
incurred under the Credit Agreement, the Company will cause such Restricted Subsidiary to guarantee
the Companys obligations under the Notes. Foreign Subsidiaries of the Company, which have
substantial assets, liabilities, net sales and income, will not initially guarantee the Notes, and
the Company does not anticipate that any Foreign Subsidiary will at any time become a Subsidiary
Guarantor. The Note Guarantee of any Subsidiary Guarantor may be released in certain circumstances. 29




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##### Table of Contents



Covenants The Senior Subordinated Note Agreement also contains general covenants, which restrict
Limitation on Indebtedness, Limitation on Senior Subordinated Indebtedness, Limitation on
Restricted Payments, Limitation on Dividend and Other Payment Restrictions Affecting Restricted
Subsidiaries, and Limitation on Liens. The Senior Subordinate Note Agreement also contains the
following covered in detail below. Limitation on Asset Sales The Company will not, and will not permit any Restricted Subsidiary to, consummate any Asset
Sale, unless: (i) the consideration received by the Company or such Restricted Subsidiary is at
least equal to the fair market value of the assets sold or disposed of; and (ii) at least 75% of
the consideration received consists of: (A) Replacement Assets; or (B) cash or Temporary Cash
Investments, provided that the amount of: (a) any liabilities of the Company or any such Restricted
Subsidiary that are assumed by the transferee of any such assets, provided that the Company or such
Restricted Subsidiary is irrevocably and unconditionally released in writing from all such
liabilities, or (b) any notes or other obligations received by the Company or any such Restricted
Subsidiary from such transferee that are converted within 120 days by the Company or such
Restricted Subsidiary into, shall be deemed to be cash for the purposes of determining the
percentage of cash or Temporary Cash Investments received by the Company or such Restricted
Subsidiary. Repurchase of Notes upon a Change of Control The Company must commence, within 30 days of the occurrence of a Change of Control, and
consummate an Offer to Purchase for all Notes then outstanding, at a purchase price equal to 101%
of the principal amount thereof, plus accrued interest (if any) to the Payment Date. There can be no assurance that the Company will have sufficient funds available at the time of
any Change of Control to make any debt payment (including repurchases of Notes) required by the
foregoing covenant (as well as any covenant that may be contained in other securities of the
Company which might be outstanding at the time). The above covenant requiring the Company to
repurchase the Notes will, unless consents are obtained, require the Company to repay all
indebtedness then outstanding which by its terms would prohibit such Note repurchase, either prior
to or concurrently with such Note repurchase. 10% Senior Subordinated Notes due 2009 We issued a Note under a Note Purchase Agreement dated August 28, 2002, among us, the
Subsidiary Guarantors and Key Acquisition LLC. The Note is a general unsecured obligation of the
Company, ranks subordinate to all Senior Indebtedness of the Company and pari passu to the 13 1/8%
Senior Subordinated Notes due 2009. Principal, Maturity and Interest The
Company issued a $10,000,000 Note on August 28, 2002 that will mature on October 15,
2009 and not be entitled to the benefit of any mandatory sinking fund. Interest on the Note will accrue at the rate of 10% per annum and will be payable
semi-annually in arrears on each April 15 and October 15 (each, an Interest Payment Date),
commencing on April 15, 2003. Payments will be made to the persons who are registered Holders of
such Note either in cash or at the option of the Company, by issuance of an additional Note
registered in the name of such Holders, bearing interest from the relevant Interest Payment Date at
a rate of 10%, and having a face value equal to the amount of the Interest Payment applicable to
such Note. Guarantees Payment of the principal of, premium, if any, and interest on the Notes will be guaranteed,
jointly and severally, on an unsecured senior subordinated basis by certain Subsidiaries of the
Company (the Subsidiary Guarantors), each of which has guaranteed Indebtedness of the Company
incurred under the Credit Agreement. All current and future Restricted Subsidiaries of the Company
other than Foreign Subsidiaries will be Subsidiary Guarantors. In addition, if any Restricted
Subsidiary which is a Foreign Subsidiary becomes a guarantor of Indebtedness of the Company
incurred under the Credit Agreement, the Company will cause such
Restricted Subsidiary to guarantee the Companys obligations under the Notes. Foreign
Subsidiaries of the Company, which have 30




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##### Table of Contents



substantial assets, liabilities, net sales and income, will
not initially guarantee the Notes, and the Company does not anticipate that any Foreign Subsidiary
will at any time become a Subsidiary Guarantor. The Note Guarantee of any Subsidiary Guarantor may be released in certain circumstances. Covenants The Senior Subordinated Note Agreement also contains general covenants, which restrict
Limitation on Indebtedness, Limitation on Restricted Payments, Limitation on Dividend and Other
Payment Restrictions Affecting Restricted Subsidiaries, Limitation on the Issuance of Capital Stock
of Restricted Subsidiaries, Limitation on Issuances of Guarantees by Restricted Subsidiaries,
Limitation on Transactions with Stockholders and Affiliates, Limitation on Senior Subordinated
Indebtedness and Limitation on Liens. The Senior Subordinate Note Agreement also contains the
following covered in detail below. Limitation on Asset Sales The Company will not, and will not permit any Restricted Subsidiary to, consummate any Asset
Sale, unless: (i) the consideration received by the Company or such Restricted Subsidiary is at
least equal to the fair market value of the assets sold or disposed of; and (ii) at least 75% of
the consideration received consists of: (A) Replacement Assets; or (B) cash or Temporary Cash
Investments, provided that the amount of: (a) any liabilities of the Company or any such Restricted
Subsidiary that are assumed by the transferee of any such assets, provided that the Company or such
Restricted Subsidiary is irrevocably and unconditionally released in writing from all such
liabilities, or (b) any notes or other obligations received by the Company or any such Restricted
Subsidiary from such transferee that are converted within 120 days by the Company or such
Restricted Subsidiary into, shall be deemed to be cash for the purposes of determining the
percentage of cash or Temporary Cash Investments received by the Company or such Restricted
Subsidiary. Repurchase of Notes upon a Change of Control The Company must commence, within 30 days of the occurrence of a Change of Control, and
consummate an Offer to Purchase for all Notes then outstanding, at a purchase price equal to 101%
of the principal amount thereof, plus accrued interest (if any) to the Payment Date. There can be no assurance that the Company will have sufficient funds available at the time of
any Change of Control to make any debt payment (including repurchases of Notes) required by the
foregoing covenant (as well as any covenant that may be contained in other securities of the
Company which might be outstanding at the time). The above covenant requiring the Company to
repurchase the Notes will, unless consents are obtained, require the Company to repay all
indebtedness then outstanding which by its terms would prohibit such Note repurchase, either prior
to or concurrently with such Note repurchase. Credit Agreement dated as of December 20, 2004 We entered into a Credit Agreement,
dated as of December 20, 2004 with Xerion Partners II
Master Fund Limited as lender and other lenders party hereto from time to time. The Credit
Agreement provides for the granting of loans at the Companys request up to $10 million and in the case
of the initial borrowing, not less than $8.5 million. The commitment to provide loans terminates
January 31, 2005. Any borrowings mature June 29, 2007. Except in certain limited specified cases,
the loans bear interest at a one-, two-, three-, or six-month adjusted LIBOR plus 7.75%. Subsequent Events The
Company borrowed $9.0 million under the Xerion Credit Agreement dated as of December 20, 2004 in
January, 2005. The Company obtained an Amendment No. 8 and Waiver dated as of March 10, 2005, to the Credit
Agreement dated as of June 28, 1999. The Amendment, among other
things, permits us to incur
an additional $10 million of unsecured indebtedness and increases for each period beginning
December 31, 2004 through maturity of the loans, the maximum allowable leverage ratio applicable to
us under the Credit Agreements leverage ratio covenant. 31




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Pursuant
to the terms of the Xerion Credit Agreement dated as of December 20, 2004 that Agreement is
deemed to be amended by the Amendment No. 8 to the same extent. The
Company obtained Amendment One to the Xerion Credit Agreement March
29, 2005 which increased the
credit facility by $10 million. The Company borrowed $10 million
under the Xerion Credit Agreement in March 2005. See Exhibit 10.33
filed with this Form 10-K. Critical Accounting Policies The consolidated financial statements are prepared in accordance with accounting principles
generally accepted in the United States, which require management to make estimates and
assumptions. We believe that of our significant accounting policies (see Note 1 to the consolidated
financial statements), the following may involve a higher degree of judgment and complexity. Bad Debt We maintain allowances for doubtful accounts for estimated losses resulting from the inability
of our customers to make required payments. If the financial condition of our customers were to
deteriorate, resulting in an impairment of their ability to make payments, additional allowances
may be required. Excess and Obsolete Inventory Significant management judgment is required to determine the reserve for obsolete or excess
inventory. Inventory on hand may exceed future demand either because the product is outdated, or
obsolete, or because the amount on hand is more than can be used to meet future need. We currently
make a 50% provision for all inventory that has had no activity for 18 months and a 100% provision
for all inventory that had no activity for more than 36 months as well as any additional
specifically identified inventory to be excess. We also provide for the total value of inventories
that we determine to be obsolete based on criteria such as customer demand and changing
technologies. At December 31, 2004, our inventory reserves were $5.3 million, or 15% of our $34.7
million gross inventories. We value our inventories at lower of cost or market. Cost is determined by the first-in,
first-out (FIFO) method. Warranties Products sold are generally covered by a warranty for periods ranging from one to three years.
We accrue a warranty reserve for estimated costs to provide warranty services. Our estimate of
costs to service warranty obligations is based on historical claims experience and expectation of
future conditions. To the extent we experience increased (or decreased) warranty claim activity or
increased (or decreased) costs associated with servicing those claims, our warranty accrual will
increase (or decrease) resulting in decreased (or increased) gross profit. Pension Benefits The Companys pension benefit costs and obligations are dependent on the various actuarial
assumptions used in calculating such amounts. These assumptions relate to discount rates, salary
growth, long-term return on plan assets and other factors. The Company bases the discount rate
assumptions on current investment yields on AA-rated long-term corporate bonds. The salary growth
assumptions reflect the Companys actual experience and near-term outlook. Long-term return on plan
assets is determined based on historical portfolio results and managements expectation of the
future economic environment. The Companys key assumptions are
described in further detail in  Consolidated Financial Statement Note
8. Deferred Tax Assets We account for deferred income taxes based upon differences between the financial reporting
and income tax bases of our assets and liabilities. The measurement of deferred tax assets is
adjusted by a valuation allowance, if necessary, to recognize the extent to which, more likely than
not, the future tax benefits will be recognized. New Accounting Pronouncements In May 2003, the Financial Accounting Standards Board (FASB) issued SFAS No 150  Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and Equity.SFAS 150
requires certain obligations including mandatorily 32




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##### Table of Contents



redeemable preferred stock to be reflected as liabilities in the balance sheet. Additionally,
dividends paid or accrued on mandatorily redeemable preferred stock will be presented as interest
expense in the income statement. We adopted the provisions of SFAS 150 on January 1, 2004. Since
the Companys preferred stock contains provisions whereby the preferred stock and accumulated
dividends may be converted to common stock, the preferred stock and its dividends continue to be
reflected as such. There was no material impact on our financial position or results of operations
as a result of the adoption of SFAS 150. In
November 2004, the FASB issued SFAS No. 151, Inventory Costs - an amendment of ARB No. 43
Chapter 4. SFAS No. 151 more clearly defines when excessive idle facility expense, freight,
handling costs, and spoilage are to be current-period charges. In addition, SFAS No. 151 requires
the allocation of fixed production overhead to the cost of conversion to be based on the normal
capacity of the production facilities. SFAS No. 151 is effective for inventory costs incurred
during fiscal years beginning after June 15, 2005. The Company has reviewed the provisions of this
standard, and does not expect SFAS No. 151 to have a material impact on the financial statements. In December 2004, the FASB issued
SFAS No. 123R, Share-Based Payment. SFAS No. 123R
supercedes APB No. 25, SFAS No. 123, as amended by SFAS No. 148, and related interpretations. Under
FAS No. 123R, compensation cost is measured at the grant date based on the estimated fair value of
the award and is required to be recognized as compensation expense over the vesting period. The
Company plans to adopt SFAS No. 123R in the third quarter of 2005. The Company has reviewed the
provisions of this standard, and its adoption is not expected to have a material effect on the
Companys Consolidated Financial Statements. Management does not anticipate the adoption of any other new accounting pronouncement will
have a material effect on our results of operations or on the financial position of the company. Restatement of Financial Statements The Company is restating its prior years financial statements because an error was discovered
that affects cost of sales and other comprehensive income and certain disclosures previously
reported in our financial statements. The results for 2000 have been restated to correct an error
in the balance of other comprehensive income resulting from the conversion to a new consolidation
system in 2000. The error incorrectly recorded a translation loss as an adjustment to equity
rather than an adjustment to the income statement and was primarily related to the U.K. entity.
The correction increased cost of sales in 2000 by $1,578 and
decreased net income by the same amount. Appropriate balance sheet accounts have
also been restated. Discontinued Operations The Companys consolidated financial statements and related footnote disclosures reflect the
Synchro-Start and Infrared (Ruwido) businesses as discontinued operations, net of applicable income
taxes, for all periods presented in accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. As such, discontinued operations includes the January thru May
operating results of the Synchro-Start business, the sale of which was completed May 30, 2003, and
the gain on the Synchro-Start sale. Discontinued operations also includes the January thru July
operating results of the Infrared business, the sale of which was completed July 29, 2003, and the
loss on the sale. The assets and liabilities of these businesses have been summarized as current on
a gross basis and reclassified for presentation on the December 31, 2002 balance sheet. The Synchro-Start division was part of the Companys Automotive Components reporting segment.
The Infrared business was part of the Companys Acoustic and Infrared Technology reporting segment.
The Company has subsequently modified its segment reporting, see footnote 3  Segments and
Geographical Information. Summarized selected financial information for the discontinued operations is as follows: For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Net sales
    
    $
    
    
    
    $
    26,513
    
    
    $
    51,986Income (loss) from discontinued operations
    
    $
    
    
    
    $
    1,102
    
    
    $
    6,591Income tax expense
    
    
    
    
    
    
    170
    
    
    
    46Income (loss) from discontinued operations, net of tax
    
    $
    
    
    
    $
    932
    
    
    $
    6,545
 33




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The Company sold Synchro-Start for $49.7 million. The Company retained pension liabilities of
$3.5 million associated with the pension plan covering U.S. employees. The Company recorded a
pre-tax gain on the sale of Synchro-Start of $36.3 million. The tax on the gain was $0.7 million
which reflects an alternative minimum tax created by the transaction. The benefit of the
carryforward of the alternative minimum tax credit has not been recognized due to the uncertainty
of the realization of this benefit. The tax on the gain was limited to the alternative minimum tax
due to the utilization of net operating loss carryforwards that had previously not been benefited. The Company sold the Infrared business for $0.1 million on July 29, 2003 and the buyer
retained debt of $4.0 million. The Company recorded a pre-tax loss on the sale of $8.6 million. No
tax benefit from the loss was recorded because the loss is netted against the gain on the
Synchro-Start sale and the tax on that net gain is offset by the utilization of net operating loss
carryforwards that had previously not been benefited. In November 2002, the Company sold its Ruf division, which was part of the Companys
Automotive Components reporting segment. In accordance with APB No. 30 Reporting the Results of
Operations  Reporting the Effects of Disposal of a Segment of a Business and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions,the Ruf business did not qualify as a
discontinued operation and therefore, its results of operations and cash flows are included in the
Companys results of continuing operations and cash flows for all 2002 and 2001 periods presented
in this document. Forward Looking Statements This Annual Report on Form 10-K contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. These statements are based on the Companys
current plans and expectations as of the date of this document and involve risks and uncertainties
that may cause actual results to differ materially from the forward-looking statements. Generally,
the words believe, expect, estimate, anticipate, will and similar expressions identify
forward-looking statements. Important factors that could cause such differences include, among others: general economic
conditions in the U.S. and worldwide; fluctuations in currency exchange rates and interest rates;
implementation of new software systems; dependence on our largest customers and key suppliers; the
competitive environment applicable to the Companys operations; political, economic and regulatory
changes effecting our foreign operations; greater than expected expenses associated with the
Companys activities or personnel needs; changes in accounting assumptions; changes in customers
business environments; regulatory, legislative and judicial developments, including environmental
regulations; ability to generate sufficient liquidity to service debt obligations; and ability to
maintain compliance with debt covenants. The risks included here are not exhaustive. New risk factors emerge from time to time and it
is not possible for management to predict all such risk factors or to assess the impact of such
risk factors on the Companys business. Accordingly, the Company undertakes no obligation to
publicly update or revise any forward-looking statements, whether as a result of new information,
future events or otherwise. 
 Item 7a.Quantitative and Qualitative Disclosures about Market Risk We do not hedge our foreign currency
exchange rate exposure. Therefore, we are exposed to
foreign currency exchange rate risks. Our revenues are primarily denominated in the U.S. dollar.
During 2004, approximately 91% of our revenue was denominated in U.S.
dollars compared to 93% in 2003. In 2004 and 2003, approximately 7%
and 4%, respectively, of
our revenue was denominated in Japanese Yen, and the balance were denominated in other foreign
currencies. Some of our expenses are denominated in the local currencies of the United Kingdom,
China, Japan, Malaysia and Taiwan, 34




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##### Table of Contents



a number of which are closely tied to the U.S. dollar. China has had a managed floating
exchange rate since 1994 and the exchange rate to the U.S. Dollar has been effectively fixed since
1996. Malaysia has practiced a fixed exchange rate regime since 1998 and the exchange rate to the
U.S. Dollar has been effectively fixed since then. If the China
Renminbi were to appreciate 10% against the U.S. Dollar, the Company
estimates its Renminbi denominated costs would increase approximately
$2.6 million. Similarly, a 10% appreciation of the Malaysia Ringgit
would increase Ringgit denominated costs approximately $2.3 million. We do not invest in speculative or derivative financial instruments. We have significant
amounts of debt that are subject to interest rate fluctuation risk. The amounts outstanding under
the B and D Facilities of the Credit Agreement have variable interest rates, and therefore, adjust
to market conditions. An increase of 1 percentage point in the interest rate of the loans under the
Credit Agreement would increase annual interest expense by approximately $1.4 million. The amount
outstanding under the 13 1/8% Senior Subordinated Notes accrues interest at a fixed rate of
13.125%. We have estimated the fair value of the notes as of December 31, 2004 to be 104% of their
face value or $159 million based on current market prices. We also have $10 million outstanding
under 10% Senior Subordinated Notes. 35




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##### Table of Contents



Item 8 KNOWLES ELECTRONICS HOLDINGS, INC. CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2004, 2003 and 2002 CONTENTS PageReport
of Independent Registered Public Accounting Firm
    
    
    37Consolidated Financial StatementsConsolidated Balance Sheet
    
    
    38Consolidated Statements of Operations
    
    
    39Consolidated Statements of Changes in Stockholders Equity (Deficit)
    
    
    40Consolidated Statements of Cash Flows
    
    
    41Notes to Consolidated Financial Statements
    
    
    42
 36




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##### Table of Contents



Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders
Knowles Electronics Holdings, Inc. We have audited the accompanying consolidated balance sheets of Knowles Electronics Holdings, Inc.
and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of
operations, changes in stockholders equity (deficit) and cash flows for each of the three years in
the period ended December 31, 2004. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These
financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on
these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. We
were not engaged to perform an audit of the Companys internal control over financial reporting.
Our audit included consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Companys internal control over financial
reporting. Accordingly, we express no such opinion. An audit also 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. In our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Knowles Electronics Holdings, Inc. and
subsidiaries at December 31, 2004 and 2003, and the consolidated results of their operations and
their cash flows for each of the three years in the period ended December 31, 2004, in conformity
with U.S. generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, present
fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP Chicago, Illinois
February 25, 2005 37




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KNOWLES ELECTRONICS HOLDINGS, INC. 
 CONSOLIDATED BALANCE SHEETS RestatedDecember 31,
    
    
    December 31,2004
    
    

    2003(in thousands except share data)AssetsCash & cash equivalents
    
    $
    16,970
    
    
    $
    11,227Accounts receivable, less allowance for doubtful accounts of $452 and $527
    
    
    22,464
    
    
    
    23,128Inventories, net
    
    
    29,421
    
    
    
    17,373Prepaid expenses and other
    
    
    5,053
    
    
    
    5,023Total
current assets
    
    
    73,908
    
    
    
    56,751Property, plant and equipment, at cost:Land
    
    
    2,688
    
    
    
    2,787Building and improvements
    
    
    12,875
    
    
    
    19,273Machinery
and equipment
    
    
    69,827
    
    
    
    48,750Furniture
and fixtures
    
    
    25,408
    
    
    
    24,104Construction
in progress
    
    
    3,397
    
    
    
    11,743Subtotal
    
    
    114,195
    
    
    
    106,657Accumulated depreciation
    
    
    (60,723
    )
    
    
    (61,152
    )53,472
    
    
    
    45,505Net assets held for sale
    
    
    3,231
    
    
    
    Other assets, net
    
    
    1,045
    
    
    
    3,149Deferred finance costs, net
    
    
    6,418
    
    
    
    7,168Total assets
    
    $
    138,074
    
    
    $
    112,573Liabilities and stockholders deficitAccounts payable
    
    $
    22,893
    
    
    $
    11,272Accrued compensation and employee benefits
    
    
    11,358
    
    
    
    8,681Accrued interest payable
    
    
    4,945
    
    
    
    4,868Accrued warranty and rebates
    
    
    1,866
    
    
    
    5,902Accrued restructuring costs
    
    
    1,405
    
    
    
    1,490Other liabilities
    
    
    1,945
    
    
    
    2,645Income taxes
    
    
    4,120
    
    
    
    3,784Deferred income taxes
    
    
    609
    
    
    
    968Short term debt
    
    
    9,000
    
    
    
    Total
current liabilities
    
    
    58,141
    
    
    
    39,610Accrued pension liability
    
    
    13,639
    
    
    
    12,350Other noncurrent liabilities
    
    
    1,019
    
    
    
    407Notes payable
    
    
    298,793
    
    
    
    288,180Preferred stock mandatorily redeemable in 2019 including accumulating
dividends of: $127,842 December 2004; $99,401 December 2003
    
    
    312,842
    
    
    
    284,401Stockholders equity (deficit):Common stock, Class A, $0.001 par value, 1,052,632 shares authorized,
outstanding: 952,500 December 2004; 957,500 December 2003
    
    
    1
    
    
    
    1Common stock, Class B, $0.001 par value, 52,632 shares
authorized: none ever issued
    
    
    
    
    
    
    Capital in excess of par value
    
    
    16,337
    
    
    
    16,487Accumulated deficit
    
    
    (555,610
    )
    
    
    (522,404
    )Accumulated other comprehensive loss
    
    
    (7,088
    )
    
    
    (6,459
    )Total stockholders deficit
    
    
    (546,360
    )
    
    
    (512,375
    )Total liabilities and stockholders deficit
    
    $
    138,074
    
    
    $
    112,573
 See accompanying notes. 38




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##### Table of Contents



KNOWLES ELECTRONICS HOLDINGS, INC. 
 CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31,2004
    
    
    2003
    
    
    2002(In thousands)Net sales
    
    $
    185,511
    
    
    $
    154,042
    
    
    $
    164,119Cost of sales
    
    
    100,684
    
    
    
    75,594
    
    
    
    87,970Gross margin
    
    
    84,827
    
    
    
    78,448
    
    
    
    76,149Research and development expenses
    
    
    11,141
    
    
    
    10,225
    
    
    
    11,735Selling and marketing expenses
    
    
    11,951
    
    
    
    9,185
    
    
    
    9,503General and administrative expenses
    
    
    21,462
    
    
    
    20,547
    
    
    
    21,478Loss on sale of business
    
    
    
    
    
    
    
    
    
    
    16,736Impairment of assets held for sale
    
    
    850
    
    
    
    
    
    
    
    Restructuring activities
    
    
    5,326
    
    
    
    1,532
    
    
    
    2,112Operating income
    
    
    34,097
    
    
    
    36,959
    
    
    
    14,585Other income (expense):Interest income
    
    
    57
    
    
    
    111
    
    
    
    129Interest expense
    
    
    (33,790
    )
    
    
    (34,735
    )
    
    
    (33,891
    )Loss on extinguishment of debt
    
    
    (2,256
    )
    
    
    (1,100
    )
    
    
    Income (loss) from continuing operations before income
taxes
    
    
    (1,892
    )
    
    
    1,235
    
    
    
    (19,177
    )Income taxes
    
    
    2,873
    
    
    
    491
    
    
    
    11,744Income (loss) from continuing operations
    
    
    (4,765
    )
    
    
    744
    
    
    
    (30,921
    )Income (loss) from discontinued operations after income
taxes:Loss on sale of Infrared division
    
    
    
    
    
    
    (8,576
    )
    
    
    Gain on sale of Synchro-Start division
    
    
    
    
    
    
    35,570
    
    
    
    Income from discontinued operations
    
    
    
    
    
    
    932
    
    
    
    6,545Income from discontinued operations after income taxes
    
    
    
    
    
    
    27,926
    
    
    
    6,545Net income (loss)
    
    $
    (4,765
    )
    
    $
    28,670
    
    
    $
    (24,376
    )
 See accompanying notes. 39




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##### Table of Contents



KNOWLES ELECTRONICS HOLDINGS, INC. 
 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (DEFICIT) Retained
    
    
    AccumulatedCapital in
    
    
    Earnings
    
    
    OtherCommon
    
    
    Excess of
    
    
    (Accumulated
    
    
    ComprehensiveStock
    
    
    Par Value
    
    
    Deficit)
    
    
    Loss
    
    
    TotalBalance, December 31, 2001 as previously
reported
    
    $
    1
    
    
    $
    17,212
    
    
    $
    (475,827
    )
    
    $
    (7,166
    )
    
    $
    (465,780
    )Prior period
adjustment (see Note 2)
    
    
    
    
    
    
    
    
    
    
    (1,578
    )
    
    
    1,578
    
    
    
    Balance at December 31, 2001 as restated
    
    $
    1
    
    
    $
    17,212
    
    
    $
    (477,405
    )
    
    $
    (5,588
    )
    
    $
    (465,780
    )Net loss
    
    
    
    
    
    
    
    
    
    
    (24,376
    )
    
    
    
    
    
    
    (24,376
    )Other
comprehensive income (loss):Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,068
    
    
    
    4,068Minimum pension liability pension
adjustment net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,249
    )
    
    
    (8,249
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (28,557
    )Issue common stock
    
    
    
    
    
    
    150
    
    
    
    
    
    
    
    
    
    
    
    150Repurchase stock
    
    
    
    
    
    
    (525
    )
    
    
    
    
    
    
    
    
    
    
    (525
    )Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    (23,505
    )
    
    
    
    
    
    
    (23,505
    )Other
    
    
    
    
    
    
    
    
    
    
    66
    
    
    
    
    
    
    
    66Balance at December 31, 2002 as restated
    
    $
    1
    
    
    $
    16,837
    
    
    $
    (525,220
    )
    
    $
    (9,769
    )
    
    $
    (518,151
    )Net income
    
    
    
    
    
    
    
    
    
    
    28,670
    
    
    
    
    
    
    
    28,670Other comprehensive income:Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,543
    
    
    
    1,543Minimum
pension liability pension adjustment net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,767
    
    
    
    1,767Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31,980Repurchase stock
    
    
    
    
    
    
    (350
    )
    
    
    
    
    
    
    
    
    
    
    (350
    )Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    (25,854
    )
    
    
    
    
    
    
    (25,854
    )Balance at December 31, 2003 as restated
    
    $
    1
    
    
    $
    16,487
    
    
    $
    (522,404
    )
    
    $
    (6,459
    )
    
    $
    (512,375
    )Net loss
    
    
    
    
    
    
    
    
    
    
    (4,765
    )
    
    
    
    
    
    
    (4,765
    )Other
comprehensive income (loss):Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32
    
    
    
    32Minimum pension liability pension
adjustment net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (661
    )
    
    
    (661
    )Comprehensive
loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,394
    )Repurchase stock
    
    
    
    
    
    
    (150
    )
    
    
    
    
    
    
    
    
    
    
    (150
    )Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    (28,441
    )
    
    
    
    
    
    
    (28,441
    )Balance at December 31, 2004
    
    $
    1
    
    
    $
    16,337
    
    
    $
    (555,610
    )
    
    $
    (7,088
    )
    
    $
    (546,360
    )
 See accompanying notes. 40




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##### Table of Contents



KNOWLES ELECTRONICS HOLDINGS, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 312004
    
    
    2003
    
    
    2002(in thousands)Operating ActivitiesIncome (loss) from continuing operations
    
    
    ($4,765
    )
    
    $
    744
    
    
    
    ($30,921
    )Adjustments to reconcile net income (loss) from continuing
operations to net cash provided by operating activities:Depreciation
    
    
    8,300
    
    
    
    7,443
    
    
    
    8,703Restructuring activities
    
    
    (85
    )
    
    
    293
    
    
    
    (2,632
    )Loss on sale
of business
    
    
    
    
    
    
    
    
    
    
    16,626Amortization
of deferred financing fees
and debt discount
    
    
    1,962
    
    
    
    1,288
    
    
    
    1,434Loss on
extinguishment of debt
    
    
    2,256
    
    
    
    1,100
    
    
    
    Impairment
of assets held for sale
    
    
    850
    
    
    
    
    
    
    
    Inventory
obsolescence provision
    
    
    1,151
    
    
    
    1,416
    
    
    
    2,391Deferred
income taxes
    
    
    (359
    )
    
    
    427
    
    
    
    6,733Stock
compensation expense
    
    
    
    
    
    
    
    
    
    
    504Loss on
disposal of assets
    
    
    351
    
    
    
    160
    
    
    
    1,170Change in
assets and liabilities:Accounts receivable
    
    
    664
    
    
    
    (2,044
    )
    
    
    6,882Inventories
    
    
    (13,199
    )
    
    
    831
    
    
    
    9,362Other assets
    
    
    106
    
    
    
    272
    
    
    
    1,200Accounts payable
    
    
    10,065
    
    
    
    411
    
    
    
    (2,380
    )Accrued
interest payable
    
    
    77
    
    
    
    (1,717
    )
    
    
    2,157Accrued
compensation and benefits
    
    
    1,758
    
    
    
    2,719
    
    
    
    132Other
current liabilities
    
    
    (5,342
    )
    
    
    (3,273
    )
    
    
    (196
    )Other non
current liabilities
    
    
    2,733
    
    
    
    833
    
    
    
    1,426Income taxes payable
    
    
    336
    
    
    
    (3,763
    )
    
    
    141Net cash provided by discontinued operating activities
    
    
    
    
    
    
    3,971
    
    
    
    6,947Net cash provided by operating activities
    
    
    6,859
    
    
    
    11,111
    
    
    
    29,679Investing ActivitiesProceeds
from sale of businesses and property
    
    
    2,000
    
    
    
    45,245
    
    
    
    3,560Purchases of property, plant, and equipment
    
    
    (19,143
    )
    
    
    (14,776
    )
    
    
    (8,427
    )Net cash provided by (used in) investing activities
    
    
    (17,143
    )
    
    
    30,469
    
    
    
    (4,867
    )Financing ActivitiesDebt payments  long term
    
    
    (37,668
    )
    
    
    (87,102
    )
    
    
    (10,541
    )Debt proceeds  long term
    
    
    48,000
    
    
    
    35,000
    
    
    
    10,055Debt proceeds (payments) short term, net
    
    
    9,000
    
    
    
    
    
    
    
    (1,996
    )Costs associated with debt
    
    
    (2,107
    )
    
    
    (1,749
    )
    
    
    (681
    )Premium on early retirement of debt
    
    
    (1,080
    )
    
    
    
    
    
    
    Repurchase of common stock
    
    
    (150
    )
    
    
    (350
    )
    
    
    (400
    )Net cash provided by (used in) financing activities
    
    
    15,995
    
    
    
    (54,201
    )
    
    
    (3,563
    )Effect of exchange rate changes on cash
    
    
    32
    
    
    
    (31
    )
    
    
    600Net change in cash and cash equivalents
    
    
    5,743
    
    
    
    (12,652
    )
    
    
    21,849Cash and cash equivalents at beginning of period
    
    
    11,227
    
    
    
    23,879
    
    
    
    2,030Cash and cash equivalents at end of period
    
    $
    16,970
    
    
    $
    11,227
    
    
    $
    23,879Cash paid for interest
    
    $
    34,118
    
    
    $
    36,276
    
    
    $
    30,525Cash paid for taxes
    
    $
    2,721
    
    
    $
    3,592
    
    
    $
    5,131
 See accompanying notes. 41




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##### Table of Contents



KNOWLES ELECTRONICS HOLDINGS, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004 and 2003
 (In thousands)
 1. Accounting Policies Basis of Recapitalization and Presentation The consolidated financial statements of Knowles Electronics Holdings, Inc. (the Company)
include the accounts and transactions of the Company and all of its
subsidiaries. Significant intercompany and affiliate accounts and
transactions have been eliminated in consolidation. In connection with a reorganization as a holding company, the Company changed its name from
Knowles Electronics, Inc. to Knowles Electronics Holdings, Inc. on September 23, 1999. On June 23, 1999, the Company entered into a recapitalization agreement with Key Acquisition
L.L.C., (the Investor) and the preexisting common stockholders of the Company (the
Recapitalization). The recapitalization transaction closed on June 30, 1999. The Recapitalization
was treated as a leveraged recapitalization in which the issuance of the debt has been accounted
for as a financing transaction, the sales and purchases of the Companys stock have been accounted
for as capital transactions at amounts paid or received, and no changes were made to the carrying
values of the Companys assets and liabilities. In conjunction with the Recapitalization, the Company authorized and issued, on June 30, 1999,
new shares of mandatorily redeemable preferred stock (Series A-1 and Series A-2), each with par
value $0.001 per share (the Preferred Stock), and common stock (Class A and Class B), par value
$0.001 per share (Common Stock). The Investor purchased 800,000 shares of Common Stock for $24,000
and 164,444 shares of Series A-1 Preferred Stock for $164,444. In addition, certain members of
management purchased 71,667 shares of Common Stock for $2,150. After the transactions related to
the Recapitalization, which are described below, the preexisting stockholders held 100,000 shares
of Common Stock and 20,556 shares of Series A-2 Preferred Stock which was recorded at $20,556. As
of December 31, 2004, the liquidation value of the outstanding Series A-1 Preferred Stock is
$278,081 and the liquidation value of the outstanding Series A-2 Preferred stock is $34,761. The Preferred Stock ranks senior to all other equity securities of the Company with respect to
dividend and distribution preference. The liquidation value of each share of Preferred Stock is
$1,000. Dividends on each share of Preferred Stock accrue at a rate of 10% per annum of the
liquidated value plus any accumulated dividends. Such dividends for the year ended December 31,
2004, amounted to $28,441. The Preferred Stock is mandatorily redeemable on July 2, 2019, at a
redemption price per share equal to the liquidation value plus all previously accumulated dividends
and all accrued dividends not yet paid or accumulated. The Company may, at any time, and the
holders may, upon the earlier of June 30, 2010, or an initial public offering of the Companys
Common Stock which is a primary registered offering or the sale of all or substantially all of the
Companys Common Stock or assets, require the Company to redeem all or any portion of the Series
A-1 Preferred Stock then outstanding at a price per share equal to the liquidation value plus all
accumulated and all accrued and unpaid or unaccumulated dividends. The Series A-2 Preferred Stock
is not redeemable at the Companys option at any time. In the event of such an initial public
offering, holders of Series A-1 and A-2 Preferred Stock may elect to convert the shares into Common
Stock. In addition, on each June 30, the Company has an option to exchange the then outstanding
shares of Series A-1 Preferred Stock in whole, but not part of, for 10% Junior Subordinated Notes
due 2010 of the Company, in an aggregate principal amount equal to the sum of the liquidation value
of the Series A-1 Preferred Stock plus an amount equal to all accumulated and all accrued and
unpaid, but not yet accumulated, dividends. Series A Preferred Stock have no voting rights; with respect to any issue required to be voted
on and approved by holders of Series A-1 Preferred Stock, the holders of the Series A-1 Preferred
Stock and the holders of Series A-2 Preferred Stock will each vote as a single class. 42




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##### Table of Contents



After completion of the Recapitalization transactions, the Investors, preexisting
stockholders, and managements ownership percentage of the Company was approximately 82.3%, 10.3%,
and 7.4%, respectively. Description of Business The Company develops, manufactures, and supplies audio communications components, primarily
miniaturized microphones and receivers used in hearing aids, microphones, headsets, cell phones and
accessories for the computer and communication industries. Foreign Operations Assets and liabilities are translated using the exchange data at the balance sheet date and
revenues and expenses are translated using weighted-average exchange data. Translation adjustments
for those entities which have the U.S. dollar as their functional currency are recorded to the
income statement and adjustments for all other entities are recorded
as a separate component of stockholders equity (deficit). 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 at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ from those
estimates. Reclassifications Certain prior years amounts have been reclassified to conform to the 2004 financial statement
presentation. Cash Equivalents Cash equivalents consist of highly liquid investments, having maturities of three months or
less from date of purchase, which are readily convertible into cash. Accounts Receivable and Allowances for Doubtful Accounts The Company carries its accounts receivable at face value amount net of an allowance for
doubtful accounts. The allowance for doubtful accounts is calculated by applying standard reserve
percentages to the aging categories. An additional reserve is also recorded for uncollectible
accounts that have been specifically identified. A receivable is considered past due if payments
have not been received within agreed upon invoice terms. Uncollectible receivables are charged
against the allowance for doubtful accounts when approved by management after all collection
efforts have been exhausted. Inventories Inventories are stated at the lower of cost (first in, first out) or market. Costs include
direct material, direct labor and applicable production overhead costs. Deferred Finance Costs Deferred finance costs associated with the issuance of long-term debt are capitalized and
amortized over the life of the related debt using the effective interest method. 43




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##### Table of Contents



Property, Plant, and Equipment Property, plant and equipment are valued at cost. Interest expense capitalized as part of the
cost of property, plant and equipment was $405, $442 and $225 in 2004, 2003 and 2002 respectively. Depreciation of property, plant, and equipment is computed principally on a declining-balance
method based on the following estimated useful lives: Buildings and Improvements  10 to 40 years;
Leasehold Improvements  lesser of useful life of assets or
lease terms; Machinery and Equipment  4 to 12 years; Furniture and Fixtures  3 to 18 years; and Computer
Equipment  3 to 5 years. Property, plant, and equipment are reviewed for impairment whenever changes in circumstances
indicate that the carrying value of the assets may not be recoverable. Product Warranties The Company provides an accrual for estimated future warranty costs at the time products are
sold and periodically adjusts the accrual to reflect actual experience. The warranty on products
sold generally extends from one to three years. Pension Benefits The Companys pension benefit costs and obligations are dependent on the various actuarial
assumptions used in calculating such amounts. These assumptions relate to discount rates, salary
growth, long-term return on plan assets and other factors. The Company bases the discount rate
assumptions for the U.S. plan on current investment yields on AA-rated long-term corporate bonds.
The salary growth assumptions reflect the Companys actual experience and near-term outlook.
Long-term return on plan assets is determined based on historical portfolio results and
managements expectation of the future economic environment. The Companys key assumptions are
described in further detail in Note 8. Fair Value of Financial Instruments The carrying amounts reported in the Companys balance sheets for cash and cash equivalents,
trade accounts receivable, accounts payable, and short-term debt approximate fair value because of
the short-term nature of these instruments. The carrying amounts reported in the Companys balance sheets for variable-rate long-term debt
approximate fair value. The Company estimates the fair value of fixed rate long-term debt obligations using current
market prices available for these or similar obligations. The fair value of the 13 1/8% Senior
Subordinated Notes was approximately $159 million at December 31, 2004. The fair value of the 10%
Senior Subordinated Notes was $10 million at December 31,
2004. Accumulated Other Comprehensive Loss The
balance of accumulated other comprehensive loss is ($55) of translation adjustment plus
$7,143 of minimum pension liability in 2004, and in 2003, ($23) of translation adjustment plus
$6,482 of minimum pension liability. 44




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##### Table of Contents



Revenue Recognition Revenues from the Companys products are recognized when title to the products transfers to
the customer, which typically is upon the shipment of products to the customers. Shipping Costs Amounts invoiced to customers to cover shipping costs are included in sales. The cost of
shipping product to customers is included in cost of sales. Research and Development Research and development expenditures are charged to expense as incurred. Interest Expense The Company presents interest expense net of capitalized interest cost and includes amortized
deferred finance costs and bond discount. Income Taxes Income taxes are provided currently on financial statement earnings of non-U.S. subsidiaries
expected to be repatriated. The Company accounts for income taxes using the asset and liability
method. This approach requires the recognition of deferred tax assets and liabilities for the
expected future tax consequences of temporary differences between the carrying amounts and the tax
basis of assets and liabilities. Stock Options The Company accounts for its stock-based
compensation plan using the intrinsic value method in
accordance with Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to
Employees, and related interpretations. Under the intrinsic value method, compensation expense for
stock options is based on the excess, if any, of the fair value of the stock at the date of the
grant over the exercise price. New Accounting Standards In May 2003, the Financial Accounting Standards Board (FASB) issued SFAS No 150  Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and Equity.SFAS 150
requires certain obligations including mandatorily redeemable preferred stock to be reflected as
liabilities in the balance sheet. Additionally, dividends paid or accrued on mandatorily redeemable
preferred stock will be presented as interest expense in the income statement. We adopted the
provisions of SFAS 150 on January 1, 2004. Since the Companys preferred stock contains provisions
whereby the preferred stock and accumulated dividends may be converted to common stock, the
preferred stock and its dividends continue to be reflected as such. There was no material impact
on our financial position or results of operations as a result of the adoption of SFAS 150. In
November 2004, the FASB issued SFAS No. 151, Inventory Costs  an amendment of ARB No. 43
Chapter 4. SFAS No. 151 more clearly defines when excessive idle facility expense, freight,
handling costs, and spoilage are to be current-period charges. In addition, SFAS No. 151 requires
the allocation of fixed production overhead to the cost of conversion to be based on the normal
capacity of the production facilities. SFAS No. 151 is effective for inventory costs incurred
during fiscal years beginning after June 15, 2005. The Company has reviewed the provisions of this
standard, and does not expect SFAS No. 151 to have a material impact on the financial statements. In
December 2004, the FASB issued SFAS No. 123R,
Share-Based Payment. SFAS No. 123R
supercedes APB No. 25, SFAS No. 123, as amended by SFAS No. 148, and related interpretations. Under
SFAS No. 123R, compensation cost is measured at the grant date based on the estimated fair value of
the award and is required to be recognized as compensation expense over the vesting period. The
Company plans to adopt SFAS No. 123R in the third quarter of 2005. The Company has reviewed the
provisions of this standard, and its adoption is not expected to have a material effect on the
Companys Consolidated Financial Statements. 45




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##### Table of Contents



2. Restatement of Financial Statements The Company is restating its prior years financial statements because an error was discovered
that affects cost of sales and other comprehensive income and certain disclosures previously
reported in our financial statements. The results for 2000 have been restated to correct an error
in the balance of other comprehensive income resulting from the conversion to a new consolidation
system in 2000. The error incorrectly recorded a translation loss as an adjustment to equity
rather than an adjustment to the income statement and was primarily related to the U.K. entity.
The correction increased cost of sales in 2000 by $1,578. Appropriate balance sheet accounts have
also been restated. 3. Discontinued Operations The Companys consolidated financial statements and related footnote disclosures reflect the
Synchro-Start and Infrared (Ruwido) businesses as discontinued operations, net of applicable income
taxes, for all periods presented in accordance with SFAS
No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. As such, discontinued operations includes the January through May
2003 operating results of the Synchro-Start business, the sale of which was completed May 30, 2003,
and the gain on the Synchro-Start sale. Discontinued operations also includes the January through
July 2003 operating results of the Infrared business, the sale of which was completed July 29,
2003, and the loss on the sale. 46




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##### Table of Contents



The Synchro-Start division was part of the Companys Automotive Components reporting segment.
The Infrared business was part of the Companys Acoustic and Infrared Technology reporting segment.
The Company has subsequently modified its segment reporting, see Note 10. Summarized selected financial information for the discontinued operations is as follows: For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Net sales
    
    $
    
    
    
    $
    26,513
    
    
    $
    51,986Income (loss) from discontinued operations
    
    $
    
    
    
    $
    1,102
    
    
    $
    6,591Income tax expense
    
    
    
    
    
    
    170
    
    
    
    46Income (loss) from discontinued operations, net of tax
    
    $
    
    
    
    $
    932
    
    
    $
    6,545
 The Company sold Synchro-Start for $49.7 million in 2003. The Company retained pension
liabilities of $3.5 million associated with the pension plan covering U.S. employees. The Company
recorded a pre-tax gain on the sale of Synchro-Start of $36.3 million. The tax on the gain was $0.7
million which reflects an alternative minimum tax created by the transaction. The benefit of the
carryforward of the alternative minimum tax credit has not been recognized due to the uncertainty
of the realization of this benefit. The tax on the gain was limited to the alternative minimum tax
due to the utilization of net operating loss carryforwards that had previously not been benefited. The Company sold the Infrared business for $100 on July 29, 2003 and the buyer retained debt
of $4.0 million. The Company recorded a pre-tax loss on the sale of $8.6 million. No tax benefit
from the loss was recorded because the loss is netted against the gain on the Synchro-Start sale
and the tax on that net gain is offset by the utilization of net operating loss carryforwards that
had previously not been benefited. In November 2002, the Company sold its Ruf division, which was part of the Companys
Automotive Components reporting segment. In accordance with APB
No. 30 Reporting the Results of
Operations  Reporting the Effects of Disposal of a Segment of a Business and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions, the Ruf business did not qualify as a
discontinued operation and therefore, its results of operations and cash flows are included in the
Companys results of continuing operations and cash flows for all 2002 periods presented. 47




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##### Table of Contents



4. Inventory Inventories are as follows: 2004
    
    
    2003Raw materials
    
    $
    15,627
    
    
    $
    9,211Work in process
    
    
    3,652
    
    
    
    1,341Finished goods
    
    
    15,453
    
    
    
    10,96934,732
    
    
    
    21,521Less allowances for :Obsolescence and net realizable value
    
    
    (5,311
    )
    
    
    (4,148
    )$
    29,421
    
    
    $
    17,373
 5. Income Taxes Income (loss) from continuing operations before income taxes consists of the following: 2004
    
    
    2003
    
    
    2002United States
    
    $
    (10,196
    )
    
    $
    (17,396
    )
    
    $
    (30,946
    )Foreign
    
    
    8,304
    
    
    
    18,631
    
    
    
    11,769$
    (1,892
    )
    
    $
    1,235
    
    
    $
    (19,177
    )
 A reconciliation of income tax expense to the statutory federal rate of 35% is as follows: Year ended December 312004
    
    
    2003
    
    
    2002Statutory
federal income tax effects:
    
    $
    (662
    )
    
    $
    432
    
    
    $
    (6,712
    )Foreign rate differential
    
    
    (803
    )
    
    
    (4,283
    )
    
    
    (10,633
    )Taxes on unremitted foreign earnings
    
    
    (10,259
    )
    
    
    3,800
    
    
    
    (1,179
    )Valuation allowance
    
    
    18,544
    
    
    
    2,286
    
    
    
    29,574Reduction of prior year taxes
    
    
    (3,559
    )
    
    
    (1,596
    )Other, net
    
    
    (388
    )
    
    
    (148
    )
    
    
    694$
    2,873
    
    
    $
    491
    
    
    $
    11,744
 During
2004 and 2003, the Company had a net reduction in income tax
provision of $3.6 and $1.6 million, respectively, related
primarily to an adjustment in foreign tax credits and net operating
losses. 48




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##### Table of Contents



The income tax provision for the years ended December 31, 2004, 2003, and 2002 consists of the
following: Year ended December 312004
    
    
    2003
    
    
    2002Current:Federal
    
    $
    (710
    )
    
    $
    (1,641
    )
    
    $
    State
    
    
    
    
    
    
    
    
    
    
    Foreign
    
    
    3,942
    
    
    
    1,006
    
    
    
    5,432Total Current
    
    
    3,232
    
    
    
    (635
    )
    
    
    5,432DeferredFederal
    
    
    
    
    
    
    
    
    
    
    6,797State
    
    
    
    
    
    
    
    
    
    
    Foreign
    
    
    (359
    )
    
    
    1,126
    
    
    
    (485
    )Total Deferred
    
    
    (359
    )
    
    
    1,126
    
    
    
    6,312Total tax provision
    
    $
    2,873
    
    
    $
    491
    
    
    $
    11,744
 Deferred income taxes reflect the net tax effect of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the amounts used for income
tax purposes. Significant components of deferred tax assets and liabilities as of December 31, 2004 and
2003, are as follows: December 312004
    
    
    2003Deferred tax assets:Non-U.S. net operating loss carryforward
    
    $
    1,759
    
    
    $
    910U.S. net operating loss carryforward
    
    
    8,514
    
    
    
    6,018Foreign tax credits carryforward
    
    
    24,171
    
    
    
    17,632Pension
    
    
    3,280
    
    
    
    2,429Inventory
    
    
    1,068
    
    
    
    1,484Accrued expenses
    
    
    2,677
    
    
    
    3,893Other, net
    
    
    130
    
    
    
    715Total deferred tax assets
    
    
    41,599
    
    
    
    33,081Valuation
allowance
    
    
    (39,868
    )
    
    
    (21,324
    )Net deferred
tax asset
    
    
    1,731
    
    
    
    11,757Deferred tax liabilities:Taxes on unremitted foreign earnings
    
    
    
    
    
    
    (10,259
    )Other deferred tax liabilities
    
    
    (2,340
    )
    
    
    (2,466
    )Total deferred tax liabilities
    
    
    (2,340
    )
    
    
    (12,725
    )Net deferred tax liabilities
    
    $
    (609
    )
    
    $
    (968
    )
 The Company had foreign net operating loss carryforwards of $7,022 and $3,466 at December 31,
2004 and 2003 that have an indefinite carryforward period. In addition, the Company had state net
operating loss carry forwards of $61,644 at December 31, 2004, that begin to expire in 2016. The
Companys foreign tax credit carryforward of $24,171 begins to expire in 2009. The Company has
provided a valuation allowance against the net deferred tax assets due to the uncertainty of
realization of those assets. The Company had federal net operating
loss carryforwards of $15,969 and $2,627 at December 31, 2004 and
2003, respectively, that begin to expire in 2022. 49




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##### Table of Contents



During 2004, the Company reversed $10,259 of deferred tax liabilities related to unrepatriated
accumulated earnings of several wholly owned foreign subsidiaries. At December 31, 2004 the
Company determined that such foreign earnings are permanently reinvested and are unlikely to be
repatriated as dividends to the U.S. The Companys future operating plan is to repatriate current
year foreign earnings not needed for near term investment in each country. 6. Notes Payable As part of the Recapitalization transaction, the Company entered into a Credit Agreement dated
June 28, 1999 and amended and restated as of July 21, 1999, and further amended and otherwise
modified from time to time, most recently as of April 14, 2004, with certain lenders (Credit
Agreement). The Company obtained a Seventh Amendment to Credit Agreement
as of April 14, 2004, amending the (i) Credit Agreement and (ii) the Security Agreement
dated as of June 30, 1999 (as amended, restated, supplemented or otherwise modified from time to
time), among Knowles Electronics Holdings, Inc., its U.S. subsidiaries and JPMorgan Chase Bank
(successor to The Chase Manhattan Bank) as Administrative Agent (the Seventh Amendment). The
Seventh Amendment, which became effective April 14, 2004, provides for D Facility loans due June
2007 in a principal amount of $48 million, the repayment in full of C Facility loans with part of
the proceeds of D Facility loans and an amendment to the Credit Agreements interest coverage ratio
and leverage ratio requirements, among other changes. Pursuant to the Seventh Amendment, the
Company has repaid the outstanding principal balance under the C Facility loans, (which had an
18.5% interest rate) together with accrued interest thereon, together totaling approximately $36.0
million. The Company also paid a related prepayment penalty of $1.1 million and certain other fees
to the lenders in connection with the Seventh Amendment. The Credit Agreement as amended consists of approximately $153 million, which provides for
revolving loans of $15 million (Revolving Credit Facility) through June 30, 2006 (unless the B
Facility is paid in full prior to such date in which case the Revolving Credit Facility will cease
to exist and any amounts outstanding thereunder shall become due and payable), a B Facility of $90
million (B Facility), which matures on June 29, 2007, and a D Facility of $48 million (D
Facility), which matures on June 29, 2007. The Revolving Credit Facility bears interest, at the Companys option, at either: (1) one-,
two-, three-, or six-month LIBOR plus 4.0%, or (2) the greater of the prime rate, a base
certificate of deposit rate plus 1.00%, or the federal funds effective rate plus 0.50% (the
Alternate Base Rate), in each case plus an initial margin of 3%. The borrowings under this
facility at December 31, 2004 and 2003 were $9.0 million at
an interest rate of 6.4375% and none, respectively. The B Facility bears interest, at the Companys option, at either: (1) one-, two-, three-, or
six-month LIBOR plus 5.00%, or (2) Alternate Base Rate plus an initial margin of 4.00%. The D
Facility loans bear currently payable interest, at the Companys option, at either: (1) one-, two-,
three-, or six-month LIBOR plus 7.25%, or (2) the greatest of the prime rate, a base certificate of
deposit rate plus 1.0% or the federal funds effective rate plus 0.50%, in each case plus an initial
margin of 6.25%. At December 31, 2004, the weighted average interest rate was 7.1875% for the B
Facility and 9.5% for the D Facility. The initial margin may be reduced if the Company meets certain specified leverage ratios
during a period consisting of the prior four consecutive fiscal quarters. Any reduced interest
margin may be increased to the original margin if such leverage ratios do not continue to be met by
the Company. The B Facility is due on June 29, 2007, and is payable in quarterly installments during the
following periods, as amended, subject to the effect of prepayments: September 30, 2006
    
    
    21,950December 31, 2006 to June 29, 2007
    
    
    22,550
 50




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##### Table of Contents



The
balance under the B Facility, C Facility, D Facility, the 13 1/8% Senior Subordinated
Notes (13 1/8% Notes), and the 10% Senior Subordinated Notes (10% Notes) is as follows: December 31,2004
    
    
    2003B Facility
    
    $
    89,601
    
    
    $
    91,601C Facility
    
    
    
    
    
    
    35,668D Facility
    
    
    48,000
    
    
    
    13 1/8% Senior Subordinated Notes, net
    
    
    151,192
    
    
    
    150,91110% Senior Subordinated Notes
    
    
    10,000
    
    
    
    10,000298,793
    
    
    
    288,180Less: Current portion
    
    
    
    
    
    
    Total long-term notes payable
    
    $
    298,793
    
    
    $
    288,180
 Maturities of Notes Payable follows (including B Facility and D Facility under the Credit
Agreement as amended April 14, 2004): 2005
    
    $
    2006
    
    
    44,5002007
    
    
    93,1012008
    
    
    2009
    
    
    163,200$
    300,801
 The 13 1/8% Notes were issued in a private placement on October 1, 1999, and are due October
15, 2009, with interest payable semiannually at 13 1/8% commencing April 15, 2000. The Company
subsequently exchanged all of the privately placed 13 1/8% Notes for a like amount of identical Notes
registered with the Securities and Exchange Commission. The 13 1/8% Notes rank equally with all
other unsecured senior subordinated indebtedness of the Company. The
13 1/8% Notes are junior to all of the
Companys current and future indebtedness, except indebtedness which is expressly not senior to the
13 1/8% Notes. On
December 20, 2004 the company entered into a new unsecured $10
million credit agreement with Xerion Partners (Xerion Credit
Agreement). Except in certain circumstances, loans under the
new unsecured agreement bear interest at the one, two, three or six
month LIBOR rate plus 7.75%. No borrowing was outstanding under this
loan agreement as of December, 31, 2004. The 10% Senior Subordinated Notes were issued in a private placement to an affiliate of
Doughty Hanson on August 29, 2002 and are due October 15, 2009, with interest payable semiannually
at 10% commencing April 15, 2003. The 10% Notes rank subordinate to all Senior Indebtedness of the
Company and pari passuto the 13 1/8% Notes. The Companys Credit Agreement requires that the Company comply with certain covenants
and restrictions, including specific financial ratios that must be maintained. As of December 31,
2004, the Company is in compliance with these covenants. If future actual results are lower than
planned the Company may be unable to comply with the debt covenants or make required debt service
payments. Such inability could have a material adverse impact on the Companys financial condition,
results of operations or liquidity. There are no assurances that the Company could favorably
resolve such a situation. As security for our obligations under the Credit Agreement, we have pledged all of the shares
of our U.S. subsidiaries and 65% of the shares of our non-U.S. subsidiaries and have granted the
lenders a security interest in substantially all the assets of our U.S. subsidiaries. The 13 1/8% Notes and 10% Notes are unconditionally guaranteed, on a joint and several basis,
by the following wholly owned U.S. subsidiaries of the Company: Knowles Electronics LLC, Knowles
Intermediate Holding, Inc., Knowles Electronics Sales Corp. and Knowles Manufacturing Ltd. The
following tables present summarized balance sheet information of the Company as of December 31,
2004 and 2003, and summarized income statement and cash flow information for the years ended
December 31, 2004, 2003, and 2002. The column labeled Parent Company represents the holding
company for each of the Companys direct subsidiaries which are
guarantors of the 13 1/8% and 10% Notes, all of
which are wholly owned by the parent company; and the column labeled Nonguarantors represents
wholly owned subsidiaries of the Guarantors which are not guarantors
of the 13 1/8% and 10% Notes. The Company
believes that separate financial statements and other disclosures regarding the Guarantors, except
as otherwise required under Regulation S-X, are not material to investors. 51




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##### Table of Contents



Summarized information as of December 31, 2004 and 2003, and for the three years ended
December 31, 2004, is as follows: December 31, 2004Parent
    
    
    Guarantors
    
    
    Non-Guarantors
    
    
    Eliminations
    
    
    ConsolidatedCash
    
    $
    625
    
    
    $
    10,053
    
    
    $
    6,292
    
    
    $
    
    
    
    $
    16,970Accounts receivable
    
    
    
    
    
    
    40,089
    
    
    
    80,621
    
    
    
    (98,246
    )
    
    
    22,464Inventories
    
    
    
    
    
    
    8,222
    
    
    
    21,199
    
    
    
    
    
    
    
    29,421Other current assets
    
    
    
    
    
    
    3,398
    
    
    
    1,655
    
    
    
    
    
    
    
    5,053Net property, plant and equipment
    
    
    
    
    
    
    17,481
    
    
    
    35,991
    
    
    
    
    
    
    
    53,472Assets held for sale, net of impairment
    
    
    
    
    
    
    3,231
    
    
    
    
    
    
    
    
    
    
    
    3,231Investment in and advances to subsidiaries
    
    
    101,346
    
    
    
    380,928
    
    
    
    60
    
    
    
    (482,334
    )
    
    
    Deferred finance costs, net
    
    
    6,418
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,418Other non-current assets
    
    
    
    
    
    
    197
    
    
    
    848
    
    
    
    
    
    
    
    1,045Total assets
    
    $
    108,389
    
    
    $
    463,599
    
    
    $
    146,666
    
    
    $
    (580,580
    )
    
    $
    138,074Accounts payable
    
    $
    
    
    
    $
    40,028
    
    
    $
    80,886
    
    
    $
    (98,021
    )
    
    $
    22,893Accrued restructuring costs
    
    
    
    
    
    
    1,405
    
    
    
    
    
    
    
    
    
    
    
    1,405Advances from parent
    
    
    233,090
    
    
    
    86,027
    
    
    
    350
    
    
    
    (319,467
    )
    
    
    Other current liabilities
    
    
    4,944
    
    
    
    14,669
    
    
    
    4,846
    
    
    
    (225
    )
    
    
    24,234Short-term debt
    
    
    9,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,000Deferred income taxes
    
    
    
    
    
    
    
    
    
    
    609
    
    
    
    
    
    
    
    609Noncurrent liabilities
    
    
    
    
    
    
    10,844
    
    
    
    3,814
    
    
    
    
    
    
    
    14,658Notes payable
    
    
    298,793
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    298,793Preferred stock
    
    
    312,842
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    312,842Stockholders equity (deficit)
    
    
    (750,280
    )
    
    
    310,626
    
    
    
    56,161
    
    
    
    (162,867
    )
    
    
    (546,360
    )Total liabilities and stockholders equity (deficit)
    
    $
    108,389
    
    
    $
    463,599
    
    
    $
    146,666
    
    
    $
    (580,580
    )
    
    $
    138,074
 52




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##### Table of Contents



December 31, 2003Parent
    
    
    Guarantors
    
    
    Non-Guarantors
    
    
    Eliminations
    
    
    ConsolidatedCash
    
    $
    866
    
    
    $
    5,627
    
    
    $
    4,734
    
    
    $
    
    
    
    $
    11,227Accounts receivable
    
    
    
    
    
    
    29,333
    
    
    
    60,541
    
    
    
    (66,746
    )
    
    
    23,128Inventories
    
    
    
    
    
    
    6,047
    
    
    
    11,326
    
    
    
    
    
    
    
    17,373Other current assets
    
    
    
    
    
    
    1,169
    
    
    
    3,854
    
    
    
    
    
    
    
    5,023Net property, plant and equipment
    
    
    
    
    
    
    25,609
    
    
    
    19,896
    
    
    
    
    
    
    
    45,505Assets held for sale, net of impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Investment in and advances to subsidiaries
    
    
    101,347
    
    
    
    358,574
    
    
    
    2,443
    
    
    
    (462,364
    )
    
    
    Deferred finance costs, net
    
    
    7,168
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,168Deferred income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other non-current assets
    
    
    
    
    
    
    2,969
    
    
    
    180
    
    
    
    
    
    
    
    3,149Total assets
    
    $
    109,381
    
    
    $
    429,328
    
    
    $
    102,974
    
    
    $
    (529,110
    )
    
    $
    112,573Accounts payable
    
    $
    
    
    
    $
    32,642
    
    
    $
    45,376
    
    
    $
    (66,746
    )
    
    $
    11,272Accrued restructuring costs
    
    
    
    
    
    
    1,490
    
    
    
    
    
    
    
    
    
    
    
    1,490Advances from parent
    
    
    217,164
    
    
    
    90,385
    
    
    
    350
    
    
    
    (307,899
    )
    
    
    Other current liabilities
    
    
    4,875
    
    
    
    15,761
    
    
    
    5,244
    
    
    
    
    
    
    
    25,880Deferred income taxes
    
    
    
    
    
    
    
    
    
    
    968
    
    
    
    
    
    
    
    968Noncurrent liabilities
    
    
    
    
    
    
    9,043
    
    
    
    3,714
    
    
    
    
    
    
    
    12,757Notes payable
    
    
    288,180
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    288,180Preferred stock
    
    
    284,401
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    284,401Stockholders equity (deficit)
    
    
    (685,239
    )
    
    
    280,007
    
    
    
    47,322
    
    
    
    (154,465
    )
    
    
    (512,375
    )Total liabilities and stockholders equity (deficit)
    
    $
    109,381
    
    
    $
    429,328
    
    
    $
    102,974
    
    
    $
    (529,110
    )
    
    $
    112,573
 53




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##### Table of Contents



Twelve Months Ended December 31, 2004Parent
    
    
    Guarantors
    
    
    Non-guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet sales
    
    $
    
    
    
    $
    167,419
    
    
    $
    227,937
    
    
    $
    (209,845
    )
    
    $
    185,511Cost of sales
    
    
    
    
    
    
    97,482
    
    
    
    210,991
    
    
    
    (207,789
    )
    
    
    100,684Gross margin
    
    
    
    
    
    
    69,937
    
    
    
    16,946
    
    
    
    (2,056
    )
    
    
    84,827Selling, research and
administrative expenses
    
    
    
    
    
    
    36,626
    
    
    
    9,984
    
    
    
    (2,056
    )
    
    
    44,554Impairment of assets held for sale
    
    
    
    
    
    
    850
    
    
    
    
    
    
    
    
    
    
    
    850Restructuring activity
    
    
    
    
    
    
    3,752
    
    
    
    1,574
    
    
    
    
    
    
    
    5,326Operating income
    
    
    
    
    
    
    28,709
    
    
    
    5,388
    
    
    
    
    
    
    
    34,097Other income (expense):Interest income
    
    
    
    
    
    
    22
    
    
    
    254
    
    
    
    (219
    )
    
    
    57Interest expense
    
    
    (34,195
    )
    
    
    192
    
    
    
    (6
    )
    
    
    219
    
    
    
    (33,790
    )Loss on extinguishment of debt
    
    
    (2,256
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,256
    )Income (loss) before taxes
    
    
    (36,451
    )
    
    
    28,923
    
    
    
    5,636
    
    
    
    
    
    
    
    (1,892
    )Income taxes
    
    
    
    
    
    
    1,220
    
    
    
    1,653
    
    
    
    
    
    
    
    2,873Net income (loss)
    
    $
    (36,451
    )
    
    $
    27,703
    
    
    $
    3,983
    
    
    $
    
    
    
    $
    (4,765
    )
 54




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##### Table of Contents



Twelve Months Ended December 31, 2003Parent
    
    
    Guarantors
    
    
    Non-Guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet sales
    
    $
    
    
    
    $
    140,399
    
    
    $
    165,808
    
    
    $
    (152,165
    )
    
    $
    154,042Cost of sales
    
    
    
    
    
    
    84,311
    
    
    
    142,411
    
    
    
    (151,128
    )
    
    
    75,594Gross margin
    
    
    
    
    
    
    56,088
    
    
    
    23,397
    
    
    
    (1,037
    )
    
    
    78,448Selling, research and administrative expenses
    
    
    
    
    
    
    33,607
    
    
    
    6,905
    
    
    
    (555
    )
    
    
    39,957Restructuring activity
    
    
    
    
    
    
    1,617
    
    
    
    (85
    )
    
    
    
    
    
    
    1,532Operating income
    
    
    
    
    
    
    20,864
    
    
    
    16,577
    
    
    
    (482
    )
    
    
    36,959Other income (expense):Interest income
    
    
    
    
    
    
    134
    
    
    
    46
    
    
    
    (69
    )
    
    
    111Interest expense
    
    
    (35,131
    )
    
    
    (56
    )
    
    
    (117
    )
    
    
    569
    
    
    
    (34,735
    )Loss on extinguishment of debt
    
    
    (1,100
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,100
    )Dividend income
    
    
    
    
    
    
    46,290
    
    
    
    
    
    
    
    (46,290
    )
    
    
    Income (loss) from continuing operations before income taxes
    
    
    (36,231
    )
    
    
    67,232
    
    
    
    16,506
    
    
    
    (46,272
    )
    
    
    1,235Income taxes
    
    
    
    
    
    
    (1,500
    )
    
    
    1,991
    
    
    
    
    
    
    
    491Income (loss) from continuing operations after income taxes
    
    
    (36,231
    )
    
    
    68,732
    
    
    
    14,515
    
    
    
    (46,272
    )
    
    
    744Income (loss) from discontinued operations after income taxes
    
    
    
    
    
    
    27,743
    
    
    
    559
    
    
    
    (376
    )
    
    
    27,926Net income (loss)
    
    $
    (36,231
    )
    
    $
    96,475
    
    
    $
    15,074
    
    
    $
    (46,648
    )
    
    $
    28,670
 55




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##### Table of Contents



Year Ended December 31, 2002Parent
    
    
    Guarantors
    
    
    Non-Guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet sales
    
    $
    
    
    
    $
    120,352
    
    
    $
    161,911
    
    
    $
    (118,144
    )
    
    $
    164,119Cost of sales
    
    
    
    
    
    
    75,847
    
    
    
    129,723
    
    
    
    (117,600
    )
    
    
    87,970Gross margin
    
    
    
    
    
    
    44,505
    
    
    
    32,188
    
    
    
    (544
    )
    
    
    76,149Selling, research and administrative expenses
    
    
    
    
    
    
    31,739
    
    
    
    11,704
    
    
    
    (727
    )
    
    
    42,716Loss on sale of business
    
    
    
    
    
    
    
    
    
    
    16,736
    
    
    
    
    
    
    
    16,736Restructuring activity
    
    
    
    
    
    
    1,139
    
    
    
    925
    
    
    
    48
    
    
    
    2,112Operating income
    
    
    
    
    
    
    11,627
    
    
    
    2,823
    
    
    
    135
    
    
    
    14,585Other income (expense):Interest income
    
    
    
    
    
    
    2,305
    
    
    
    431
    
    
    
    (2,607
    )
    
    
    129Interest expense
    
    
    (34,106
    )
    
    
    (1,382
    )
    
    
    (1,009
    )
    
    
    2,606
    
    
    
    (33,891
    )Dividend income
    
    
    3,380
    
    
    
    12,280
    
    
    
    
    
    
    
    (15,660
    )
    
    
    Income (loss) from continuing operations before taxes
    
    
    (30,726
    )
    
    
    24,830
    
    
    
    2,245
    
    
    
    (15,526
    )
    
    
    (19,177
    )Income taxes
    
    
    
    
    
    
    6,858
    
    
    
    4,886
    
    
    
    
    
    
    
    11,744Income (loss) from continuing operations after income tax
    
    
    (30,726
    )
    
    
    17,972
    
    
    
    (2,641
    )
    
    
    (15,526
    )
    
    
    (30,921
    )Income (loss) from discontinued operations
    
    
    
    
    
    
    4,205
    
    
    
    2,413
    
    
    
    (73
    )
    
    
    6,545Net income (loss)
    
    $
    (30,726
    )
    
    $
    22,177
    
    
    $
    (228
    )
    
    $
    (15,599
    )
    
    $
    (24,376
    )
 56




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##### Table of Contents



Twelve Months Ended December 31, 2004Parent
    
    
    Guarantors
    
    
    Non-guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet cash provided by (used in) operating activities
    
    $
    (32,162
    )
    
    $
    38,163
    
    
    $
    858
    
    
    $
    
    
    
    $
    6,859Proceeds
from sale of business(1)
    
    
    
    
    
    
    2,000
    
    
    
    
    
    
    
    
    
    
    
    2,000Equity contributions into subsidiaries
    
    
    
    
    
    
    (3,902
    )
    
    
    
    
    
    
    3,902
    
    
    
    Purchases of property , plant and equipment, net
    
    
    
    
    
    
    (13,494
    )
    
    
    (5,649
    )
    
    
    
    
    
    
    (19,143
    )Net cash provided by (used in) investing activities
    
    
    
    
    
    
    (15,396
    )
    
    
    (5,649
    )
    
    
    3,902
    
    
    
    (17,143
    )Debt payments - long term
    
    
    (37,668
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (37,668
    )Debt proceeds - long term
    
    
    48,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    48,000Debt proceeds - short term
    
    
    9,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,000Costs associated with debt
    
    
    (2,107
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,107
    )Premium on early retirement of debt
    
    
    (1,080
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,080
    )Common stock transactions
    
    
    (150
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (150
    )Intercompany loans
    
    
    15,926
    
    
    
    (18,341
    )
    
    
    2,415
    
    
    
    
    
    
    
    Equity contributions into subsidiaries
    
    
    
    
    
    
    
    
    
    
    3,902
    
    
    
    (3,902
    )
    
    
    Net cash provided by (used in) financing activities
    
    
    31,921
    
    
    
    (18,341
    )
    
    
    6,317
    
    
    
    (3,902
    )
    
    
    15,995Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    32
    
    
    
    
    
    
    
    32Net change in cash and cash equivalents
    
    
    (241
    )
    
    
    4,426
    
    
    
    1,558
    
    
    
    
    
    
    
    5,743Cash and cash equivalents at beginning of period
    
    
    866
    
    
    
    5,627
    
    
    
    4,734
    
    
    
    
    
    
    
    11,227Cash and cash equivalents at end of period
    
    $
    625
    
    
    $
    10,053
    
    
    $
    6,292
    
    
    $
    
    
    
    $
    16,970
 (1)  Escrow payment from sale of Synchro - Start business. 57




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##### Table of Contents



Twelve Months Ended December 31, 2003Parent
    
    
    Guarantors
    
    
    Non-Guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet cash provided by (used in) continuing operating activities
    
    $
    (34,418
    )
    
    $
    45,705
    
    
    $
    20,933
    
    
    $
    (25,080
    )
    
    $
    7,140Net cash provided by discontinued activities
    
    
    
    
    
    
    1,625
    
    
    
    2,346
    
    
    
    
    
    
    
    3,971Net cash provided by (used in) operating activities
    
    
    (34,418
    )
    
    
    47,330
    
    
    
    23,279
    
    
    
    (25,080
    )
    
    
    11,111Proceeds from sales of businesses and property
    
    
    
    
    
    
    45,245
    
    
    
    
    
    
    
    
    
    
    
    45,245Equity contributions into subsidiaries
    
    
    
    
    
    
    (6,450
    )
    
    
    
    
    
    
    6,450
    
    
    
    Purchases of property, plant and equipment, net
    
    
    
    
    
    
    (12,521
    )
    
    
    (2,255
    )
    
    
    
    
    
    
    (14,776
    )Net cash provided by (used in) investing activities
    
    
    
    
    
    
    26,274
    
    
    
    (2,255
    )
    
    
    6,450
    
    
    
    30,469Debt payments  long term
    
    
    (87,102
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (87,102
    )Debt proceeds  long term
    
    
    35,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35,000Common stock transactions
    
    
    (350
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (350
    )Intercompany loans
    
    
    79,871
    
    
    
    (75,555
    )
    
    
    (4,316
    )
    
    
    
    
    
    
    Costs associated with debt
    
    
    (1,749
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,749
    )Intercompany dividends
    
    
    
    
    
    
    
    
    
    
    (25,080
    )
    
    
    25,080
    
    
    
    Equity contributions into subsidiaries
    
    
    
    
    
    
    
    
    
    
    6,450
    
    
    
    (6,450
    )
    
    
    Net cash provided by (used in) financing activities
    
    
    25,670
    
    
    
    (75,555
    )
    
    
    (22,946
    )
    
    
    18,630
    
    
    
    (54,201
    )Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    (31
    )
    
    
    
    
    
    
    (31
    )Net change in cash and cash equivalents
    
    
    (8,748
    )
    
    
    (1,951
    )
    
    
    (1,953
    )
    
    
    
    
    
    
    (12,652
    )Cash and cash equivalents at beginning of period
    
    
    9,614
    
    
    
    7,578
    
    
    
    6,687
    
    
    
    
    
    
    
    23,879Cash and cash equivalents at end of period
    
    $
    866
    
    
    $
    5,627
    
    
    $
    4,734
    
    
    $
    
    
    
    $
    11,227
 Year Ended December 31, 2002Parent
    
    
    Guarantors
    
    
    Non-Guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet cash provided by (used in) continuing operating activities
    
    $
    (30,495
    )
    
    $
    56,719
    
    
    $
    8,788
    
    
    $
    (12,280
    )
    
    $
    22,732Net cash provided by (used in) discontinued operating activities
    
    
    
    
    
    
    8,026
    
    
    
    (1,079
    )
    
    
    
    
    
    
    6,947Net cash provided by (used in) operating activities
    
    
    (30,495
    )
    
    
    64,745
    
    
    
    7,709
    
    
    
    (12,280
    )
    
    
    29,679Proceeds from sales of property
    
    
    
    
    
    
    
    
    
    
    3,560
    
    
    
    
    
    
    
    3,560Equity contributions into subsidiaries
    
    
    
    
    
    
    (2,690
    )
    
    
    
    
    
    
    2,690
    
    
    
    Purchases of property, plant and equipment, net
    
    
    
    
    
    
    (4,345
    )
    
    
    (4,082
    )
    
    
    
    
    
    
    (8,427
    )Net cash provided by (used in) investing activities
    
    
    
    
    
    
    (7,035
    )
    
    
    (522
    )
    
    
    2,690
    
    
    
    (4,867
    )Debt payments  long term
    
    
    (10,541
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,541
    )Debt proceeds  long term
    
    
    10,000
    
    
    
    
    
    
    
    55
    
    
    
    
    
    
    
    10,055Debt proceeds (payments)  short term, net
    
    
    (2,000
    )
    
    
    
    
    
    
    4
    
    
    
    
    
    
    
    (1,996
    )Common stock transactions
    
    
    (400
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (400
    )Intercompany loans
    
    
    43,726
    
    
    
    (44,721
    )
    
    
    995
    
    
    
    
    
    
    
    Costs associated with debt
    
    
    (681
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (681
    )Intercompany dividends
    
    
    
    
    
    
    (5,651
    )
    
    
    (6,629
    )
    
    
    12,280
    
    
    
    Equity contributions into subsidiaries
    
    
    
    
    
    
    
    
    
    
    2,690
    
    
    
    (2,690
    )
    
    
    Net cash provided by (used in) financing activities
    
    
    40,104
    
    
    
    (50,372
    )
    
    
    (2,885
    )
    
    
    9,590
    
    
    
    (3,563
    )Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    600
    
    
    
    
    
    
    
    600Net change in cash and cash equivalents
    
    
    9,609
    
    
    
    7,338
    
    
    
    4,902
    
    
    
    
    
    
    
    21,849Cash and cash equivalents at beginning of period
    
    
    5
    
    
    
    240
    
    
    
    1,785
    
    
    
    
    
    
    
    2,030Cash and cash equivalents at end of period
    
    $
    9,614
    
    
    $
    7,578
    
    
    $
    6,687
    
    
    $
    
    
    
    $
    23,879
 58




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##### Table of Contents



7. Operating Leases The Company leases various manufacturing facilities and office space. Future minimum payments
under operating leases with initial terms of one year or more are as follows: 2005
    
    $
    1,9762006
    
    
    1,6232007
    
    
    1,4142008
    
    
    1,3442009
    
    
    1,299Thereafter
    
    
    6,591$
    14,247
 Rent expense was $1,862, $866 and $1,179 for the years ended December 31, 2004, 2003, and
2002, respectively. 8. Retirement Plans The Company has defined-benefit plans covering approximately substantially all of its U.S.,
U.K. and Taiwanese employees. The U.S. Plan was amended effective January 1, 2002 to change the
calculation of benefits for employees hired after May 1, 2002 to a cash balance benefit where the
employees account is credited each year with a percentage of their salary based on their age and
years of service. Additionally, any prior year accumulated benefit balance is credited with
interest based on the ten year U.S. Treasury Notes rate. The pension benefit for employees age
forty or older continues to be calculated under the previous method generally based on salary and
years of service. Employees under age forty have their benefit under the previous method frozen as
of December 31, 2001 and start accruing a benefit under the cash balance formula starting January
1, 2002. Annual contributions to retirement plans equal or exceed the minimum funding requirements
of applicable local regulations. 59




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##### Table of Contents



The following table provides a reconciliation of the changes in the plans benefit obligations
and fair value of assets for the years ended December 31, 2004 and 2003 as well as a statement of
the funded status and balance sheet reporting for these plans as of December 31, 2004 and 2003: U.S.  Plan
    
    
    Foreign  Plans2004
    
    
    2003
    
    
    2004
    
    
    2003Change in benefit obligation:Benefit obligation at beginning of year
    
    $
    65,310
    
    
    $
    65,223
    
    
    $
    13,142
    
    
    $
    11,870Service cost
    
    
    1,307
    
    
    
    1,618
    
    
    
    264
    
    
    
    197Interest cost
    
    
    3,891
    
    
    
    3,830
    
    
    
    680
    
    
    
    615Plan participants contributions
    
    
    
    
    
    
    
    
    
    
    45
    
    
    
    42Curtailment
(1)
    
    
    (1,022
    )
    
    
    (3,641
    )
    
    
    
    
    
    
    Actuarial loss (gain)
    
    
    3,282
    
    
    
    1,398
    
    
    
    830
    
    
    
    825Foreign currency exchange rate change
    
    
    
    
    
    
    
    
    
    
    163
    
    
    
    30Benefits paid
    
    
    (3,219
    )
    
    
    (3,118
    )
    
    
    (323
    )
    
    
    (437
    )Benefit obligation at end of year
    
    $
    69,549
    
    
    $
    65,310
    
    
    $
    14,801
    
    
    $
    13,142Change in plan assets:Fair value of plan assets at beginning of year
    
    $
    49,757
    
    
    $
    44,160
    
    
    $
    9,184
    
    
    $
    7,774Adjustment to fair asset value disclosed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10Actual return on plan assets
    
    
    5,897
    
    
    
    8,715
    
    
    
    849
    
    
    
    1,427Employer contributions
    
    
    366
    
    
    
    
    
    
    
    348
    
    
    
    351Plan participants contributions
    
    
    
    
    
    
    
    
    
    
    45
    
    
    
    42Foreign currency exchange rate change
    
    
    
    
    
    
    
    
    
    
    75
    
    
    
    17Benefits paid
    
    
    (3,219
    )
    
    
    (3,118
    )
    
    
    (323
    )
    
    
    (437
    )Fair value of plan assets at end of year
    
    $
    52,801
    
    
    $
    49,757
    
    
    $
    10,178
    
    
    $
    9,184Funded statusFunded status
    
    
    (16,748
    )
    
    
    (15,553
    )
    
    $
    (4,623
    )
    
    $
    (3,958
    )Unrecognized actuarial (gain) loss
    
    
    7,269
    
    
    
    6,542
    
    
    
    6,297
    
    
    
    5,958Unrecognized transition asset
    
    
    
    
    
    
    
    
    
    
    87
    
    
    
    92Unrecognized prior service cost
    
    
    156
    
    
    
    275
    
    
    
    
    
    
    
    Accrued pension cost before additional minimum liability
    
    
    (9,323
    )
    
    
    (8,736
    )
    
    
    1,761
    
    
    
    2,092Additional minimum liability
    
    
    (1,813
    )
    
    
    (950
    )
    
    
    (5,573
    )
    
    
    (5,806
    )Accrued pension cost after additional minimum liability
    
    $
    (11,136
    )
    
    $
    (9,686
    )
    
    $
    (3,812
    )
    
    $
    (3,714
    )Amounts recognized in the balance sheets:Accrued
benefit cost(2)
    
    $
    (11,136
    )
    
    $
    (9,686
    )
    
    $
    (3,812
    )
    
    $
    (3,714
    )Intangible assets
    
    
    156
    
    
    
    275
    
    
    
    87
    
    
    
    Accumulated other comprehensive income
    
    
    1,657
    
    
    
    675
    
    
    
    5,486
    
    
    
    5,806Net amount recognized
    
    $
    (9,323
    )
    
    $
    (8,736
    )
    
    $
    1,761
    
    
    $
    2,092
   (1)
    
    Curtailment relates to the Elgin, Illinois restructure in 2004 and the sale of the
Synchro-Start business in 2003.(2)
    
    Includes current liabilities in 2004 and 2003,
respectively, of $1,600 and $1,360 recorded in accrued compensation
and employee benefits. 60




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##### Table of Contents



The funded status of the Companys defined benefit pension plans at December 31, 2004,
reflects the effects of negative returns experienced in the global capital markets over the past
several years and a decline in the discount rate used to estimate the pension liability. As a
result, the accumulated benefit obligation of certain U.S. and foreign plans exceeded the fair
value of plan assets. As a result, the Company recorded a minimum pension liability of
approximately $7.1 million in the Consolidated Balance Sheet at December 31, 2004. The projected
benefit obligation, accumulated benefit obligation and fair value of plan assets for pension plans
with an accumulated benefit obligation in excess of plan assets as of December 31, 2004 and 2003
was: U.S.  Plan
    
    
    Foreign  Plans2004
    
    
    2003
    
    
    2004
    
    
    2003Projected benefit obligation
    
    $
    69,549
    
    
    $
    65,310
    
    
    $
    14,801
    
    
    $
    13,142Accumulated benefit obligation
    
    
    63,937
    
    
    
    59,443
    
    
    
    13,990
    
    
    
    12,899Fair value of plan assets
    
    
    52,801
    
    
    
    49,757
    
    
    
    10,178
    
    
    
    9,184
 The following table provides the components of net periodic benefit costs for the plans for
the years ended December 31, 2004, 2003 and 2002: U.S. Plan
    
    
    Foreign Plans2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Components of net periodic benefit cost:Service cost
    
    $
    1,307
    
    
    $
    1,618
    
    
    $
    1,738
    
    
    $
    309
    
    
    $
    239
    
    
    $

    224Interest cost
    
    
    3,891
    
    
    
    3,830
    
    
    
    4,052
    
    
    
    680
    
    
    
    615
    
    
    
    579Expected return on plan assets
    
    
    (4,365
    )
    
    
    (4,431
    )
    
    
    (4,729
    )
    
    
    (609
    )
    
    
    (582
    )
    
    
    (726
    )Amortization of prior service cost
    
    
    74
    
    
    
    92
    
    
    
    111
    
    
    
    
    
    
    
    
    
    
    
    Amortization of transitional asset
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    10
    
    
    
    3Recognized actuarial (gain) or loss
    
    
    
    
    
    
    
    
    
    
    (312
    )
    
    
    289
    
    
    
    326
    
    
    
    121Expected contributions from employees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (45
    )
    
    
    (42
    )
    
    
    (36
    )Net periodic benefit cost
    
    $
    907
    
    
    $
    1,109
    
    
    $
    860
    
    
    $
    634
    
    
    $
    566
    
    
    $
    (165
    )Curtailment cost
    
    
    45
    
    
    
    138
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total expense
    
    $
    952
    
    
    $
    1,247
    
    
    $
    860
    
    
    $
    634
    
    
    $
    566
    
    
    $
    (165
    )
 The following table presents the assumptions used in determining benefit obligations as
of December 31, 2004, 2003 and 2002 and the net periodic costs amounts for the years ended December
31, 2004, 2003 and 2002: U.S Plan
    
    
    Foreign Plans2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Weighted-average assumption forbenefit obligations at year end:Discount rate
    
    
    5.70
    %
    
    
    6.00
    %
    
    
    6.60
    %
    
    
    5.08
    %
    
    
    5.27
    %
    
    
    5.32
    %Rate of compensation increase
    
    
    4.90
    %
    
    
    4.90
    %
    
    
    4.90
    %
    
    
    4.22
    %
    
    
    4.17
    %
    
    
    3.72
    %Weighted-average assumption for netperiodic cost for the year:Discount rate
    
    
    6.00
    %
    
    
    6.60
    %
    
    
    7.25
    %
    
    
    5.25
    %
    
    
    5.32
    %
    
    
    5.89
    %Expected return on plan assets
    
    
    8.00
    %
    
    
    8.00
    %
    
    
    8.00
    %
    
    
    6.59
    %
    
    
    7.51
    %
    
    
    7.55
    %Rate of compensation increase
    
    
    4.90
    %
    
    
    4.90
    %
    
    
    5.20
    %
    
    
    4.17
    %
    
    
    3.72
    %
    
    
    4.00
    %
 61




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##### Table of Contents



The following table reflects the U.S. pension plans actual asset allocation as of
December 31, 2004 and 2003, and target allocation as of December 31, 2004: Actual
    
    
    ActualAsset category
    
    Target
    
    
    2004
    
    
    2003Equity securities
    
    
    70
    %
    
    
    73
    %
    
    
    72
    %Debt securities
    
    
    30
    %
    
    
    27
    %
    
    
    28
    %Total
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 To the extent that the actual allocation of plan assets differs from the targeted
allocation by more that 5% for any category, plan assets are re-balanced. The Company establishes
its estimated long-term return on plan assets considering various factors, which include the
targeted asset allocation percentages, historic returns, and expected future returns. Specifically,
the factors are considered in the fourth quarter of the year preceding the year for which those
assumptions are applied. The expected cash flows for the Companys pension plans follow. PensionBenefitsCompany contribution expected to be made in 2005
    
    $
    2,028Expected benefit payments:2005
    
    
    3,7072006
    
    
    3,7682007
    
    
    3,9512008
    
    
    4,1602009
    
    
    4,2792010 - 2014
    
    
    26,102
 The Company has a defined-contribution plan covering substantially all of its U.S. employees.
The plan has funding provisions which, in certain situations, require Company contributions based
upon a formula relating to employee gross wages, participant contributions, or hours worked. The
plan also allows for additional discretionary Company contributions based upon profitability. The
contributions made by the Company to the plan for 2004, 2003 and 2002 were $528, $470 and $482,
respectively. 9. Stock Options The Company implemented the 2001 Stock Option Plan (2001 Plan) during 2001, and authorized
375,000 options. Eligibility for the 2001 Plan is recommended by the Chief Executive Officer and
approved by the Board of Directors. Options are for shares of Class A Common Stock and are
exercisable only from and after an initial public offering (IPO) at a price per share equal to
eighty percent of the price per share which the underwriters pay for the stock in connection with
an initial public offering. Options are exercisable for fifty percent (50%) of the shares on the
second anniversary of the grant, and for one hundred percent (100%) of the shares after the third
anniversary of the grant. Options expire ten years from the date of the grant. The Company will
record a charge for the difference between the exercise price and the IPO price of these options
upon the completion of the IPO. The exercise price is based on an IPO transaction and is not
determinable, therefore no expense has been recorded. 62




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Stock option activity for the three years ended December 31, was as follows: 2004
    
    
    2003
    
    
    2002Outstanding on January 1
    
    
    263,058
    
    
    
    337,689
    
    
    
    316,733Granted
    
    
    42,644
    
    
    
    13,000
    
    
    
    46,306Cancelled
    
    
    (70,279
    )
    
    
    (87,631
    )
    
    
    (25,350
    )Exercised
    
    
    
    
    
    
    
    
    
    
    Outstanding on December 31
    
    
    235,423
    
    
    
    263,058
    
    
    
    337,689Exercisable on December 31
    
    
    
    
    
    
    
    
    
    
    
 The Company implemented the 2004 Stock Option Plan (2004 Plan) during 2004, and authorized
28,334 options. Eligibility for the 2004 Plan is recommended by the Chief Executive Officer and
approved by the Board of Directors. Options are for shares of Class A Common Stock and are
exercisable only on the date prior to the date of an IPO or the sale of a material portion of
capital stock or consolidated assets of the Company. Options are exercisable at a price of $1.00
per share. Options expire ten years from the date of the grant. The options that had been granted
and were outstanding were 28,334 as of December 31, 2004. The Company will record a charge for the
difference between the exercise price and an IPO price of these
options upon the completion of an IPO. The
weighted average remaining contractual life of options outstanding as
of December 31, 2004 is 7.2 years and 9.9 years for options
outstanding under the 2001 and 2004 stock option plans, respectively. 10. Segments and Geographical Information The Companys continuing business consists of one operating segment known as Microacoustics.
In the third quarter of 2003 after the sale of the Synchro-Start and Infrared operations, the
Company reviewed its segment reporting under SFAS No. 131, Disclosure about Segments of an
Enterprise and Related Information, and concluded that the operating results of the Company should
be reported as a single operating segment. Previously, the Company reported three operating
segments: hearing aid components, acoustic and infrared technology, and automotive components. The
Synchro-Start division was sold May 30, 2003, and was part of the Companys Automotive Components
reporting segment. The two businesses that once made up this reporting segment have now been sold.
The 2002 amounts for Automotive Components represent the Ruf business. The Infrared business was
part of the Companys Acoustic and Infrared Technology reporting segment. (see footnote 3.
Discontinued Operations.) As a result of this change, segment information for the prior year has
been restated to reflect the Microacoustic segment. The Microacoustic operating segment utilizes the Companys acoustic technologies to design,
manufacture, and market transducers and other components for hearing aids, mobile communications
and computer telephony integration telematics (voice controlled wireless services delivered to an
automobile environment). The Company uses the following financial information presented below to assess performance and
make resource allocation decisions: RufMicroacoustics
    
    
    Electronics
    
    
    Total2004Revenues from external customers
    
    $
    185,511
    
    
    $
    
    
    
    $
    185,511Operating income
    
    
    34,097
    
    
    
    
    
    
    
    34,097
    (1)2003Revenues from external customers
    
    $
    154,042
    
    
    $
    
    
    
    $
    154,042Operating income
    
    
    36,959
    
    
    
    
    
    
    
    36,959
    (1)2002Revenues from external customers
    
    $
    149,936
    
    
    $
    14,183
    
    
    $
    164,119Operating income (loss)
    
    
    32,631
    
    
    
    (1,310
    )
    
    
    31,321
    (1)
   (1)
    
    A reconciliation of segment operating income (loss) and assets to the Companys consolidated
totals follows below. 63




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The total assets of the microacoustics operating segment as of December 31, 2004, 2003 and
2002 were $138,074, $112,573 and $117,349, respectively. Depreciation expense associated with these
assets was $8,300 $7,443 and $8,236 for the years ended December 31, 2004, 2003, and 2002,
respectively. Total capital expenditures for the microacoustic operating segment were $19,143,
$14,776 and $6,734 for the years ended December 31, 2004, 2003, and 2002, respectively. The assets of the Ruf Electronics were sold in November 2002 In 2003, the Company announced the closure of its Elgin, Illinois facility and recorded
restructuring expense of $1,479, which affected the microacoustic segment. The Company also
recorded a final adjustment related to the restructuring of its worldwide manufacturing operations
announced in 2000 of $53 which affected the microacoustic segment. In 2002, the Company essentially finalized the restructuring of its worldwide manufacturing
operations and recorded restructuring expenses of $2,112, which affected the operating segments as
follows: microacoustics $2,064 and Ruf Electronics $48. The charge for microacoustics includes a
loss on the sale of the Taiwan facility of $1,170. The Company also recorded a $16,736 loss on the
sale of its Ruf operations. The following is a reconciliation of segment operating income and assets to the Companys
consolidated totals: Year EndedDecember31,2004
    
    
    2003
    
    
    2002Profit or LossTotal operating income for
reportable segments
    
    $
    34,097
    
    
    $
    36,959
    
    
    $
    31,321Loss on sale of business
    
    
    
    
    
    
    
    
    
    
    (16,736
    )Total consolidated operating income
    
    
    34,097
    
    
    
    36,959
    
    
    
    14,585Other expense
    
    
    (35,989
    )
    
    
    (35,724
    )
    
    
    (33,762
    )Income (loss) before income taxes
    
    $
    (1,892
    )
    
    $
    1,235
    
    
    $
    (19,177
    )AssetsMicroacoustic
    
    $
    138,074
    
    
    $
    112,573Geographic InformationRevenues (based on invoicing location):United States
    
    $
    110,366
    
    
    $
    88,022
    
    
    $
    81,551Germany
    
    
    
    
    
    
    
    
    
    
    14,183United Kingdom
    
    
    54,389
    
    
    
    50,293
    
    
    
    52,661Other geographic areas
    
    
    20,756
    
    
    
    15,727
    
    
    
    15,724$
    185,511
    
    
    $
    154,042
    
    
    $
    164,119Long Lived AssetsUnited States
    
    $
    20,857
    
    
    $
    28,578Malaysia
    
    
    13,879
    
    
    
    11,489China
    
    
    21,056
    
    
    
    6,591Taiwan
    
    
    1,502
    
    
    
    1,528Other geographic areas
    
    
    444
    
    
    
    468$
    57,748
    
    
    $
    48,654
  Major Customers The Company is dependent on sales of products to a small number of large customers. The
Companys top ten customers accounted for approximately 72%, 80% and 81%, of consolidated sales in
2004, 2003, and 2002 respectively. Revenues from one customer accounted for approximately 20%, 24%
and 20% of consolidated revenues in those same years respectively. Two other customers had sales
of approximately 14% and 13% of consolidated revenues in 2004 and 14% and 10% in 2003
respectively. 64




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11. Restructuring Expenses  November 2003 Elgin, Illinois Restructure The Company announced the closure of its Elgin,
Illinois facility in November of 2003, which
it completed in September of 2004. Operations will be shifted to facilities in China,
Malaysia and Itasca, Illinois, with 76 positions at the Elgin facility being eliminated. The
Company recorded employee severance and outplacement expenses of $1,479 in accordance with SFAS No.
112 Employers Accounting for Post Retirement Benefits. The $5.0 million facility consolidation costs represent charges to move equipment from Elgin to China
and Malaysia. Other costs included training and relocation of employees. In the second quarter of 2004, the Company recorded a $850 charge to reduce the carrying value of the Elgin
facility to $3.4 million, its estimated fair value less cost to sell. AccruedRestructure
    
    
    RestructureExpense
    
    
    LiabilityBalance December 31, 2003
    
    $
    
    
    
    $
    1,490Facility consolidation costs
    
    
    4,982
    
    
    
    4,982Facility consolidation payments
    
    
    
    
    
    
    (4,982
    )Employee severance and outplacement payments
    
    
    
    
    
    
    (429
    )Employee severance and outplacement
    
    
    344
    
    
    
    344Balance December 30, 2004
    
    $
    5,326
    
    
    $
    1,405
 12. Commitments and Contingencies Synchro-Start Divestiture Indemnifications.In connection with sale of the Synchro-Start
business, the Company has agreed to indemnify certain tax obligations arising out of tax audits or
administrative or court proceedings relating to tax returns for any periods ending on or prior to
the closing date of the sale. The Company has also agreed to indemnify certain liabilities, losses
or claims arising from presale operations, limited such that the Company is not liable for total
claims under $250, is fully liable for claims totaling between $250 and $7.5 million, is 50% liable
for total claims between $7.5 million and $12.5 million and is not liable for total claims
exceeding $12.5 million. Proceeds from the Synchro-Start sale include $2.5 million in escrow for
potential indemnification obligations, of which the Company received $2.0 million in September,
2004. The Company considers it unlikely that a claim would be made of such magnitude that it would
have a material impact on the Companys financial position. Retention Incentive Plan.In 2003 the Company established the Retention Incentive Plan to
provide key management employees with an incentive to remain in the employ of the Company. The Plan
provides for a Retention Bonus Pool of $4.0 million to be paid on the earlier of an initial public
offering, sale of the Company or August 31, 2008. In 2004 the Company established the Asia
Retention Incentive Plan to provide key management employees with an incentive to remain in the
employ of the Company which provides for a Retention Bonus Pool of $400 to be paid on the earlier
of an initial public offering, sale of the Company or August 31, 2008. Other Commitments and Contingencies.The Company is involved in various lawsuits, claims,
investigations and proceedings including patent and commercial matters that are in the ordinary
course of business. The Company cannot at this time estimate with any certainty the impact of such
matters on its financial position. Product Warranties.The Company provides an accrual for estimated future warranty costs at
the time products are sold and periodically adjusts the accrual to reflect actual experience. The
warranty on products sold generally extends from one to three years. 65




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Changes in the Companys accrual for warranty during the years ended December 31, 2004
and 2003 are as follows: 2004
    
    
    2003Beginning balance
    
    $
    2,282
    
    
    $
    4,438Settlements made during the period
    
    
    (1,697
    )
    
    
    (1,321
    )Provision for warranty liability on sales
    
    
    385
    
    
    
    1,601Adjustments in estimates for pre-existing warranties
    
    
    (406
    )
    
    
    (2,436
    )Ending balance
    
    $
    564
    
    
    $
    2,282
 Adjustments in pre-existing
warranties in 2004 and 2003 were due to substantial improvements
in the warranty experience of the Company after 2001. In addition,
the Company has agreed with certain customers to eliminate the
warranty program, which contributed significantly to the lower warranty provision. 13. Disposal of Long Lived Assets In November 2002 the Company sold its Ruf Electronics operations, and recorded a loss of
$16,736. The loss includes $1,186 of accumulated other comprehensive income relating to foreign
currency translation. The proceeds from the sale were not material. The Company may receive
additional payment amounts in 2004 and 2005 if the Ruf operations meet certain financial targets. In December 2002, the Company sold its Taiwan facility as part of the restructuring plan
announced in March 2000 and recorded a loss of $1,170 which is included in Restructuring Expenses
in the Statement of Operations. Proceeds from the sale were $3,560. 14. Subsequent Events The
Company borrowed $9.0 million under the Xerion Credit Agreement in
January, 2005. The
Company obtained an Eighth Amendment and Waiver dated as of
March 10, 2005, to the Credit
Agreement dated as of June 28, 1999. The Eighth Amendment, among other things, permits the Company to incur
an additional $10 million of unsecured indebtedness and increases for each period beginning
December 31, 2004 through maturity of the loans, the maximum allowable leverage ratio applicable to
the Company under the Credit Agreements leverage ratio covenant. Pursuant
to the terms of the Xerion Credit Agreement dated as of December 20, 2004, that Credit
Agreement is deemed to be amended by the Amendment No. 8 to the same extent. The
Company obtained Amendment One to the Xerion Credit Agreement March
29, 2005 which increased the
credit facility by $10 million. The Company borrowed $10 million
under the Xerion Credit Agreement in March 2005. See Exhibit 10.33
filed with this Form 10-K. 
 Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 
 Item 9A.Controls and Procedures Under the supervision and with the participation of the Companys management, including the
Companys Chief Executive Officer and Chief Financial Officer, the Company evaluated the
effectiveness of the design and operation of the Companys disclosure controls and procedures as of
December 31, 2004. Based upon that evaluation, the Companys Chief Executive Officer and Chief
Financial Officer have concluded that the Companys disclosure controls and procedures are
effective to ensure that information required to be disclosed by the Company in reports it files is
recorded, processed, summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms. There have been no changes in the Companys internal controls
over financial reporting during the quarterly period ended December 31, 2004, that have materially
affected, or are reasonably likely to materially affect, the Companys internal control over
financial reporting. 66




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##### Table of Contents



PART III 
 Item 10.Directors and Executive Officers Pursuant to Knowles by-laws, each of its directors is designated as a Class A director or a
Class B director. Each Class A director is entitled to four votes and each Class B director is
entitled to one vote. Knowles currently has five directors, three of whom are with Doughty Hanson
(Christopher Wallis, John Leahy and Harry Green). Set forth below is certain information with
respect to our directors and officers. Name
    
    Age
    
    PositionChristopher Wallis
    
    
    46
    
    
    Class A Director and ChairmanJohn Leahy
    
    
    39
    
    
    Class A DirectorHarry Green
    
    
    36
    
    
    Class A DirectorJames E. Knowles
    
    
    74
    
    
    Class B DirectorJohn J. Zei
    
    
    60
    
    
    President and Chief Executive Officer,

Class B DirectorJames H. Moyle
    
    
    52
    
    
    Executive Vice President and ChiefFinancial OfficerLouis T. Morabito
    
    
    60
    
    
    Vice President of OperationsJeffrey S. Niew
    
    
    38
    
    
    Vice President and General Manager of 

Knowles AcousticsDennis R. Kirchhoefer
    
    
    55
    
    
    Vice President Research & DevelopmentStephen D. Petersen
    
    
    46
    
    
    Vice President Finance and Secretary
 Christopher Wallis joined Doughty Hanson & Co Limited at its inception in 1990 and is a
director, co-founder and has served as Senior Principal for 13 years. Mr. Wallis previously worked
with the other co-founders of Doughty Hanson at Standard Chartered Bank since 1985, having
previously been a corporate banking officer at Standard Chartered Bank in Hong Kong and the Middle
East. He is a member of the Investment Committee of Doughty Hanson & Co. He is also a director of
North American Membership Group, Inc., a Doughty Hanson & Co fund portfolio company. He holds a
degree in Economics (M.A.) from Cambridge University. John Leahy joined Doughty Hanson & Co. Limited in 2002 and is a
Principal in the London office. Prior to joining Doughty Hanson he worked for Quaker Oats, Arthur Andersen and PricewaterhouseCoopers. Mr. Leahy is also a Director of RHM Limited and Impress Group B.V, both of which
are Doughty Hanson & Co. fund portfolio companies. Mr. Leahy is a qualified CPA and holds an MBA from Edinburgh University. Harry Green is head of the New York office of Doughty Hanson & Co. Mr. Green joined Doughty
Hanson & Co in 1999 as a principal. Prior to joining Doughty Hanson he worked at Donaldson, Lufkin
& Jenrette Securities Corporation, where he concentrated in bridge financing and financial sponsor
coverage. Mr. Green is also a director of North American Membership Group Holdings Inc. and Tumi
Inc., both of which are Doughty Hanson & Co fund portfolio companies. Mr. Green graduated from the
University of Witwatersrand in Johannesburg, South Africa with a Bachelor of Commerce as well as a
postgraduate honors degree in Financial Accounting. He received his M.B.A. from the University of
Pennsylvanias Wharton School. James E. Knowles is president of The Financial Corporation of Illinois. Prior to his current
position, Mr. Knowles served as a Director of Knowles from 1987 to 1996. He served as Chairman of
the Compensation Committee and the Audit Committee of Knowles from 1990 to 1996. Mr. Knowles also
served as President of Synergistic International Ltd. from 1969 to 1996. Mr. Knowles holds a
bachelor of science and a Master of Business Administration degree from Stanford University. John J. Zei joined Knowles in January, 2000 as President and Chief Operating Officer. He was
elected a Class B Director in March, 2000 and President and Chief Executive Officer as of April,
2000. Mr. Zei was with Siemens Hearing Instrument Corporation from 1987 to 1999 and served as
President and Chief Executive Officer from 1990 through 1999. Prior to Siemens, John was with
Beltone Electronics from 1976 to 1987. Mr. Zei is a graduate of Loyola University, Loyola
University School of Law and the University of Chicago. James H. Moyle joined Knowles in July of 2002 as Vice President & Chief Financial Officer.
Prior to joining Knowles, he was Senior Vice President & Chief Financial Officer of Contech
Construction Products, the nations leading supplier of civil engineering site solutions. He is a
graduate of Bethany College and the University of Pennsylvania. Louis T. Morabito Vice President of Operations joined Knowles in 1996. Prior to joining
Knowles he was Director of Operations for US Robotics, and Director Operations for a subsidiary of
United Technologies Corporation. He is a graduate of the University of Bridgeport, and has an
Executive MBA from the University of New Haven in Connecticut. 67




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##### Table of Contents



Jeffrey S. Niew joined Knowles in May 2000 as Director of Advanced Products for Knowles
Acoustics. He was promoted to Vice President and General Manager of Knowles Acoustics in November
of 2002. Prior to Knowles, Mr. Niew has held various management positions in product development,
operations, sales, and product management. He spent 1995 to 2000 with Littelfuse, Inc. Prior to
Littelfuse, he was with Hewlett Packards (now Agilent) from 1988 to 1995. Mr. Niew is a graduate
of University of Illinois at Chicago, College of Mechanical Engineering. Dennis R. Kirchhoefer joined Knowles in December of 1992 as Engineering Manager, was promoted
to Director of Research & Development in March of 2000 and Vice President of Research & Development
in May of 2003. He was with Electro-Voice (EV) Inc. from 1984 to 1992 and served as Chief Acoustic
Engineer. Prior to Electro-Voice he was with Shure Brothers Inc., now known as Shure. Mr.
Kirchhoefer is a graduate of DeVry and Southwestern Illinois University. Stephen D. Petersen joined Knowles in 1980 and served in various accounting positions
including Assistant Treasurer and Vice President  Controller of KE. He was promoted to Vice
President Finance in 1999. Mr. Petersen is a graduate of Augustana College, holds a Master of
Management degree from Northwestern University, and is a certified public accountant. Audit Committee The Company is not a listed company under SEC rules and is therefore not required to have an
audit committee comprised of independent directors. The Company does not currently have an audit
committee and does not have an audit committee financial expert. The Board of Directors has
determined that each of its members is able to read and understand fundamental financial statements
and has substantial business experience that results in that members financial sophistication.
Accordingly, the Board of Directors believes that each of its members have the sufficient knowledge
and experience necessary to fulfill the duties and obligations that an audit committee would have. Code of Ethics The Company has adopted a code of ethics that applies to officers (including its chief
executive officer, chief financial officer, chief accounting officer, senior executive officers and
persons performing similar functions) and employees. The Company has filed a copy of the code of
ethics as Exhibit 14.1 to the 2003 Form 10-K and copies are available upon request. 68




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Item 11.Executive Compensation Summary Compensation Table The following table provides information concerning the compensation we paid to our senior
officers for 2004, 2003 and 2002: Long-TermCompensationAnnual Compensation
    
    
    SecuritiesOther Annual
    
    
    Underlying
    
    
    All OtherName and Principal Position
    
    Year
    
    
    Salary
    
    
    Bonus
    
    
    Compensation
    
    
    Options (3)
    
    
    Compensation (1)John J. Zei
    
    
    2004
    
    
    $
    460,174
    
    
    $
    521,991
    
    
    $
    
    
    
    
    3,333
    
    
    $
    9,342President and Chief
    
    
    2003
    
    
    
    440,884
    
    
    
    686,973
    
    
    
    
    
    
    
    
    
    
    
    8,325Executive Officer
    
    
    2002
    
    
    
    430,533
    
    
    
    300,000
    
    
    
    
    
    
    
    
    
    
    
    282,480James H. Moyle
    
    
    2004
    
    
    
    282,181
    
    
    
    287,351
    
    
    
    
    
    
    
    3,333
    
    
    
    7,097Executive Vice President
    
    
    2003
    
    
    
    275,522
    
    
    
    468,516
    
    
    
    
    
    
    
    
    
    
    
    366,480& Chief Financial Officer
    
    
    2002
    
    
    
    127,413
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23,598Louis T. Morabito
    
    
    2004
    
    
    
    178,885
    
    
    
    54,166
    
    
    
    
    
    
    
    1,667
    
    
    
    4,980Vice President of
    
    
    2003
    
    
    
    171,840
    
    
    
    199,959
    
    
    
    11,073
    (2)
    
    
    
    
    
    
    7,477Operations
    
    
    2002
    
    
    
    161,720
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,904Jeffrey S. Niew
    
    
    2004
    
    
    
    186,121
    
    
    
    189,060
    
    
    
    
    
    
    
    
    
    
    
    5,651Vice President & General
    
    
    2003
    
    
    
    178,391
    
    
    
    171,128
    
    
    
    
    
    
    
    
    
    
    
    3,886Manager Knowles Acoustics
    
    
    2002
    
    
    
    146,247
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,912Dennis R. Kirchhoefer
    
    
    2004
    
    
    
    176,559
    
    
    
    106,785
    
    
    
    
    
    
    
    5,000
    
    
    
    5,466Vice President R&D
    
    
    2003
    
    
    
    161,357
    
    
    
    103,373
    
    
    
    
    
    
    
    
    
    
    
    5,5772002
    
    
    
    143,603
    
    
    
    50,000
    
    
    
    
    
    
    
    
    
    
    
    4,159
   (1)
    
    The following chart is a breakdown of the payments made to the executive officers under the
heading All Other Compensation. The Company also made contributions to the Knowles
Electronics, LLC. Employee Retirement Savings 401(k) Plan on behalf of the executive officers
and paid life insurance premiums on behalf of the executive officers in the amounts set forth
in the chart.(2)
    
    Short-term disability compensation.(3)
    
    Amounts shown in this column represent stock options awarded under the 2004 Stock Option
Plan. On November 15, 2004 Messrs. Zei, Moyle, Morabito and Kirchhoefer were awarded options
of 3,333, 3,333, 1,667 and 5,000 shares respectively. 69




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##### Table of Contents



Knowles
    
    
    Life
    
    
    Relocation/Special
    
    
    401(k) Plan
    
    
    Insurance
    
    
    MovingExecutive
    
    Year
    
    
    Bonus
    
    
    Contributions
    
    
    Premiums
    
    
    ExpensesJohn J. Zei
    
    
    2004
    
    
    $
    
    
    
    $
    5,863
    
    
    $
    3,479
    
    
    $
    President and Chief
    
    
    2003
    
    
    
    
    
    
    
    6,000
    
    
    
    2,325
    
    
    
    Executive Officer
    
    
    2002
    
    
    
    275,000
    
    
    
    5,500
    
    
    
    1,980
    
    
    
    James H. Moyle
    
    
    2004
    
    
    
    
    
    
    
    5,855
    
    
    
    1,242
    
    
    
    Executive Vice President
    
    
    2003
    
    
    
    
    
    
    
    4,705
    
    
    
    1,242
    
    
    
    360,533
    (1)& Chief Financial Officer
    
    
    2002
    
    
    
    
    
    
    
    612
    
    
    
    518
    
    
    
    22,468Louis T. Morabito
    
    
    2004
    
    
    
    
    
    
    
    1,416
    
    
    
    3,564
    
    
    
    Vice President of
    
    
    2003
    
    
    
    
    
    
    
    5,155
    
    
    
    2,322
    
    
    
    Operations
    
    
    2002
    
    
    
    
    
    
    
    4,582
    
    
    
    2,322
    
    
    
    Jeffrey S. Niew
    
    
    2004
    
    
    
    
    
    
    
    5,592
    
    
    
    59
    
    
    
    Vice President & General
    
    
    2003
    
    
    
    
    
    
    
    3,601
    
    
    
    285
    
    
    
    Manager Knowles Acoustics
    
    
    2002
    
    
    
    
    
    
    
    3,912
    
    
    
    
    
    
    
    Dennis R. Kirchhoefer
    
    
    2004
    
    
    
    
    
    
    
    3,367
    
    
    
    2,099
    
    
    
    Vice President R&D
    
    
    2003
    
    
    
    
    
    
    
    5,177
    
    
    
    400
    
    
    
    2002
    
    
    
    
    
    
    
    4,159
    
    
    
    
    
    
    
    
   (1)
    
    Relocation expenses and gross-up for taxes. Retention Incentive Plan  Awards in 2003 In 2003 the Company established the Retention Incentive Plan to provide key management
employees with an incentive to remain in the employ of the Company. The Plan provides for a
Retention Bonus Pool of $4.0 million to be allocated to participants based on their Retention Bonus
Percentage with the resulting amount being each participants Retention Bonus. The Plan is
unfunded, with any payments coming from the general assets of the Company. Participation and the
Retention Bonus Percentage for each participant are determined by the compensation committee of the
board of directors subject to the participant signing the Participation Agreement and
Confidentiality/Non-Competition/Non-Solicitation Agreement. The Retention Bonus vests in 20%
increments on the yearly anniversary over a five year period starting September 1, 2003. Full 100%
vesting will occur at the earlier of a initial public offering, sale of the Company or August 31,
2008. Voluntary termination of employment by the participant for reason other than retirement
causes the forfeiture of all vested and non-vested benefits under the Plan. Retention bonuses awarded in 2003, with vesting and payment subject to the provisions of the
Retention Incentive Plan, include: John J. Zei
    
    $
    600,000James H. Moyle
    
    
    400,000Louis T. Morabito
    
    
    300,000Jeffrey S. Niew
    
    
    300,000Dennis R. Kirchhoefer
    
    
    300,000
 70




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##### Table of Contents



Long-Term Incentive Plans  Awards In 2003 The following table presents the Value Enhancement Bonus Percentages awarded in 2003 under the
Value Enhancement Bonus Plan which is described below: Number of
    
    
    Performance orshares, units or
    
    
    other period until
    
    
    Estimated future payouts under non-stockother rights
    
    
    maturation or
    
    
    price-based plans (in thousands)(1)Name
    
    (%)
    
    
    payout
    
    
    Threshold ($)
    
    
    Target ($)
    
    
    Maximum ($)John J. Zei
    
    
    20
    %
    
    
    
    
    
    $
    2,000
    
    
    
    
    
    
    
    James H. Moyle
    
    
    16
    %
    
    
    
    
    
    
    1,600
    
    
    
    
    
    
    
    Louis T. Morabito
    
    
    10
    %
    
    
    
    
    
    
    1,000
    
    
    
    
    
    
    
    Jeffrey S. Niew
    
    
    10
    %
    
    
    
    
    
    
    1,000
    
    
    
    
    
    
    
    Dennis R. Kirchhoefer
    
    
    10
    %
    
    
    
    
    
    
    1,000
    
    
    
    
    
    
    
    
   (1)
    
    The threshold payout assumes the minimum payment level is achieved, there is no target payout
and maximum payout cannot be determined until the liquidity event proceeds, if any, are known. Value Enhancement Incentive Plan  Awards in 2003 In 2003 the Company established the Value Enhancement Incentive Plan to motivate and reward
key management employees for increasing the enterprise value of the Company. The Plan provides for
a Value Enhancement Bonus Pool to be determined on the occurrence of an initial public offering or
sale of the Company as follows: Value EnhancementLiquidity Event Proceeds
    
    Bonus PoolLess than $212 million
    
    NoneExceed $212 million but less than $275 million
    
    $10.0 millionEqual $275 million
    
    $12.65 millionExceed $275 million
    
    $12.65 million plus 5% of the proceedsin excess of $275 million up to the sum of $275 million plus the redemption value of the Company's preferred stock and its accrued but unpaid dividends.
 A partial Liquidity Event will result in a prorated calculation of the Bonus Pool. The Bonus
Pool will be allocated to participants based on their Value Enhancement Bonus Percentage with the
resulting amount being each participants Value Enhancement Bonus. The Plan is unfunded, with any
payments coming from the general assets of the Company. Participation and the Retention Bonus
Percentage for each participant are determined by the compensation committee of the board of
directors subject to the participant signing the Participation Agreement and
Confidentiality/Non-Competition/Non-Solicitation Agreement. 71




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##### Table of Contents



Pension Plan The following table provides information concerning the estimated annual pension benefit we
pay to U.S. employees of the Company on their retirement, based upon their years of service and
their average monthly earnings prior to their retirement (as described below). Years of ServiceRenumeration
    
    15
    
    
    20
    
    
    25
    
    
    30
    
    
    35$125,000
    
    $
    34,000
    
    
    $
    45,000
    
    
    $
    56,000
    
    
    $
    56,000
    
    
    $
    56,000150,000
    
    
    41,000
    
    
    
    55,000
    
    
    
    69,000
    
    
    
    69,000
    
    
    
    69,000175,000
    
    
    48,000
    
    
    
    64,000
    
    
    
    80,000
    
    
    
    80,000
    
    
    
    80,000200,000
    
    
    48,000
    
    
    
    64,000
    
    
    
    80,000
    
    
    
    80,000
    
    
    
    80,000225,000
    
    
    48,000
    
    
    
    64,000
    
    
    
    80,000
    
    
    
    80,000
    
    
    
    80,000250,000
    
    
    48,000
    
    
    
    64,000
    
    
    
    80,000
    
    
    
    80,000
    
    
    
    80,000275,000
    
    
    48,000
    
    
    
    64,000
    
    
    
    80,000
    
    
    
    80,000
    
    
    
    80,000300,000
    
    
    48,000
    
    
    
    64,000
    
    
    
    80,000
    
    
    
    80,000
    
    
    
    80,000325,000
    
    
    48,000
    
    
    
    64,000
    
    
    
    80,000
    
    
    
    80,000
    
    
    
    80,000350,000
    
    
    48,000
    
    
    
    64,000
    
    
    
    80,000
    
    
    
    80,000
    
    
    
    80,000400,000
    
    
    48,000
    
    
    
    64,000
    
    
    
    80,000
    
    
    
    80,000
    
    
    
    80,000450,000
    
    
    48,000
    
    
    
    64,000
    
    
    
    80,000
    
    
    
    80,000
    
    
    
    80,000500,000
    
    
    48,000
    
    
    
    64,000
    
    
    
    80,000
    
    
    
    80,000
    
    
    
    80,000
 The U.S. pension plan, which became effective on July 1, 1963, is a non-contributory defined
benefit plan covering U.S. employees. As of December 31, 2004, John Zei, James Moyle, Louis
Morabito, Jeffery Niew, and Dennis Kirchhoefer have 4, 2, 8, 4 and 12 credited years of service,
respectively. Under the plan, a participant who terminates employment with a vested benefit, and
either immediately or at a later date attains his or her early or normal retirement age is entitled
to receive a monthly pension benefit commencing on his or her normal or deferred retirement date,
which may be an early retirement date. Normal retirement is at age 65. However, early retirement
may commence any first of the month following attainment of age 55, but benefits are actuarially
reduced for early retirement. The Plan was amended effective January 1, 2002 to change the
calculation of benefits for employees hired after May 1, 2002 to a cash balance benefit where the
employees account is credited each year with a percentage of their salary based on their age and
years of service. Additionally, any prior year accumulated benefit balance is credited with
interest based on the ten year U.S. Treasury Notes. The pension benefit for employees age forty or
older would continue to be calculated under the previous method generally based on salary and years
of service. Employees under age forty would have their benefit under the previous method frozen as
of December 31, 2001 and start accruing a benefit under the cash balance formula starting January
1, 2002. The retirement benefit for the executives listed would be calculated using the previous
calculation, with the exception of Mr. Niew whose benefit under the previous calculation was frozen
and is accruing a benefit under the cash balance formula. The previous retirement benefit payable
under the plan is equal to 2% of a participants average monthly covered compensation during the
five consecutive years during which such participant received his or her highest earnings within
the ten year period ending on the date of termination, multiplied by credited service up to a
maximum of twenty-five years, reduced by the participants Social Security offset allowance. Under
the plan, the Social Security offset allowance is equal to the product of 0.65% multiplied by (i)
the participants years of credited service up to a maximum of twenty-five years and (ii) the
lessor of: (A) the participants average monthly earnings over the three years prior to termination
or (B) 1/12th of the average of the Social Security taxable wage base for the 35 year period ending
with the last day of the calendar year in which the participant attains Social Security retirement
age. Employment Agreements Effective January 3, 2000, John Zei
became the President and Chief Operating Officer of
Knowles, eligible to participate in certain bonus plans generally available for senior
management employees. Mr. Zei was appointed Chief Executive Officer of Knowles on April 1, 2000. 72




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In connection with the commencement of his employment, Knowles agreed to loan Mr. Zei $300,000
to purchase Knowles common stock at fair market value, and Mr. Zei has purchased an additional
$200,000 worth of common stock at fair market value with his own funds. The stock is subject to
Stockholders and Registration Rights Agreements described under the heading Related Party
Transactions. As of December 31, 2002, the Company deemed the note satisfied in its entirety. Mr.
Zei received a special bonus related to interest on the note and income taxes of $275,000. In July of 2002, James H. Moyle joined the Company as Vice President and Chief Financial
Officer with eligibility to participate in certain bonus plans generally available for senior
management employees. The Company agreed to reimburse Mr. Moyle for certain relocation expenses and
in connection with his relocation provided a bridge loan of $900,000 which was repaid within one
week. Mr. Moyle is also eligible to receive common stock of the Company of $200,000 and $150,000 as
part of his incentive for 2002 and 2003, respectively. Executive Stock Purchase Agreement In connection with the purchase of Class A Common Stock by members of management, each
executive purchasing stock entered into an Executive Stock Purchase Agreement with Knowles and Key
Acquisition, LLC. Among other things, the Executive Stock Purchase Agreements (i.) define Vested
Stock, the Executives Put Option, and the Companys Call Option, (ii.) provides for restrictions
on the executive from competing with Knowles or soliciting its employees and (iii.) provides for
severance benefits to the executive under certain circumstances. Mr. Zei and Mr. Moyle would receive severance payments
equal to twenty four months of salary and medical coverage for the same time period.
Other executives would receive similar severance benefits for various time periods not exceeding twenty four months. Compensation of Directors Following the Recapitalization, our directors no longer receive any fees or other compensation
for services rendered in their capacity as directors. 
 Item 12.Security Ownership of Certain Beneficial Owners and Management Set forth below is certain information, as of February 28, 2004, concerning (a) the beneficial
ownership of our voting securities by entities and persons who beneficially own more than 5% of our
voting securities and (b) the ownership of our securities by our executive officers and directors.
The determinations of beneficial ownership of voting securities are based upon Rule 13d-3 under
the Securities Exchange Act of 1934, as amended (the Exchange Act). This rule provides that
securities will be deemed to be beneficially owned where a person has, either solely or in
conjunction with others, (1) the power to vote or to direct the voting of securities and/or the
power to dispose or to direct the disposition of, the securities or (2) the right to acquire any
such power within 60 days after the date such beneficial ownership is determined. AmountBeneficially
    
    
    PercentName and Address of Beneficial Owner(1)
    
    Owned(2)
    
    
    of ClassKey
Acquisition, L.L.C
c/o Doughty Hanson & Co. Limited
Times Place, 45 Pall Mall,
London SW1Y 5JG, England
    
    
    800,000
    
    
    
    84.0
    %Doughty
Hanson & Co. Limited(3)
Times Place, 45 Pall Mall,
London SW1Y 5JG, England
    
    
    800,000
    
    
    
    84.0
    %
   (1)
    
    After the Recapitalization, various members of the Knowles family and trusts for the benefit
of members of the Knowles family hold in the aggregate 100,000 shares of common stock, or
10.5% of currently outstanding shares of common stock. Such stockholders have the right to
elect one of our directors pursuant to a stockholders agreement with Key Acquisition, L.L.C.
We have no reason to believe that various members of the Knowles family and trusts for the
benefit of members of the Knowles family constitute a group, as that term is in Section
13(d)(3) of the Exchange Act.(2)
    
    Class A Common Stock.(3)
    
    Consists only of shares of Knowles owned by Key Acquisition, L.L.C., the majority of whose
membership interests are held by limited partnerships for which Doughty Hanson acts as general
partner. 73




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##### Table of Contents



SECURITY OWNERSHIP OF DIRECTORS AND MANAGEMENT AmountBeneficially
    
    
    PercentName of Beneficial Owner
    
    Title of Class
    
    
    Owned
    
    
    of ClassJames E. Knowles
    
    Class A Common
    
    
    
    9,947
    
    
    
    1.0Series A Preferred
    
    
    
    2,045
    
    
    
    0.2Christopher Wallis
    
    
    
    
    
    
    
    
    
    
    John Leahy
    
    
    
    
    
    
    
    
    
    
    Harry Green
    
    
    
    
    
    
    
    
    
    
    John J. Zei
    
    Class A Common
    
    
 
    16,667
    
    
    
    1.7James H. Moyle
    
    
    
    
    
    
    
    
    
    
    Louis T. Morabito
    
    Class A Common
    
    
    
    5,000
    
    
    
    0.5Jeffery S. Niew
    
    Class A Common
    
    
    
    833
    
    
    
    0.0Dennis R. Kirchhoefer
    
    Class A Common
    
    
    
    1,667
    
    
    
    0.2Stephen D. Petersen
    
    Class A Common
    
    
    
    3,333
    
    
    
    0.3Combined holdings of directors and executive officers as a group
    
    Class A Common
    
    
    
    62,447
    
    
    
    6.6Series A Preferred
    
    
    
    2,045
    
    
    
    0.2
 Equity Compensation Plan Information The Company implemented the 2001 Stock Option Plan (Option Plan) during 2001, and authorized
375,000 options. Eligibility for the Option Plan is recommended by the Chief Executive Officer and
approved by the Board of Directors. Options are for shares of Class A Common Stock and are
exercisable only from and after an initial public offering (IPO) at a price per share equal to
eighty percent of the price per share which the underwriters pay for the stock in connection with
an initial public offering. Options are exercisable for fifty percent (50%) of the shares on the
second anniversary of the grant, and for one hundred percent (100%) of the shares after the third
anniversary of the grant. Options expire ten years from the date of the grant. The Company implemented the 2004 Stock Option Plan (2004 Plan) during 2004, and authorized
28,334 options. Eligibility for the 2004 Plan is recommended by the Chief Executive Officer and
approved by the Board of Directors. Options are for shares of Class A Common Stock and are
exercisable only on the date prior to the date of an IPO or the sale of a material portion of
capital stock or consolidated assets of the Company. Options are exercisable at a price of $1.00
per share. Options expire ten years from the date of the grant. The options that had been granted
and were outstanding were 28,334 as of December 31, 2004. The Company will record a charge for the
difference between the exercise price and the IPO price of these options upon the completion of the
IPO. The following table provides information as of December 31, 2004 regarding the Companys
common stock that may be issued under equity compensation plans currently maintained by the
Company: Number of securities
    
    
    
    Number ofto be issued upon
    
    
    
    securities remainingexercise of
    
    Weighted average
    
    available for futureoutstanding options
    
    exercise price
    
    issuanceEquity compensation plans not approved by securities holders
    
    263,757
    
    (a)
    
    139,577
   (a)
    
    The weighted average exercise price of options awarded under the 2001 Stock Option Plan is
based on an IPO transaction and is not determinable. The exercise price of options awarded
under the 2004 Stock Option Plan is $1.00. 74




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##### Table of Contents



Item 13.Certain Relationships and Related Transactions Stockholders and Registration Rights Agreements In connection with the Recapitalization, Knowles and the holders of its common stock,
including Key Acquisition and certain members of management, entered into a stockholders agreement
dated as of June 30, 1999 (the Stockholders Agreement) and a registration rights agreement dated
as of June 30, 1999 (the Registration Rights Agreement). Among other things, the Stockholders
Agreement and Registration Rights Agreement (i) impose certain restrictions on the transfer of
shares of common stock by such holders and (ii) give such holders registration rights under certain
circumstances. We will bear the costs of preparing and filing any such registration statement and
will indemnify and hold harmless, to the extent customary and reasonable, holders selling shares
covered by such a registration statement. Directors and executives of the company to date have
purchased 62,447 shares of common stock which are subject to the Stockholders Agreement and
Registration Rights Agreement. Loan to John J. Zei In connection with the commencement of his employment, Knowles agreed to loan Mr. Zei $300,000
to purchase Knowles common stock at fair market value. As of December 31, 2002, the Company
awarded Mr. Zei a bonus to retire the note and to pay interest and taxes totaling $275,000. (see
the description of these items under Employment Arrangements). Loan From Key Acquisition LLC The Company issued a $10 million Note to an affiliate of Doughty Hanson under a Note Purchase
Agreement dated August 28, 2002. The Note is a general unsecured obligation of the Company, ranks
subordinate to all Senior Indebtedness of the Company and pari passu to the 13 1/8% Senior
Subordinated Notes due 2009. Loan to James H. Moyle In connection with his relocation, the Company provided a bridge loan to Mr. Moyle of $900,000
in January 2003 which was repaid in one week. 75




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##### Table of Contents



Item 14.Principal Accounting Fees and Services Independent Auditor Fee Information Fees for professional services provided by our independent auditors in each of the last two
fiscal years, in each of the following categories (in thousands) are: 2004
    
    
    2003
    
    
    2002Audit fees
    
    $
    616
    
    
    $
    437
    
    
    $
    601Audit-related fees
    
    
    38
    
    
    
    307
    
    
    
    198Tax fees
    
    
    436
    
    
    
    361
    
    
    
    299All other fees
    
    
    
    
    
    
    
    
    
    
    $
    1,090
    
    
    $
    1,105
    
    
    $
    1,098
 Fees for audit services include fees associated with the annual audit, the review of the
Companys quarterly reports on Form 10-Q, and statutory audits required internationally.
Audit-related fees principally included accounting consultation related to divestitures. Tax fees
included tax compliance, tax advice and tax planning, including expatriate tax services. 
 PART IV 
 Item 15.Exhibits, Financial Statement Schedules and Reports on Form 8-K Pagea)
    
    
    1.
    
    
    Financial Statements Consolidated balance sheets  December 31, 2004 and 2003
    
    38Consolidated statements of operations for each of the
three years in the period ended December 31, 2004
    
    39Consolidated statements of changes in stockholders
equity for each of the three years in the period ended
December 31, 2004
    
    40Consolidated statements of cash flows for each of the
three years in the period ended December 31, 2004
    
    41Notes to consolidated financial statements
    
    422.
    
    
    SchedulesThe following consolidated financial schedule of
Knowles Electronics Holdings, Inc. is included in
response to Item 15(a.) II  Valuation and Qualifying
Accounts
    
    77All other schedules under Regulation S-X for Knowles
Electronics Holdings, Inc. have been omitted because
they are either non-applicable, not required or because
the information required is included in the financial
statements or notes theretoSignatures
    
    783.
    
    
    Index to Exhibits
    
    79b)
    
    Reports on Form 8-K
 1. On December 22, 2004 the Company filed a Form 8-K announcing that it had entered into a new
unsecured credit agreement providing for borrowings up to $10 million. A copy of the credit
agreement was filed with the Form 8-K. 2. On March 17, 2005 the Company file a Form 8-K announcing that it obtained an Amendment No.
8 and Waiver dated as of March 10, 2005 to its Credit Agreement dated June 28, 1999. The Amendment,
among other things, permits Knowles to incur an additional $10 million of unsecured indebtedness
and increases for each period beginning December 31, 2004 through maturity of the loans, the
maximum allowable leverage ratio applicable to Knowles under the Credit Agreements leverage ratio
covenant. Pursuant to the terms of the Credit Agreement dated as of December 20, 2004 (the Xerion
Credit Agreement), the Xerion Credit Agreement is deemed to be amended by the Amendment No. 8 to
the same extent. 76




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##### Table of Contents



SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS KNOWLES ELECTRONICS HOLDINGS, INC. AdditionsBalance
    
    
    Charge
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balanceat
    

    
    to
    
    
    Charge to
    
    
    
    
    
    

    
    
    
    
    
    
    
    atbeginning
    
    
    costs and
    
    
    other
    
    
    
    
    
    
    
    
    
    
    
    
    
    end ofof period
    
    
    expenses
    
    
    accounts
    
    
    
    
    
    
    Deductions
    
    
    
    
    
    
    periodYear ended December 31, 2004Reserves and allowances deducted
from asset accounts:Allowance for doubtful accounts
    
    $
    527
    
    
    $
    101
    
    
    $
    1
    
    
    (1
    )
    
    
    $
    177
    
    (2
    )
    

    
    
    $
    452Allowance
for inventory valuation
    
    
    4,148
    
    
    
    2,568
    
    
    
    9
    
    
    (1
    )

    
    
    
    1,414
    
    (3
    )

    
    
    
    
    5,311Year ended December 31, 2003Reserves and allowances deducted
from asset accounts:Allowance for doubtful accounts
    
    
    350
    
    
    
    247
    
    
    
    (6
    )
    
    (4
    )

    
    
    
    64
    
    (2
    )

    
    
    
    
    527Allowance
for inventory valuation
    
    
    5,114
    
    
    
    1,416
    
    
    
    (9
    )
    
    (4
    )

    
    
    
    2,373
    
    (3
    )

    
    
    
    
    4,148Year ended December 31, 2002Reserves and allowances deducted
from asset accounts:Allowance for doubtful accounts
    
    
    647
    
    
    
    (180
    )
    
    
    (1
    )
    
    (4
    )

    
    
    
    116
    
    (2
    )

    
    
    
    
    350Allowance
for inventory valuation
    
    
    7,817
    
    
    
    2,391
    
    
    
    133
    
    
    (1
    )

    
    
    
    5,227
    
    (3
    )

    
    
    
    
    5,114
   (1)
    Foreign currency translation loss.(2)
    Uncollectible accounts written off.(3)
    Disposal of obsolete inventory.(4)
    Foreign currency translation gain. 77




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 the
registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized: KNOWLES ELECTRONICS HOLDINGS, INC.
(Registrant)By:
    /s/ JOHN J. ZEIJohn J. ZeiPresident and Chief Executive Officer Dated: March 28, 2005 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacities and on the
dates indicated: Signature
    
    Title
    
    Date/s/ JOHN J. ZEI

John J. Zei
    
    President and Chief Executive
Officer Class B Director
    
    March 28, 2005/s/ JAMES H. MOYLE

James H. Moyle
    
    Vice President and Chief Financial Officer
    
    March 28, 2005/s/ JOHN LEAHY

John Leahy
    
    Class A Director
    
    March 28, 2005/s/ CHRISTOPHER WALLIS

Christopher Wallis
    
    Class A Director
    
    March 28, 2005s/ STEPHEN D. PETERSEN

Stephen D. Petersen
    
    Vice President Finance and
Secretary
    
    March 28, 2005
 78




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##### Table of Contents



EXHIBIT INDEX 2.1
    
    
    
    Recapitalization Agreement dated as of June 23, 1999, among Key Acquisition, L.L.C.,
Knowles Electronics Holdings, Inc. and the Stockholders (incorporated by reference to
Exhibit 2.1 to Registration Statement No. 333-40076)2.2
    
    
    
    Contribution Agreement dated August 30, 1999, between Knowles Electronics Holdings, Inc.
and Knowles Electronics, LLC (incorporated by reference to Exhibit 2.2 to Registration
Statement No. 393-40076)3.1
    
    
    
    Second Amended and Restated Certificate of Incorporation of Knowles Electronics, Inc.
(incorporated by reference to Exhibit 3.1 to Registration Statement No. 333-40076)3.2
    
    
    
    Certificate of Amendment to Second Amended and Restated Certificate of Incorporation of
Knowles Electronics, Inc. changing its name to Knowles Electronics Holdings, Inc.
(incorporated by reference to Exhibit 3.2 to Registration Statement No. 333-40076)3.3
    
    
    
    Certificate of Incorporation of Knowles Intermediate Holding, Inc. (incorporated by
reference to Exhibit 3.3 to Registration Statement No. 333-40076)3.4
    
    
    
    Certificate of Incorporation of Emkay Associates, Inc. (incorporated by reference to
Exhibit 3.4 to Registration Statement No. 333-40076)3.5
    
    
    
    Certificate of Amendment of Certificate of Incorporation of Emkay Associates, Inc.
changing its name to Emkay Innovative Products, Inc. (incorporated by reference to Exhibit
3.5 to Registration Statement No. 333-40076)3.6
    
    
    
    Certificate of Incorporation of Knowles Manufacturing Ltd. (incorporated by reference to
Exhibit 3.6 to Registration Statement No. 333-40076)3.7
    
    
    
    Certificate of Incorporation of Synchro-Start Products, Inc. (incorporated by reference to
Exhibit 3.7 to Registration Statement No. 333-40076)3.8
    
    
    
    Certificate of Formation of Knowles Electronics, LLC (incorporated by reference to Exhibit
3.8 to Registration Statement No. 333-40076)3.9
    
    
    
    Amended and Restated By-laws of Knowles Electronics Holdings, Inc. (incorporated by
reference to Exhibit 3.9 to Registration Statement No. 333-40076)3.10
    
    
    
    By-laws of Knowles Intermediate Holding, Inc. (incorporated by reference to Exhibit 3.10
to Registration Statement No. 333-40076)3.11
    
    
    
    By-laws of Emkay Innovative Products, Inc. (incorporated by reference to Exhibit 3.11 to
Registration Statement No. 333-40076)3.12
    
    
    
    By-laws of Knowles Manufacturing Ltd. (incorporated by reference to Exhibit 3.12 to
Registration Statement No. 333-40076)3.13
    
    
    
    By-laws of Synchro-Start Products, Inc. (incorporated by reference to Exhibit 3.13 to
Registration Statement No. 333-40076)3.14
    
    
    
    Limited Liability Company Agreement of Knowles Electronics, LLC, and an amendment dated as
of March 14, 2000 thereto (incorporated by reference to Exhibit 3.14 to Registration
Statement No. 333-40076)4.1
    
    
    
    Indenture, dated as of October 1, 1999, among Knowles Electronics Holdings, Inc., the
Subsidiary Guarantors and The Bank of New York, as trustee, relating to the 13 1/8% Senior
Subordinated Notes due 2009 (incorporated by reference to Exhibit 4.1 to Registration
Statement No. 333-40076)4.2
    
    
    
    Form of 13 1/8% Senior Subordinated Note due 2009 of Knowles Electronics Holdings, Inc.
(the Initial Note) (included as Exhibit A to the Indenture filed as Exhibit 4.1)
(incorporated by reference to Exhibit 4.2 to Registration Statement No. 333-40076)4.3
    
    
    
    Form of 13 1/8% Senior Subordinated Note due 2009 of Knowles Electronics Holdings, Inc.
(the Exchange Note) (included as Exhibit A to the Indenture filed as Exhibit 4.1)
(incorporated by reference to Exhibit 4.3 to Registration Statement No. 333-40076)4.4
    
    
    
    Registration Rights Agreement, dated October 1, 1999, between Knowles Electronics
Holdings, Inc., Morgan Stanley & Co. Incorporated and Chase Securities, Inc. (incorporated
by reference to Exhibit 4.4 to Registration Statement No. 333-40076)
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4.5
    
    
    
    Note Purchase Agreement dated August 28, 2002 between Knowles Electronic Holdings, Inc.,
the Subsidiary Guarantors and Key Acquisition LLC, (incorporated by reference to Exhibit
4.5 to the Quarterly Report on Form 10-Q for the quarter ended September 30, 2002)10.1
    
    
    
    Credit Agreement, dated as of June 28, 1999, as amended and restated as of July 21, 1999,
among Knowles Electronics Holdings, Inc., The Chase Manhattan Bank, as Administrative
Agent, Morgan Stanley Senior Funding, Inc., as Syndication Agent and Chase Securities
Inc., as Lead Arranger and Book Manager, and an amendment dated December 23, 1999 and an
amendment dated April 10, 2000 thereto (incorporated by reference to Exhibit 10.1 to
Registration Statement No. 333-40076)10.2
    
    
    
    Parent Guarantee Agreement, dated as of June 30, 1999, between Knowles Electronics
Holdings, Inc. and The Chase Manhattan Bank, as administrative agent (incorporated by
reference to Exhibit 10.2 to Registration Statement No. 333-40076)10.3
    
    
    
    Subsidiary Guarantee Agreement, dated as of June 30, 1999 among Knowles Intermediate
Holding, Inc., Emkay Innovative Products, Inc., Knowles Manufacturing Ltd.,
Synchrony-Start Products, Inc., Knowles Electronics, LLC, the subsidiary guarantors of
Knowles Electronics Holdings, Inc. that are signatories thereto, and The Chase Manhattan
Bank, as administrative agent (incorporated by reference to Exhibit 10.3 to Registration
Statement No. 333-40076)10.4
    
    
    
    Security Agreement, dated as of June 30, 1999, among Knowles Intermediate Holding, Inc.,
Emkay Innovative Products, Inc., Knowles Manufacturing Ltd., Synchro-Start Products, Inc.,
Knowles Electronics, LLC, the subsidiary guarantors of Knowles Electronics Holdings, Inc.
that are signatories thereto, and The Chase Manhattan Bank, as administrative agent
(incorporated by reference to Exhibit 10.4 to Registration Statement No. 333-400076)10.5
    
    
    
    Pledge Agreement, dated as of June 30, 1999 among Knowles Electronics, Inc., the
Subsidiary Pledgors and The Chase Manhattan Bank, as administrative agent (incorporated by
reference to Exhibit 10.5 to Registration Statement No. 333-40076)10.6
    
    
    
    Amended and Restated Employment Agreement, dated as of June 21, 1993, between Knowles
Electronics Holdings, Inc. and Reg G. Garratt (incorporated by reference to Exhibit 10.6
to Registration Statement No. 333-40076)10.7
    
    
    
    Employment Agreement between Knowles Electronics Holdings, Inc. and John J. Zei
(incorporated by reference to Exhibit 10.7 to Registration Statement No. 333-40076)10.8
    
    
    
    Employment Agreement, dated December 29, 1999, between Knowles Electronics Holdings, Inc.
and James F. Brace (incorporated by reference to Exhibit 10.8 to Registration Statement
No. 333-40076)10.9
    
    
    
    Executive Stock Purchase Agreement, dated as of April 28, 2000, by and among Knowles
Electronic Holdings, Inc., John J. Zei and Key Acquisition, L.L.C. (incorporated by
reference to Exhibit 10.9 to Registration Statement No. 333-40076)10.10
    
    
    
    Executive Stock Purchase Agreement, dated as of April 28, 2000, by and among Knowles
Electronics Holdings, Inc., James F. Brace and Key Acquisition, L.L.C. (incorporated by
reference to Exhibit 10.10 to Registration Statement No. 333-40076)10.11
    
    
    
    Executive Stock Purchase Agreement, dated as of June 30, 1999, by and among Knowles
Electronics Holdings, Inc., Stephen D. Peterson and Key Acquisition, L.L.C. (incorporated
by reference to Exhibit 10.11 to Registration Statement No. 333-40076)10.12
    
    
    
    Special Severance Commitment, dated as of September 9, 1998, between Knowles Electronics
Holdings, Inc. and Bernard J. Smith (incorporated by reference to Exhibit 10.12 to
Registration Statement No. 333-40076)10.13
    
    
    
    Change-in-Control Severance Pay Plan, dated as of September 21, 1998, established by
Knowles Electronics Holdings, Inc. (incorporated by reference to Exhibit 10.13 to
Registration Statement No. 333-40076)10.14
    
    
    
    Management Incentive Plan of Knowles Electronics Holdings, Inc. for Calendar Year 1999
(incorporated by reference to Exhibit 10.14 to Registration Statement No. 333-40076)10.15
    
    
    
    Long Term Incentive Plan of Knowles Electronics Holdings, Inc. (incorporated by reference
to Exhibit 10.15 to Registration Statement No. 333-40076)
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10.16
    
    
    
    Service Agreement, dated June 28, 1999, between Doughty Hanson & Co. Managers Limited and
Knowles Electronics Holdings, Inc. (incorporated by reference to Exhibit 10.16 to
Registration Statement No. 333-40076)10.17
    
    
    
    Commission Agreement, dated June 28, 1999, between Doughty Hanson & Co. Managers Limited
and Knowles Electronics Holdings, Inc. (incorporated by reference to Exhibit 10.17 to
Registration Statement No. 333-40076)10.18
    
    
    
    Stockholders Agreement dated as of June 30, 1999, among Knowles Electronics Holdings,
Inc., Key Acquisition, L.L.C., Management, the Vendor Group, Morgan Stanley Senior
Funding, Inc., Chase Securities, Inc. and The Chase Manhattan Bank (incorporated by
reference to Exhibit 10.18 to Registration Statement No. 333-40076)10.19
    
    
    
    Registration Rights Agreement, dated as of June 20, 1999, among Knowles Electronics
Holdings, Inc., Key Acquisition, L.L.C., Management, the Existing Holder Group, Morgan
Stanley Senior Funding Inc., Chase Securities Inc. and The Chase Manhattan Bank
(incorporated by reference to Exhibit 10.19 to Registration Statement No. 333-40076)10.20
    
    
    
    Amendment No. 3 dated as of December 12, 2001 to the Credit Agreement, dated as of June
28, 1999, as amended and restated as of July 21, 1999, and further amended as of December
23, 1999 and April 10, 2000, among Knowles Electronics Holdings, Inc., The Chase Manhattan
Bank, as Administrative Agent, Morgan Stanley Senior Funding, Inc., as Syndication Agent
and Chase Securities Inc., as Lead Arranger and Book Manager. (incorporated by reference
to Exhibit 10.20 to Annual Report on Form 10-K for the year ended December 31, 2001)10.21
    
    
    
    Amendment No. 4 and Waiver dated as of May 10, 2002 to the Credit Agreement, dated as of
June 28, 1999, as amended and restated as of July 21, 1999, and further amended as of
December 23, 1999, April 10, 2000 and December 12, 2001, among Knowles Electronics
Holdings, Inc., The Chase Manhattan Bank, as Administrative Agent, Morgan Stanley Senior
Funding, Inc., as Syndication Agent and Chase Securities Inc., as Lead Arranger and Book
Manager. (incorporated by reference to Exhibit 10.21 to Annual Report on Form 10-K for the
year ended December 31, 2001)10.22
    
    
    
    Investor Funding Agreement dated as of May 10, 2002 among Key Acquisition, LLC, a Delaware
limited liability company, Knowles Electronics Holdings, Inc., a Delaware limited
liability company, and JP Morgan Chase Bank, in its capacity as Administrative Agent for
the lenders under the Credit Agreement, dated as of June 28, 1999, as amended and restated
as of July 21, 1999, among Knowles Electronics Holdings, Inc., The Chase Manhattan Bank,
as Administrative Agent, Morgan Stanley Senior Funding, Inc., as Syndication Agent and
Chase Securities Inc., as Lead Arranger and Book Manager. (incorporated by reference to
Exhibit 10.22 to Annual Report on Form 10-K for the year ended December 31, 2001)10.23
    
    
    
    Employment Agreement between Knowles Electronics Holdings, Inc. and James H. Moyle.
(incorporated by reference to Exhibit 4.5 to the Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002)10.24
    
    
    
    Limited Waiver and Fifth Amendment dated March 25, 2003 and entered into by and among
Knowles Electronics Holdings, Inc. (f/k/a Knowles Electronics, Inc.), the financial
institutions listed on the signature pages hereof, JPMorgan Chase Bank as agent for the
lenders, and, for the purposes of Section 3.9 and Section 6 thereof, the subsidiaries of
the Company party thereto. (incorporated by reference to Exhibit 10.24 on Form 10-K for
the year ended December 31, 2003)10.25
    
    
    
    Stock Purchase Agreement between and among Woodward Governor Company and Knowles
Intermediate Holding, Inc. and Knowles Electronics Holdings, Inc dated May 20, 2003.
(incorporated by reference to Exhibit 10.25 to Form 8-K filed June 16, 2003)10.26
    
    
    
    Share Deal agreed by and between Knowles Intermediate Holding, Inc. and FM
Electronics-Holding GmbH and WEHA Holding GmbH dated July 29, 2003. (incorporated by
reference to Form 10-Q for the quarter ended June 30, 2003)10.27
    
    
    
    Knowles Electronics Holdings, Inc. Retention Incentive Plan dated December 12, 200310.28
    
    
    
    Knowles Electronics Holdings, Inc. Value Enhancement Incentive Plan dated December 12, 200310.29
    
    
    
    Amendment No. 6 and Waiver dated as of May 28, 2003 to the Credit Agreement dated as of
June 28, 1999, as amended and restated as of July 21, 1999, as amended, among Knowles
Electronics Holdings, Inc.; the financial institutions party thereto as Lenders; JPMorgan
Chase Bank as administrative agent and Morgan Stanley Senior Funding, Inc. as Syndication
Agent. (incorporated by reference to Exhibit 10.26 on Form 10-Q for the quarter ended June
30, 2004)10.30
    
    
    
    Seventh Amendment to Credit Agreement and Second Amendment to Security Agreement dated as
of April 8, 2004 among Knowles Electronics Holdings, Inc., the financial institutions
listed on the signature pages hereof, JPMorgan Chase bank as agent for the Lenders, and
for purposes of Sections 2,5 and 6 hereof, the Loan Parties listed on the signature pages
hereof, with reference to the Credit Agreement dated as of June 28, 1999, as amended and
restated July 21, 1999, as amended, among Knowles Electronics Holdings, Inc.; the
financial institutions party thereto as Lenders; JPMorgan Chase Bank as administrative
agent and Morgan Stanley Senior Funding, Inc. as Syndication Agent. (incorporated by
reference to Exhibit 10.27 on Form 10-Q for the quarter ended June 30, 2004)10.31
    
    
    
    Credit Agreement dated as of December 20, 2004 among Knowles Electronics Holdings, Inc.,
as Borrower, Xerion Partners II Master Fund Limited, as Lender, and the other lenders
party thereto from time to time. (incorporate by reference to Exhibit 99.1 on Form 8-K
filed on December 22, 2004)
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10.32
    
    
    
    2004 Stock Option Plan (incorporated by reference to Exhibit 10.32 on Form 10-K for the
year ended December 31, 2004)10.33
    
    
    
    Amendment No. 1 to Credit Agreement
dated as of March 29, 2005 among Knowles
Electronics Holdings, Inc., Xerion Partners II Master Fund Limited and
Jefferies & Company, Inc. filed with Form 10-K for the year ended
December 31, 2004.12.1
    
    
    
    Calculation of Ratio of Earnings to Fixed Charges21.1
    
    
    
    List of Subsidiaries31.1
    
    
    
    Rule 13a-14 and 15d-14 Certification of the Chief Executive Officer31.2
    
    
    
    Rule 13a-14 and 15d-14 Certification of the Chief Financial Officer
 82