##### Table of Contents









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 1934    
|          
|           |  | For the year ended December 31,
    2003                                                    
|          
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For 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
    incorporation or organization)                     |  | (I.R.S. Employer
    Identification Number)
|                                                                                      
|1151 Maplewood Drive,
    Itasca, Illinois(Address of principal executive
    offices) |  | 60143(Zip Code)                            

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 Registered
|                    |  |                                          
|None                |  |                                          

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, 2003


CONTENTS

|                                                  |  |                                                                                           |    |      |    | 
|------------------------------------------------- |  | ----------------------------------------------------------------------------------------- | -- | ---- | -- | 
|Section                                           |  |                                                                                           |    | Page
|                                                  |  |                                                                                           |    |     
|PART I                                           
|Item 1                                            |  | Business                                                                                  |    |      | 2  | 
|Item 2                                            |  | Properties                                                                                |    |      | 10 | 
|Item 3                                            |  | Legal Matters                                                                             |    |      | 10 | 
|Item 4                                            |  | Submission of Matters to a
    Vote of Security Holders                                   |    |      | 11 | 
|PART II                                          
|Item 5                                            |  | Market for Registrants
    Common Equity and Related Stockholder Matters                 |    |      | 11 | 
|Item 6                                            |  | Selected Consolidated
    Financial Data                                                  |    |      | 11 | 
|Item 7                                            |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations |    |      | 13 | 
|Item 7A                                           |  | Quantitative and Qualitative
    Disclosures about Market Risk                            |    |      | 37 | 
|Item 8                                            |  | Financial Statements and
    Supplementary Data                                           |    |      | 38 | 
|Item 9                                            |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure  |    |      | 72 | 
|Item 9A                                           |  | Control and Procedures                                                                    |    |      | 72 | 
|PART III                                         
|Item 10                                           |  | Directors and Executive
    Officers                                                      |    |      | 72 | 
|Item 11                                           |  | Executive Compensation                                                                    |    |      | 74 | 
|Item 12                                           |  | Security Ownership of
    Certain Beneficial Owners and Management                        |    |      | 78 | 
|Item 13                                           |  | Certain Relationships and
    Related Transactions                                        |    |      | 80 | 
|Item 14                                           |  | Principal Accounting Fees
    and Services                                                |    |      | 81 | 
|PART IV                                          
|Item 15                                           |  | Exhibits, Financial
    Statement Schedules and Reports on Form 8-K                       |    |      | 81 | 
|Signatures                                        |  |                                                                                           | 83 |     
|Retention Incentive Plan                         
|Value Enhancement Incentive Plan                 
|Calculation of Ratio of Earnings to Fixed Charges
|Code of Ethics                                   
|List of Subsidiaries                             
|Certification                                    
|Certification                                    



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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 2003
results from continuing operations reflect revenue, operating
income and EBITDA, of $154.0 million, $37.0 million
and $44.4 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,
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 approximately 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.

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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 approximately 75%.
    We protect our leading market share by maintaining strong
    relationships with all of the key manufacturers that require
    high quality transducers including 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 manufacture a MEMS-based surface mount
    silicon microphone.
|
| |  | To enhance our technological expertise, we
    emphasize research and development investment. Our 2003 research
    and development expenditures were $10.2 million, or 6.6% 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 that our Elgin, Illinois facility will be
    closed by the end of 2004. The majority of manufacturing
    activity will be transferred from Elgin to our locations in
    China and Malaysia, which will be expanded to accommodate the
    additional volume. Certain high value operations will be
    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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

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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 approximately 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                                                        
|
| |  | 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
    SiSonicTMSilicon 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
SiSonicTM 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:

IntellisonicTMFar-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.

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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.After
the completion of our restructuring efforts in 2004, nearly all
of our manufacturing activity will be located in China and
Malaysia to benefit from both their lower cost labor markets and
proximity to emerging product markets.

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.

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Research and Development

Our 2003 research and development expenditures
were $10.2 million, or 6.6% of net sales. We have a team of
63 scientists, engineers and technicians located primarily in
Itasca, Illinois and in Taiwan. 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. Custom acoustic assembly and microphone product
development are conducted in Taiwan. In 2003, 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®. 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 2003 allowed us to move 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.

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. With the closure of our Elgin, Illinois
facility at the end of 2004, we will be expanding our operations
with additional facilities in our Penang, Malaysia and Suzhou,
China locations. These new facilities will be in the place by
the end of the second quarter of 2004 and will add approximately
55,000 square feet of assembly capacity and 25,000 square feet
of metal fabrication capacity.

In March 2000, we announced plans to consolidate
our worldwide manufacturing operations, including the ceasing of
production in the United Kingdom and Taiwan and outsourcing some
activities performed in the United States. In December 2003 we
announced that our Elgin, Illinois facility will be closed by
the end of 2004. Certain high value manufacturing operations
will be 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 will
be 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 75%
utilized. Our transducer manufacturing facilities are ISO
9001:2000 certified. Our manufacturing processes

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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 24 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 25 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 such as Guidant; and pro-audio manufacturers such
as Shure. In addition, we are a major supplier of micro-acoustic
devices for electronics manufactures including Plantronics,
Phillips and HTC. In 2003, we had four customers that each
represented more than ten percent of our consolidated sales and
accounts receivable. As a group, these four customers
represented 60 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 approximately 75% in 2003.
Our principal competitor is SonionMicrotronic, which we believe
had a significant portion of the remaining market share in 2003.
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.

Patents, Copyrights and Trademarks

Patents play an important role in the strategy
for each of our business units. As a matter of practice, we
follow an aggressive 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 and approval by the appropriate business unit. We
currently have approximately 170 patents issued in
15 countries around the world. In addition, we have more
than 70 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 than 50
trademarks registrations and applications for registration in
20 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.

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Our patents and other intellectual property
rights may not protect us from competition. 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 2,166 employees as of December 31,
2003. Of these, approximately 70% were direct production
employees and 30% were staff. Geographically, 302 of our
employees are based in North America, 26 in Europe and 1,838 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 performance
capabilities of any hearing aid. Without high performance
transducers, the processing capabilities of hearing devices are
ineffective.

The overall market for hearing aids improved in
the second half of 2003 after stagnating in 2001 and 2002 and
the first two quarters of 2003. The United States is currently
the worlds largest market for hearing aids. Hearing aid
sales in the U.S. increased by 12% and 10% in the third and
fourth quarters of 2003, respectively, compared to the prior
year period, according to the Hearing Industries Association, an
industry trade group. For the total year 2003, hearing aid sales
in the United States increased 4.9% over the prior year.
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.

8



---



##### Table of Contents



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 in developed countries could
    benefit from hearing aids, but only approximately 2% of the
    population in developed countries owns them. 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 520 million mobile
phones sold in 2003, 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



---



##### Table of Contents



High End Consumer Electronics

We manufacture the largest offering of balance
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.).

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      |        | Area         
|Location                  |  | Usage |         | Leased |  | Expiration |        | (Square feet)
|                          |  |       |         |        |  |            |        |              
|US                        |  |       |         |        |  |            |        |               |  |  |            |  |  |  |         | 
|                          |  |       |         |        |  |            |        |               |  |  |            |  |  |  |         | 
|Elgin, IL(1)              |  |       | Mfg.    |        |  |            | Owned  |               |  |  |            |  |  |  | 71,800  | 
|Itasca, IL                |  |       | Hdqtrs. |        |  |            | Owned  |               |  |  |            |  |  |  | 60,900  | 
|                          |  |       |         |        |  |            |        |               |  |  |            |  |  |  |         | 
|                          |  |       |         |        |  |            |        |               |  |  |            |  |  |  | 132,700 | 
|EUROPE                    |  |       |         |        |  |            |        |               |  |  |            |  |  |  |         | 
|                          |  |       |         |        |  |            |        |               |  |  |            |  |  |  |         | 
|Burgess Hill, UK          |  |       | Sales   |        |  |            | Leased |               |  |  | 3/31/2016  |  |  |  | 15,000  | 
|                         
|ASIA                      |  |       |         |        |  |            |        |               |  |  |            |  |  |  |         | 
|                          |  |       |         |        |  |            |        |               |  |  |            |  |  |  |         | 
|Suzhou, China (No. 20)(2) |  |       | Mfg.    |        |  |            | Leased |               |  |  | 3/31/2004  |  |  |  | 21,000  | 
|Suzhou, China (Block B)   |  |       | Mfg.    |        |  |            | Leased |               |  |  | 1/1/2005   |  |  |  | 12,900  | 
|Suzhou, China(3)          |  |       | Mfg.    |        |  |            |        |               |  |  |            |  |  |  | 83,700  | 
|Tokyo, Japan(5)           |  |       | Sales   |        |  |            | Leased |               |  |  | 6/30/2004  |  |  |  | 600     | 
|Penang, Malaysia(4)       |  |       | Mfg.    |        |  |            | Owned  |               |  |  |            |  |  |  | 57,500  | 
|Weifang, China            |  |       | Mfg.    |        |  |            | Leased |               |  |  | 9/30/2005  |  |  |  | 32,900  | 
|Taipei, Taiwan            |  |       | Sales   |        |  |            | Leased |               |  |  | 11/30/2005 |  |  |  | 13,200  | 
|                          |  |       |         |        |  |            |        |               |  |  |            |  |  |  |         | 
|                          |  |       |         |        |  |            |        |               |  |  |            |  |  |  | 221,800 | 
|                          |  |       |         |        |  |            |        |               |  |  |            |  |  |  |         | 
|GRAND TOTAL               |  |       |         |        |  |            |        |               |  |  |            |  |  |  | 369,500 | 
|                          |  |       |         |        |  |            |        |               |  |  |            |  |  |  |         | 



---



|    |                                                                     
|--- | --------------------------------------------------------------------
|(1) | This facility is expected to be closed in
    September 2004.       
|   
|(2) | Lease will not be renewed.                                          
|   
|(3) | Occupancy March 2004, lease or purchase terms
    under negotiation.
|   
|(4) | Land lease expires 09/18/2049                                       
|   
|(5) | Lease will be renewed.                                              






|        |              
|------- | -------------
|Item 3. | Legal Matters

The Company has no material pending or threatened
litigation.

10



---



##### Table of Contents








|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders

Not applicable.




PART II






|        |                                                                          
|------- | -------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity
    and Related Stockholder Matters

Not applicable.






|        |                                         
|------- | ----------------------------------------
|Item 6. | Selected Consolidated Financial
    Data

|                                                                   |                                                                                                |         |         |         |   |      |         |        |  |      |         |        |   |   |         |        |  |   |         |        |  
|------------------------------------------------------------------ | ---------------------------------------------------------------------------------------------- | ------- | ------- | ------- | - | ---- | ------- | ------ |  | ---- | ------- | ------ | - | - | ------- | ------ |  | - | ------- | ------ | -
|                                                                   |                                                                                                | 1999(9) |         | 2000(9) |   | 2001 |         | 2002   |  | 2003
|                                                                   |                                                                                                |         |         |         |   |      |         |        |  |     
|Statement of Operations Data(3):                                   |                                                                                                |         |         |         |   |      |         |        |  |      |         |        |   |   |         |        |  |   |         |       
|Net sales                                                          |                                                                                                | $       | 180,595 |         |   | $    | 184,573 |        |  | $    | 173,116 |        |   | $ | 164,119 |        |  | $ | 154,042 |       
|Costs and expenses:                                                |                                                                                                |         |         |         |   |      |         |        |  |      |         |        |   |   |         |        |  |   |         |       
|                                                                   | Cost of sales(7)                                                                               |         |         | 112,749 |   |      |         | 99,975 |  |      |         | 90,705 |   |   |         | 87,970 |  |   |         | 75,594 |  
|                                                                   | Research and development                                                                       |         |         | 12,247  |   |      |         | 11,753 |  |      |         | 12,845 |   |   |         | 11,735 |  |   |         | 10,225 |  
|                                                                   | Selling and administrative expense                                                             |         |         | 25,194  |   |      |         | 28,450 |  |      |         | 34,420 |   |   |         | 30,981 |  |   |         | 29,732 |  
|                                                                   | Recapitalization expense(1)                                                                    |         |         | 10,674  |   |      |         |       |  |      |         |       |   |   |         |       |  |   |         |       |  
|                                                                   | Loss on sale of business(8)                                                                    |         |         |        |   |      |         |       |  |      |         |       |   |   |         | 16,736 |  |   |         |       |  
|                                                                   | Restructuring expenses(2)                                                                      |         |         |        |   |      |         | 14,858 |  |      |         | (179   | ) |   |         | 2,112  |  |   |         | 1,532  |  
|                                                                   |                                                                                                |         |         |         |   |      |         |        |  |      |         |        |   |   |         |        |  |   |         |       
|Operating income                                                   |                                                                                                | $       | 19,731  |         |   | $    | 29,537  |        |  | $    | 35,325  |        |   | $ | 14,585  |        |  | $ | 36,959  |       
|Interest income                                                    |                                                                                                |         | 883     |         |   |      | 941     |        |  |      | 139     |        |   |   | 129     |        |  |   | 111     |       
|Interest expense                                                   |                                                                                                |         | (23,051 | )       |   |      | (43,292 | )      |  |      | (37,666 | )      |   |   | (33,891 | )      |  |   | (35,835 | )     
|Miscellaneous, net                                                 |                                                                                                |         | (123    | )       |   |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|                                                                   |                                                                                                |         |         |         |   |      |         |        |  |      |         |        |   |   |         |        |  |   |         |       
|Income (loss) from continuing operations
    before income taxes   |                                                                                                |         | (2,560  | )       |   |      | (12,814 | )      |  |      | (2,202  | )      |   |   | (19,177 | )      |  |   | 1,235   |       
|Income tax expense (benefit)                                       |                                                                                                |         | 8,786   |         |   |      | (1,580  | )      |  |      | 6,313   |        |   |   | 11,744  |        |  |   | 491     |       
|                                                                   |                                                                                                |         |         |         |   |      |         |        |  |      |         |        |   |   |         |        |  |   |         |       
|Income (loss) from continuing operations
    after income taxes    |                                                                                                |         | (11,346 | )       |   |      | (11,234 | )      |  |      | (8,515  | )      |   |   | (30,921 | )      |  |   | 744     |       
|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(3)                                                         |         |         | 6,200   |   |      |         | 7,667  |  |      |         | 7,036  |   |   |         | 6,545  |  |   |         | 932    |  
|                                                                   |                                                                                                |         |         |         |   |      |         |        |  |      |         |        |   |   |         |        |  |   |         |       
|Income from discontinued operations after income
    taxes         |                                                                                                |         | 6,200   |         |   |      | 7,667   |        |  |      | 7,036   |        |   |   | 6,545   |        |  |   | 27,926  |       
|                                                                   |                                                                                                |         |         |         |   |      |         |        |  |      |         |        |   |   |         |        |  |   |         |       
|Net income (loss)                                                  |                                                                                                | $       | (5,146  | )       |   | $    | (3,567  | )      |  | $    | (1,479  | )      |   | $ | (24,376 | )      |  | $ | 28,670  |       
|                                                                   |                                                                                                |         |         |         |   |      |         |        |  |      |         |        |   |   |         |        |  |   |         |       
|C Corporation Pro Forma Data(4) 
    unaudited:                   |                                                                                                |         |         |         |   |      |         |        |  |      |         |        |   |   |         |        |  |   |         |       
|                                                                   | C Corporation pro forma income taxes(4)                                                        |         | $       | 19,125  |   |      |         |       |  |      |         |       |   |   |         |       |  |   |         |       |  
|                                                                   | C corporation pro forma income (loss) from
    continuing operations adjusted for income taxes |         | $       | (21,685 | ) |      |         |       |  |      |         |       |   |   |         |       |  |   |         |       |  

11



---



##### Table of Contents



|                                               |                                          |         |          |         |   |      |          |         |   |      |          |         |   |   |          |        |   |   |          |         |  
|---------------------------------------------- | ---------------------------------------- | ------- | -------- | ------- | - | ---- | -------- | ------- | - | ---- | -------- | ------- | - | - | -------- | ------ | - | - | -------- | ------- | -
|                                               |                                          | 1999(9) |          | 2000(9) |   | 2001 |          | 2002    |   | 2003
|                                               |                                          |         |          |         |   |      |          |         |   |     
|Other Financial Data:                          |                                          |         |          |         |   |      |          |         |   |      |          |         |   |   |          |        |   |   |          |        
|                                               | Depreciation and amortization            |         | $        | 10,824  |   |      | $        | 10,613  |   |      | $        | 11,693  |   |   | $        | 8,703  |   |   | $        | 7,443   |  
|                                               | Capital expenditures                     |         |          | 14,500  |   |      |          | 16,151  |   |      |          | 21,276  |   |   |          | 8,427  |   |   |          | 14,776  |  
|                                               | Cash flows from operating activities(11) |         |          | 49,274  |   |      |          | 22,835  |   |      |          | 9,816   |   |   |          | 29,679 |   |   |          | 11,111  |  
|                                               | Cash flows from investing activities     |         |          | (14,500 | ) |      |          | (15,488 | ) |      |          | (17,614 | ) |   |          | (4,867 | ) |   |          | 30,469  |  
|                                               | Cash flows from financing activities     |         |          | (19,055 | ) |      |          | (12,160 | ) |      |          | (6,152  | ) |   |          | (3,563 | ) |   |          | (54,201 | )
|                                               | EBITDA(5)                                |         |          | 30,432  |   |      |          | 40,150  |   |      |          | 47,018  |   |   |          | 23,288 |   |   |          | 44,402  |  
|                                               | EBITDA as adjusted(10)                   |         |          | 44,338  |   |      |          | 54,648  |   |      |          | 46,419  |   |   |          | 42,930 |   |   |          | 45,933  |  
|                                               | Ratio of earnings to fixed charges(6)    |         |          |        |   |      |          |        |   |      |          |        |   |   |          |       |   |   |          | 1.0     | x
|Balance Sheet Data:                            |                                          |         |          |         |   |      |          |         |   |      |          |         |   |   |          |        |   |   |          |        
|Cash and cash equivalents                      |                                          | $       | 24,403   |         |   | $    | 16,292   |         |   | $    | 2,029    |         |   | $ | 23,879   |        |   | $ | 11,227   |        
|Total assets                                   |                                          |         | 188,108  |         |   |      | 193,867  |         |   |      | 179,992  |         |   |   | 150,839  |        |   |   | 112,573  |        
|Long term debt including current maturities    |                                          |         | 350,134  |         |   |      | 348,807  |         |   |      | 339,773  |         |   |   | 339,622  |        |   |   | 288,180  |        
|Preferred stock mandatorily redeemable in 2019 |                                          |         | 194,250  |         |   |      | 213,675  |         |   |      | 235,042  |         |   |   | 258,547  |        |   |   | 284,401  |        
|Total common stockholders equity (deficit)    |                                          |         | (412,724 | )       |   |      | (442,507 | )       |   |      | (465,780 | )       |   |   | (518,151 | )      |   |   | (512,375 | )      

See accompanying notes.



---



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | The Recapitalization expenses
    consisted primarily of bonuses, special one-time recognition
    payments to employees, termination costs of a supplemental
    executive retirement plan and legal, accounting, public
    relations and other professional fees.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| | (2) | The Restructuring expenses for the
    year 2000 thru 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 is primarily related to the
    closure of our Elgin, Illinois facility announced in November
    2003.                                                                                                                                  
|
| | (3) | Net income from discontinued operations in 1999
    thru 2003 represents the activities of the Synchro-Start and
    Infrared businesses sold during 2003, and in 1999, the Finance
    Company of Illinois, an equipment financing business that was
    distributed to our preexisting stockholders on June 29,
    1999. Years 1999 thru 2002 have been restated to reflect these
    discontinued operations.                                                                                                                                                                                                                                                                                                                                                
|
| | (4) | Effective January 1, 1997, our stockholders
    elected under the S Corporation rules of the Internal Revenue
    Code to have Knowles income included in their own income
    for federal income tax purposes. As a result of the
    Recapitalization, we terminated our S Corporation status for
    federal income tax purposes effective June 29, 1999. For
    informational purposes, the selected historical consolidated
    financial data includes an unaudited pro forma presentation of
    income taxes which would have been recorded if we had been a C
    Corporation.                                                                                                                                                                        
|
| | (5) | EBITDA is defined as earnings before
    interest, taxes, depreciation and amortization. For the years
    2000, 2001, 2002 and 2003 EBITDA includes restructuring charges
    of $14,858, ($179), $2,112 and $1,532 respectively. 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

12



---



##### Table of Contents



| |  |                                                                                                              
| |  | -------------------------------------------------------------------------------------------------------------
| |  | calculated under GAAP, it may not be comparable
    to similarly titled measures reported by other companies.

Reconciliation of operating income to EBITDA:

|                              |  |      |        |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|----------------------------- |  | ---- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------ |  |  | - | ------ | 
|                              |  | 1999 |        | 2000 |  | 2001 |        | 2002 |  | 2003
|                              |  |      |        |      |  |      |        |      |  |     
|Operating income              |  | $    | 19,731 |      |  | $    | 29,537 |      |  | $    | 35,325 |  |  | $ | 14,585 |  |  | $ | 36,959 | 
|Depreciation and amortization |  |      | 10,824 |      |  |      | 10,613 |      |  |      | 11,693 |  |  |   | 8,703  |  |  |   | 7,443  | 
|Miscellaneous, net            |  |      | (123   | )    |  |      |       |      |  |      |       |  |  |   |       |  |  |   |       | 
|                              |  |      |        |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|EBITDA                        |  | $    | 30,432 |      |  | $    | 40,150 |      |  | $    | 47,018 |  |  | $ | 23,288 |  |  | $ | 44,402 | 
|                              |  |      |        |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (6) | 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,
    1999, 2000, 2001 and 2002 by approximately $2.6, $14.8, $2.2 and
    $19.2 million, respectively.
|
| | (7) | 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 and 1999 results
    were decreased by $1,011 and $1,674, respectively.                                                                                                                                                                              
|
| | (8) | 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. The
    Company may receive additional payment amounts in 2004 and 2005
    if the Ruf operations meet certain financial targets.                                                                                                        
|
| | (9) | The results for 1999 and 2000 have been restated
    to correct an error in the pension expense recorded by our
    U.K. facility, increasing operating income by $267 and
    $300, respectively, and to reduce restructuring expense in 2000
    to reflect the $1.0 million pension curtailment gain that
    should have been recorded. Appropriate balance sheet accounts
    have also been restated. See Consolidated Financial Statement
    Footnote 2.                                                                                 



|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | EBITDA as adjusted is defined as
    earnings before interest, taxes, depreciation and amortization;
    and for the year 1999 recapitalization expense; for years 2000
    thru 2003 restructuring charges; for years 1999 thru 2002 EBITDA
    from Ruf Electronics (sold in 2002); and for the year 2002
    loss on sale of business. EBITDA as adjusted is a key
    measurement used by management and presented solely as a
    supplemental disclosure.

Reconciliation of EBITDA to EBITDA as
adjusted:

|                         |  |      |        |      |  |      |        |      |  |      |        |   |  |   |        |  |  |   |        | 
|------------------------ |  | ---- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------ | - |  | - | ------ |  |  | - | ------ | 
|                         |  | 1999 |        | 2000 |  | 2001 |        | 2002 |  | 2003
|                         |  |      |        |      |  |      |        |      |  |     
|EBITDA                   |  | $    | 30,432 |      |  | $    | 40,150 |      |  | $    | 47,018 |   |  | $ | 23,288 |  |  | $ | 44,401 | 
|Recapitalization expense |  |      | 10,674 |      |  |      |       |      |  |      |       |   |  |   |       |  |  |   |       | 
|Restructuring charges    |  |      |       |      |  |      | 14,858 |      |  |      | (179   | ) |  |   | 2,112  |  |  |   | 1,532  | 
|Ruf EBITDA               |  |      | 3,232  |      |  |      | (360   | )    |  |      | (420   | ) |  |   | 794    |  |  |   |       | 
|Loss on sale of business |  |      |       |      |  |      |       |      |  |      |       |   |  |   | 16,736 |  |  |   |       | 
|                         |  |      |        |      |  |      |        |      |  |      |        |   |  |   |        |  |  |   |        | 
|EBITDA as adjusted       |  | $    | 44,338 |      |  | $    | 54,648 |      |  | $    | 46,419 |   |  | $ | 42,930 |  |  | $ | 45,933 | 
|                         |  |      |        |      |  |      |        |      |  |      |        |   |  |   |        |  |  |   |        | 



|     |                                                                            
|---- | ---------------------------------------------------------------------------
|(11) | Represents total cash flow from continuing and
    discontinued operations.






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|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.

13



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##### Table of Contents



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 the last two years 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 period ending 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. The assets and liabilities
of the discontinued operations have been summarized as current
and netted together for presentation on the balance sheet. 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 2003, the Company reduced debt
by $51.4 million, and refinanced the $31.8 million
A portion of its bank debt. As of December 31,
2003, the Company had no short-term debt and Notes payable of
$288.2 million. 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, 2003 and expects to be in
compliance through December 31, 2004. For more detail,
see the Liquidity and Capital resources section below.

Our 2003 revenue, operating income and EBITDA, as
reported, were $154.0 million, $37.0 million and
$44.4 million, respectively. Our 2003 EBITDA as adjusted
(defined in Item 6. Selected Consolidated Financial Data,
Footnote 10) was $45.9 million.

Sales decreased $10.1 million in the twelve
months ending December 31, 2003 because of the sale of Ruf
in November 2002. Excluding Ruf sales of $14.2 million from
the 2002 results, sales increased by $4.1 million or 2.7%
in 2003 with increases in transducers, silicon microphones and
electromechanical devices for the hearing aid market. Gross
margin rates improved in 2003 due to the sale of Ruf and due to
improved product reliability, better inventory controls and on
going cost improvement programs. Operating expenses decreased by
$2.7 million due to the sale of Ruf, but increased by
$2.2 million or 5.8% when Ruf is excluded from the prior
year period. The Company reported restructuring expenses of
$1.5 million in 2003 (primarily accruals for restructuring
related to the scheduled closure of our Elgin, Illinois
facility) and restructuring expenses of $2.1 million in
2002 (primarily the loss on the sale of a facility in Taiwan and
severance). The Company reported a $16.7 million loss on the
sale of Ruf in 2002. Operating income increased by
$22.4 million in 2003, primarily because of the 2002 loss
on the sale of Ruf and improved operating results in 2003. The
Companys key performance indicator is EBITDA as adjusted,
which improved by $3.0 million in 2003 due to the improved
sales and gross margin rates. The increase in EBITDA was
realized in the fourth quarter, primarily due to improved
conditions in the market for hearing aids and favorable
manufacturing costs. For more detail, see the Consolidated
Results from Operations, below.

14



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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
in the worldwide market for hearing aids in the second half of
2003. We believe that this improvement in the hearing aid
markets will continue in 2004 and will more than offset any
decline in transducer prices in 2004.

Net sales for microacoustic devises 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 continued to refine this
innovative product and developed manufacturing methods that
allowed us to ship the Silicon Microphone into markets such as
cell phones in commercial quantities.

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 57% of our depreciation expense
in 2003 and 2002 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 Meadow, Illinois
facilities and ceased production at our manufacturing facilities
in the United Kingdom and Taiwan. In November 2003 we announced
that our Elgin, Illinois facility will be closed by the end of
2004. The majority of manufacturing activity will be transferred
from Elgin to our locations in China and Malaysia.

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.

15



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##### Table of Contents



We have replaced certain management information
systems, requiring expenditures of approximately
$11 million from 2000 through 2003. Approximately
$8 million was spent in 2001, of which $6.6 million
was capitalized. All locations now are integrated into the
Companys ERP system.

Other income (expense).Other income (expense) consists
of interest income, interest expense and miscellaneous expenses.
Due to our recapitalization, interest expense was
$35.8 million in 2003, $33.9 million in 2002 and
$37.7 million in 2001. The increase in interest expense in
2003 was caused by the refinancing of the A portion
of the bank debt with the higher interest C loan.

Income taxes.Effective June 30, 1999, Knowles
became a C corporation and subsequently, has been subject to
federal income taxes. Income taxes were a small net benefit in
2000 due to our ability to use a net loss carry forward from
1999. The provision for income taxes exceeded pretax income in
2001 due to not being able to offset the profitable foreign
operations with the U.S. loss arising from the interest expense.
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.

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.

16



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##### Table of Contents



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 December 2001,
the consolidated results are shown with and without the Ruf
business, which was sold in November 2002.

|                                              |  |              |       |                  |  |                  |       |               |  |              |       |          |  |               |       |   |  |   |       |   |  |   |      |   |  |   |       |  
|--------------------------------------------- |  | ------------ | ----- | ---------------- |  | ---------------- | ----- | ------------- |  | ------------ | ----- | -------- |  | ------------- | ----- | - |  | - | ----- | - |  | - | ---- | - |  | - | ----- | -
|                                              |  |              |       |                  |  |                 
|                                              |  |              |       | 12 Months Ending |  | 12 Months Ending
|                                              |  | 12 Months    |       |                  |  |                 
|                                              |  | Ending       |       |                  |  | 12/31/02         |       |               |  | 12/31/01    
|                                              |  | 12/31/03     |       | 12/31/02         |  | 12/31/02         |       | Consolidated  |  | 12/31/01     |       | 12/31/01 |  | Consolidated 
|                                              |  | Consolidated |       | Consolidated     |  | Ruf              |       | Excluding Ruf |  | Consolidated |       | Ruf      |  | Excluding Ruf
|                                              |  |              |       |                  |  |                  |       |               |  |              |       |          |  |              
|                                              |  |             
|                                              |  | $ millions  
|Net sales                                     |  | $            | 154.0 |                  |  | $                | 164.1 |               |  | $            | 14.2  |          |  | $             | 149.9 |   |  | $ | 173.1 |   |  | $ | 18.0 |   |  | $ | 155.1 |  
|Cost of sales                                 |  |              | 75.6  |                  |  |                  | 88.0  |               |  |              | 10.6  |          |  |               | 77.4  |   |  |   | 90.7  |   |  |   | 13.4 |   |  |   | 77.3  |  
|                                              |  |              |       |                  |  |                  |       |               |  |              |       |          |  |               |       |   |  |   |       |   |  |   |      |   |  |   |       |  
|Gross margin                                  |  |              | 78.4  |                  |  |                  | 76.1  |               |  |              | 3.6   |          |  |               | 72.5  |   |  |   | 82.4  |   |  |   | 4.6  |   |  |   | 77.8  |  
|Gross margin %                                |  |              | 50.9  | %                |  |                  | 46.4  | %             |  |              | 25.4  | %        |  |               | 48.4  | % |  |   | 47.6  | % |  |   | 25.6 | % |  |   | 50.2  | %
|Research and development                      |  |              | 10.2  |                  |  |                  | 11.7  |               |  |              | 1.7   |          |  |               | 10.0  |   |  |   | 12.9  |   |  |   | 1.9  |   |  |   | 11.0  |  
|Sales and marketing                           |  |              | 9.2   |                  |  |                  | 9.5   |               |  |              | 1.0   |          |  |               | 8.5   |   |  |   | 10.9  |   |  |   | 1.1  |   |  |   | 9.8   |  
|General and administrative                    |  |              | 20.5  |                  |  |                  | 21.5  |               |  |              | 2.2   |          |  |               | 19.3  |   |  |   | 23.5  |   |  |   | 2.9  |   |  |   | 20.6  |  
|                                              |  |              |       |                  |  |                  |       |               |  |              |       |          |  |               |       |   |  |   |       |   |  |   |      |   |  |   |       |  
|Total operating expenses                      |  | $            | 39.9  |                  |  | $                | 42.7  |               |  | $            | 4.9   |          |  | $             | 37.8  |   |  | $ | 47.3  |   |  | $ | 5.9  |   |  | $ | 41.4  |  
|Loss on sale of business                      |  |              |      |                  |  |                  | 16.7  |               |  |              | 16.7  |          |  |               |      |   |  |   |      |   |  |   |     |   |  |   |      |  
|Restructuring expenses                        |  |              | 1.5   |                  |  |                  | 2.1   |               |  |              |      |          |  |               | 2.1   |   |  |   | (0.2  | ) |  |   | 0.8  |   |  |   | (1.0  | )
|                                              |  |              |       |                  |  |                  |       |               |  |              |       |          |  |               |       |   |  |   |       |   |  |   |      |   |  |   |       |  
|Operating income from continuing operations   |  | $            | 37.0  |                  |  | $                | 14.6  |               |  | $            | (18.0 | )        |  | $             | 32.6  |   |  | $ | 35.3  |   |  | $ | (2.1 | ) |  | $ | 37.4  |  
|Interest expense, net                         |  |              | 35.8  |                  |  |                  | 33.8  |               |  |              |      |          |  |               | 33.8  |   |  |   | 37.5  |   |  |   |     |   |  |   | 37.5  |  
|                                              |  |              |       |                  |  |                  |       |               |  |              |       |          |  |               |       |   |  |   |       |   |  |   |      |   |  |   |       |  
|Income from continuing operations, before tax |  | $            | 1.2   |                  |  | $                | (19.2 | )             |  | $            | (18.0 | )        |  | $             | (1.2  | ) |  | $ | (2.2  | ) |  | $ | (2.1 | ) |  | $ | (0.1  | )
|EBITDA from continuing operations             |  | $            | 44.4  |                  |  |                  |       |               |  |              |       |          |  | $             | 40.8  |   |  |   |       |   |  |   |      |   |  | $ | 46.6  |  
|EBITDA as adjusted                            |  | $            | 45.9  |                  |  |                  |       |               |  |              |       |          |  | $             | 42.9  |   |  |   |       |   |  |   |      |   |  | $ | 46.4  |  

Key Changes in 2003

Excluding the decrease caused by the November
2002 sale of Ruf, sales increased by $4.1 million in 2003
compared to the year earlier due to increases in sale of
transducers for hearing aid and security applications, increased
sales of the silicon microphone and sales of electromechanical
devices to the hearing aid market.

Gross margins as a percentage of revenue in 2003
increased due to the sale of Ruf and due to improved
manufacturing efficiencies, improved inventory controls and
reduced costs of warranty.

Operating expenses decreased by $2.8 million
in 2003, with a $4.9 million decrease caused by the sale of
Ruf only partially offset by a $2.1 million increase in
ongoing expenses, primarily general and administrative expenses.

The sale of Ruf in November 2002 resulted in a
loss on the sale of the business of $16.7 million in 2002.
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.

Operating income increased by $22.4 million
in 2003, primarily due to the $16.7 million loss on the
sale of Ruf in the prior year and improved sales and margins,
only partially offset by increased operating expenses.

Interest expense increased by $2.0 million
in 2003, primarily due to the refinancing of the
$31.7 million A portion of the bank debt at a
higher interest rate partially offset by reduced borrowing
levels.

Income from continuing operations before tax
increased by $20.4 million, with $16.7 million of the
increase due to the loss on the sale of Ruf that was recorded in
2002 and $1.3 million due to the operating loss associated
with Ruf in 2002. In addition, income from continuing operations
increased by $2.4 million due to improved sales and margins,
partly offset by higher operating expenses and higher interest
expenses.

17



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##### Table of Contents



EBITDA as adjusted increased from
$42.9 million in 2002 to $45.9 million in 2003
primarily due to increased sales and improved gross margins.

For more detail on results of operations, see the
section below, Year Ended December 31, 2003
Compared to Year Ended December 31, 2002.

As a percentage of net sales, results for the
last three years were as follows 

|                                                         |  |                |       |                  |  |                  |       |               |  |              |        |          |  |               |       |   |  |  |       |   |  |  |       |   |  |  |       |  
|-------------------------------------------------------- |  | -------------- | ----- | ---------------- |  | ---------------- | ----- | ------------- |  | ------------ | ------ | -------- |  | ------------- | ----- | - |  |  | ----- | - |  |  | ----- | - |  |  | ----- | -
|                                                         |  |                |       |                  |  |                 
|                                                         |  |                |       | 12 Months Ending |  | 12 Months Ending
|                                                         |  | 12 Months      |       |                  |  |                 
|                                                         |  | Ending         |       |                  |  | 12/31/02         |       |               |  | 12/31/01    
|                                                         |  | 12/31/03       |       | 12/31/02         |  | 12/31/02         |       | Consolidated  |  | 12/31/01     |        | 12/31/01 |  | Consolidated 
|                                                         |  | Consolidated   |       | Consolidated     |  | Ruf              |       | Excluding Ruf |  | Consolidated |        | Ruf      |  | Excluding Ruf
|                                                         |  |                |       |                  |  |                  |       |               |  |              |        |          |  |              
|                                                         |  |               
|                                                         |  | % of net sales
|Net sales                                                |  |                | 100.0 | %                |  |                  | 100.0 | %             |  |              | 100.0  | %        |  |               | 100.0 | % |  |  | 100.0 | % |  |  | 100.0 | % |  |  | 100.0 | %
|Cost of sales                                            |  |                | 49.1  | %                |  |                  | 53.6  | %             |  |              | 74.6   | %        |  |               | 51.6  | % |  |  | 52.4  | % |  |  | 74.4  | % |  |  | 49.8  | %
|Gross margin                                             |  |                | 50.9  | %                |  |                  | 46.4  | %             |  |              | 25.4   | %        |  |               | 48.4  | % |  |  | 47.6  | % |  |  | 25.6  | % |  |  | 50.2  | %
|Research and development                                 |  |                | 6.6   | %                |  |                  | 7.1   | %             |  |              | 12.0   | %        |  |               | 6.7   | % |  |  | 7.5   | % |  |  | 10.6  | % |  |  | 7.1   | %
|Sales and marketing                                      |  |                | 6.0   | %                |  |                  | 5.8   | %             |  |              | 7.0    | %        |  |               | 5.7   | % |  |  | 6.3   | % |  |  | 6.1   | % |  |  | 6.3   | %
|General and administrative                               |  |                | 13.3  | %                |  |                  | 13.1  | %             |  |              | 15.5   | %        |  |               | 12.9  | % |  |  | 13.6  | % |  |  | 16.1  | % |  |  | 13.3  | %
|Total operating expenses                                 |  |                | 25.9  | %                |  |                  | 26.0  | %             |  |              | 34.5   | %        |  |               | 25.2  | % |  |  | 27.3  | % |  |  | 32.8  | % |  |  | 26.7  | %
|Loss on sale of business                                 |  |                | 0.0   | %                |  |                  | 10.2  | %             |  |              | 117.6  | %        |  |               | 0.0   | % |  |  | 0.0   | % |  |  | 0.0   | % |  |  | 0.0   | %
|Restructuring expenses                                   |  |                | 1.0   | %                |  |                  | 1.3   | %             |  |              | 0.0    | %        |  |               | 1.4   | % |  |  | -0.1  | % |  |  | 4.4   | % |  |  | -0.6  | %
|Operating income                                         |  |                | 24.0  | %                |  |                  | 8.9   | %             |  |              | -126.8 | %        |  |               | 21.7  | % |  |  | 20.4  | % |  |  | -11.7 | % |  |  | 24.1  | %
|Interest expense, net                                    |  |                | 23.2  | %                |  |                  | 20.6  | %             |  |              | 0.0    | %        |  |               | 22.5  | % |  |  | 21.7  | % |  |  | 0.0   | % |  |  | 24.2  | %
|Income (loss) from continuing operations, before
    tax |  |                | 0.8   | %                |  |                  | -11.7 | %             |  |              | -126.8 | %        |  |               | -0.8  | % |  |  | -1.3  | % |  |  | -11.7 | % |  |  | -0.1  | %
|EBITDA                                                   |  |                | 28.8  | %                |  |                  |       |               |  |              |        |          |  |               | 27.2  | % |  |  |       |   |  |  |       |   |  |  | 30.0  | %
|EBITDA as adjusted                                       |  |                | 29.8  | %                |  |                  |       |               |  |              |        |          |  |               | 28.6  | % |  |  |       |   |  |  |       |   |  |  | 29.9  | %

Operating income excluding Ruf was 24.0% in 2003
compared to 21.7% in 2002 and 24.1% in 2001. EBITDA as adjusted
was 29.8% in 2003 compared to 28.6% in 2002 and 29.9% in 2001.

The improved profitability as a percentage of
sales in 2003 was due to the 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, 2003 Compared to
Year Ended December 31, 2002

|                                  |  |                  |       |            |  |                 |       |                 |  |   |       |   |  |  |        |  
|--------------------------------- |  | ---------------- | ----- | ---------- |  | --------------- | ----- | --------------- |  | - | ----- | - |  |  | ------ | -
|                                  |  |                  |       |            |  |                
|                                  |  | 12 Months Ending |       |            |  |                
|                                  |  |                  |       | $ Change   |  | % Change       
|                                  |  | 12/31/2003       |       | 12/31/2002 |  | From Prior Year |       | From Prior Year
|                                  |  |                  |       |            |  |                 |       |                
|                                  |  |                 
|                                  |  | $ millions      
|Consolidated 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.

18



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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.

|                                          |  |                  |      |            |  |                 |      |                 |  |   |       |   |  |  |        |  
|----------------------------------------- |  | ---------------- | ---- | ---------- |  | --------------- | ---- | --------------- |  | - | ----- | - |  |  | ------ | -
|                                          |  |                  |      |            |  |                
|                                          |  | 12 Months Ending |      |            |  |                
|                                          |  |                  |      | $ Change   |  | % Change       
|                                          |  | 12/31/2003       |      | 12/31/2002 |  | From Prior Year |      | From Prior Year
|                                          |  |                  |      |            |  |                 |      |                
|                                          |  |                 
|                                          |  | $ millions      
|Consolidated 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 450 basis points, with 200 basis points 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.

The following table sets forth operating expenses
and operating expenses as a percentage of net sales compared to
the prior year:

|                           |  |                  |      |                      |  |            |      |            |  |            |      |            |  |   |      |   |  |   |     |  |  |  |     |  
|-------------------------- |  | ---------------- | ---- | -------------------- |  | ---------- | ---- | ---------- |  | ---------- | ---- | ---------- |  | - | ---- | - |  | - | --- |  |  |  | --- | -
|                           |  |                  |      |                     
|                           |  | 12 Months Ending |      | Change Excluding RUF
|                           |  |                  |      |                     
|                           |  |                  |      | 12/31/2002           |  |            |      | 12/31/2002 |  | $ Change   |      | % Change  
|                           |  | 12/31/2003       |      | Including            |  | 12/31/2002 |      | Excluding  |  | From       |      | From      
|                           |  | Consolidated     |      | RUF                  |  | Ruf        |      | RUF        |  | Prior Year |      | Prior Year
|                           |  |                  |      |                      |  |            |      |            |  |            |      |           
|                           |  |                 
|                           |  | $ millions      
|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 | %
|                           |  |                  |      |                      |  |            |      |            |  |            |      |            |  |   |      |   |  |   |     |  |  |  |     |  
|Total operating expenses   |  | $                | 39.9 |                      |  | $          | 42.7 |            |  | $          | 4.9  |            |  | $ | 37.8 |   |  | $ | 2.1 |  |  |  | 5.6 | %
|% of net sales             |  |                  | 25.9 | %                    |  |            | 26.0 | %          |  |            | 34.5 | %          |  |   | 25.2 | % |  |   |     |  |  |  |     |  

Operating expenses decreased by $2.8 million
in 2003 compared to the year earlier due to the November 2002
sale of Ruf. Excluding Ruf, total operating expenses increased
by $2.1 million or 5.6% in the twelve months ending 2003
compared to the year earlier period. 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 expenses as a
percentage of net sales (excluding Ruf) increased from 25.2% to
25.9 % due to the increased sales and marketing and general and
administrative expenses.

19



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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 Ending |  |                  |       |             
|                                              |                          |              |       |                  |  |                 
|                                              |                          | 12 Months    |       |                  |  | Change Excluding
|                                              |                          | Ending       |       |                  |  | 12/31/02         |       | RUF         
|                                              |                          | 12/31/03     |       | 12/31/02         |  | 12/31/02         |       | Consolidated |  |   
|                                              |                          | Consolidated |       | Consolidated     |  | Ruf              |       | Excl Ruf     |  | $s |       | %   
|                                              |                          |              |       |                  |  |                  |       |              |  |    |       |     
|                                              |                          |             
|                                              |                          | $ millions  
|Sales                                         |                          | $            | 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  | %   |  |   |     |      |   |   |        |      
|Total operating expenses                      |                          | $            | 39.9  |                  |  | $                | 42.7  |              |  | $  | 4.9   |      |  | $ | 37.8  |     |  |   | 2.1 |      |   |   | 5.6    | %    
|                                              | 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 |      |   | $ | 0.3    |      
|Interest expense, net                         |                          |              | 35.8  |                  |  |                  | 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    | %    
|EBITDA as adjusted                            |                          | $            | 45.9  |                  |  |                  |       |              |  |    |       |      |  | $ | 42.9  |     |  |   | 3.0 |      |   |   | 7.0    | %    

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 $4.4 million 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 portion of the bank
debt, which was replaced with $35 million of C
debt. The C debt is at a fixed rate of 18.5%
compared to a lower rate of LIBOR plus 5% for the A
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 $4.4 million of improved
operating results that were only partially offset by increased
interest expense of $2.0 million.

20



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##### Table of Contents



The key measurement used by management to gauge
the profitability of the business is EBITDA as adjusted, which
increased from $42.9 million in 2002 to $45.9 million
in 2003. The increase of $3.0 million was caused by
increased sales and improved gross margin rates, only partially
offset by increased operating expenses.

Key statistics related to income taxes and
gains/losses from discontinued operations are as follows:

|                                                        |  |              |      |                  |  |          |       |              |  |   |       |   |  |   |       |  
|------------------------------------------------------- |  | ------------ | ---- | ---------------- |  | -------- | ----- | ------------ |  | - | ----- | - |  | - | ----- | -
|                                                        |  |              |      |                 
|                                                        |  |              |      | 12 Months Ending
|                                                        |  | 12 Months    |      |                 
|                                                        |  | Ending       |      |                  |  | 12/31/02
|                                                        |  | 12/31/03     |      | 12/31/02         |  | 12/31/02 |       | Consolidated
|                                                        |  | Consolidated |      | Consolidated     |  | Ruf      |       | Excl Ruf    
|                                                        |  |              |      |                  |  |          |       |             
|                                                        |  |             
|                                                        |  | $ millions  
|Income (loss) from continuing operations,
    pre tax   |  | $            | 1.2  |                  |  | $        | (19.2 | )            |  | $ | (18.0 | ) |  | $ | (1.2  | )
|Tax provision                                           |  |              | 0.4  |                  |  |          | 11.7  |              |  |   |      |   |  |   | 11.7  |  
|                                                        |  |              |      |                  |  |          |       |              |  |   |       |   |  |   |       |  
|Income (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   |              |  |   |      |   |  |   | 6.5   |  
|                                                        |  |              |      |                  |  |          |       |              |  |   |       |   |  |   |       |  
|Net 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.

Year Ended December 31, 2002 Compared to
Year Ended December 31, 2001

|                                  |  |                  |       |            |  |                 |       |                 |  |   |      |   |  |  |       |  
|--------------------------------- |  | ---------------- | ----- | ---------- |  | --------------- | ----- | --------------- |  | - | ---- | - |  |  | ----- | -
|                                  |  |                  |       |            |  |                
|                                  |  | 12 Months Ending |       |            |  |                
|                                  |  |                  |       | $ Change   |  | % Change       
|                                  |  | 12/31/2002       |       | 12/31/2001 |  | From Prior Year |       | From Prior Year
|                                  |  |                  |       |            |  |                 |       |                
|                                  |  |                 
|                                  |  | $ millions      
|Consolidated sales                |  | $                | 164.1 |            |  | $               | 173.1 |                 |  | $ | (9.0 | ) |  |  | -5.2  | %
|Sales from Ruf                    |  |                  | 14.2  |            |  |                 | 18.0  |                 |  | $ | (3.8 | ) |  |  | -21.1 | %
|                                  |  |                  |       |            |  |                 |       |                 |  |   |      |   |  |  |       |  
|Consolidated sales, excluding Ruf |  | $                | 149.9 |            |  | $               | 155.1 |                 |  | $ | (5.2 | ) |  |  | -3.4  | %

Overall, consolidated net sales decreased 5.2% in
2002 compared to 2001. Ruf sales decreased $3.8 million.
Consolidated sales excluding Ruf decreased by $5.2 million
due to lower average selling prices for transducer products,
created by a consolidation in the ownership of the customer base
and increased price competition.

Consolidated cost of sales increased by 120 basis
points as a percent of net sales in 2002 compared to the prior
year, despite the decline in sales from the low margin Ruf
business. The increase in cost of sales as a percentage of
revenue was due to lower average selling prices for transducers,
which were only partially offset by lower warranty costs.

21



---



##### Table of Contents



The following table sets for operating expenses
and operating expenses as a percentage of revenue for the twelve
months ending December 31, 2002 compared to the prior year:

|                           |                |            |      |      |   |            |     |            |   |     |      |            |   |            |      |            |   |   |     |      |   |   |      |      |   |   |      |   |  |  |       |   | 
|-------------------------- | -------------- | ---------- | ---- | ---- | - | ---------- | --- | ---------- | - | --- | ---- | ---------- | - | ---------- | ---- | ---------- | - | - | --- | ---- | - | - | ---- | ---- | - | - | ---- | - |  |  | ----- | - | 
|                           |                |            |      |      |   |            |     |            |   |     |      |            |   | $ Change   |      | % Change  
|                           |                |            |      |      |   |            |     |            |   |     |      |            |   | From Prior |      | From Prior
|                           |                | 12/31/2002 |      |      |   | 12/31/2002 |     | 12/31/2001 |   |     |      | 12/31/2001 |   | Year       |      | Year      
|                           |                | Including  |      |      |   | Excluding  |     | Including  |   |     |      | Excluding  |   | Excluding  |      | Excluding 
|                           |                | RUF        |      | Ruf  |   | RUF        |     | RUF        |   | Ruf |      | RUF        |   | RUF        |      | RUF       
|                           |                |            |      |      |   |            |     |            |   |     |      |            |   |            |      |           
|                           |                |           
|                           |                | $ millions
|Research & development     |                | $          | 11.7 |      |   | $          | 1.7 |            |   | $   | 10.0 |            |   | $          | 12.9 |            |   | $ | 1.9 |      |   | $ | 11.0 |      |   | $ | (1.0 | ) |  |  | -9.1  | %
|Sales and marketing        |                |            | 9.5  |      |   |            | 1.0 |            |   |     | 8.5  |            |   |            | 10.9 |            |   |   | 1.1 |      |   |   | 9.8  |      |   |   | (1.3 | ) |  |  | -13.3 | %
|General and administrative |                |            | 21.5 |      |   |            | 2.2 |            |   |     | 19.3 |            |   |            | 23.5 |            |   |   | 2.9 |      |   |   | 20.6 |      |   |   | (1.3 | ) |  |  | -6.3  | %
|                           |                |            |      |      |   |            |     |            |   |     |      |            |   |            |      |            |   |   |     |      |   |   |      |      |   |   |      |   |  |  |       |  
|Total operating expenses   |                | $          | 42.7 |      |   |            | 4.9 |            |   | $   | 37.8 |            |   | $          | 47.3 |            |   | $ | 5.9 |      |   | $ | 41.4 |      |   | $ | (3.6 | ) |  |  | -8.7  | %
|                           | % of net sales |            |      | 26.0 | % |            |     | 34.5       | % |     |      | 25.2       | % |            |      | 27.3       | % |   |     | 32.8 | % |   |      | 26.7 | % |   |      |   |  |  |       |   | 

Operating expenses decreased in all categories in
the twelve months ending December 31, 2002 compared to the
year earlier period, primarily due to a program to reduce
discretionary spending on all non-essential programs.

The following table sets forth key operating
statistics for the twelve months ending 2002 compared to the
year earlier period:

|                                              |                          |                  |       |                  |  |              |       |              |  |          |       |              |  |   |       |      |   |   |      |     |  |   |       |      |  
|--------------------------------------------- | ------------------------ | ---------------- | ----- | ---------------- |  | ------------ | ----- | ------------ |  | -------- | ----- | ------------ |  | - | ----- | ---- | - | - | ---- | --- |  | - | ----- | ---- | -
|                                              |                          |                  |       |                 
|                                              |                          | 12 Months Ending |       | 12 Months Ending
|                                              |                          |                  |       |                 
|                                              |                          |                  |       | 12/31/02         |  |              |       | 12/31/01    
|                                              |                          | 12/31/02         |       | 12/31/02         |  | Consolidated |       | 12/31/01     |  | 12/31/01 |       | Consolidated
|                                              |                          | Consolidated     |       | Ruf              |  | Excl Ruf     |       | Consolidated |  | Ruf      |       | Excl Ruf    
|                                              |                          |                  |       |                  |  |              |       |              |  |          |       |             
|                                              |                          |                 
|                                              |                          | $ millions      
|Net sales                                     |                          | $                | 164.1 |                  |  | $            | 14.2  |              |  | $        | 149.9 |              |  | $ | 173.1 |      |   | $ | 18.0 |     |  | $ | 155.1 |     
|Gross margin                                  |                          |                  | 76.1  |                  |  |              | 3.6   |              |  |          | 72.5  |              |  |   | 82.4  |      |   |   | 4.6  |     |  |   | 77.8  |     
|Gross margin %                                |                          |                  | 46.4  | %                |  |              | 25.4  | %            |  |          | 48.4  | %            |  |   | 47.6  | %    |   |   | 25.6 | %   |  |   | 50.2  | %   
|Total operating expenses                      |                          | $                | 42.7  |                  |  | $            | 4.9   |              |  | $        | 37.8  |              |  | $ | 47.3  |      |   | $ | 5.9  |     |  | $ | 41.4  |     
|                                              | Loss on sale of business |                  |       | 16.7             |  |              |       | 16.7         |  |          |       |             |  |   |       |     |   |   |      |    |  |   |       |     |  
|                                              | Restructuring expenses   |                  |       | 2.1              |  |              |       | 0.0          |  |          |       | 2.1          |  |   |       | (0.2 | ) |   |      | 0.8 |  |   |       | (1.0 | )
|                                              |                          |                  |       |                  |  |              |       |              |  |          |       |              |  |   |       |      |   |   |      |     |  |   |       |     
|Operating income (loss)                       |                          | $                | 14.6  |                  |  | $            | (18.0 | )            |  | $        | 32.6  |              |  | $ | 35.3  |      |   | $ | (2.1 | )   |  | $ | 37.4  |     
|Interest expense, net                         |                          |                  | 33.8  |                  |  |              | 0.0   |              |  |          | 33.8  |              |  |   | 37.5  |      |   |   | 0    |     |  |   | 37.5  |     
|                                              |                          |                  |       |                  |  |              |       |              |  |          |       |              |  |   |       |      |   |   |      |     |  |   |       |     
|Income from continuing operations, before tax |                          | $                | (19.2 | )                |  | $            | (18.0 | )            |  | $        | (1.2  | )            |  | $ | (2.2  | )    |   | $ | (2.1 | )   |  | $ | (0.1  | )   
|EBITDA from continuing operations             |                          | $                | 40.0  |                  |  |              |       |              |  | $        | 40.8  |              |  | $ | 47.0  |      |   |   |      |     |  | $ | 46.6  |     
|EBITDA as adjusted                            |                          |                  |       |                  |  |              |       |              |  | $        | 42.9  |              |  |   |       |      |   |   |      |     |  | $ | 46.4  |     

Sales decreased by $9.0 million with
microacoustic products declining by $5.2 million due to
lower prices and Ruf sales decreasing by $3.8 million.
Gross margin decreased by $6.3 million due to the reduction
in transducer selling prices and lower sales at Ruf. Partially
offsetting these margin declines was a reduction in period
expenses of $4.6 million. Restructuring expenses of
$2.1 million were recorded in 2002, primarily for the loss
on the sale of the Taiwan building and severance. A loss on the
sale of Ruf of $16.7 million was recorded in 2002. Operating
income decreased by $20.7 million in 2002 due to the loss
on the sale of Ruf, the decline in sales and higher
restructuring expenses, only partially offset by lower operating
expenses.

The key measurement used by management to gauge
the profitability of the business is EBITDA as adjusted, which
decreased from $46.4 million in 2001 to $42.9 million
in 2002. The decrease of $3.5 million in EBITDA as adjusted
was caused by the lower sales and margins, which were a result
of the decline in average selling prices. The lower sales and
margins were only partially offset by the $3.6 million
decrease in operating expenses.

22



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##### Table of Contents



Key statistics related to income taxes and
gains/losses from discontinued operations are as follows

|                                               |  |                  |       |                  |  |              |       |              |  |          |       |              |  |   |      |   |  |   |      |   |  |   |      |  
|---------------------------------------------- |  | ---------------- | ----- | ---------------- |  | ------------ | ----- | ------------ |  | -------- | ----- | ------------ |  | - | ---- | - |  | - | ---- | - |  | - | ---- | -
|                                               |  |                  |       |                 
|                                               |  | 12 Months Ending |       | 12 Months Ending
|                                               |  |                  |       |                 
|                                               |  |                  |       | 12/31/02         |  |              |       | 12/31/01    
|                                               |  | 12/31/02         |       | 12/31/02         |  | Consolidated |       | 12/31/01     |  | 12/31/01 |       | Consolidated
|                                               |  | Consolidated     |       | Ruf              |  | Excl Ruf     |       | Consolidated |  | Ruf      |       | Excl Ruf    
|                                               |  |                  |       |                  |  |              |       |              |  |          |       |             
|                                               |  |                 
|                                               |  | $ millions      
|Loss from continuing operations, pre tax       |  | $                | (19.2 | )                |  | $            | (18.0 | )            |  | $        | (1.2  | )            |  | $ | (2.2 | ) |  | $ | (2.1 | ) |  | $ | (0.1 | )
|Tax provision                                  |  |                  | 11.7  |                  |  |              |      |              |  |          | 11.7  |              |  |   | 6.3  |   |  |   |     |   |  |   | 6.3  |  
|                                               |  |                  |       |                  |  |              |       |              |  |          |       |              |  |   |      |   |  |   |      |   |  |   |      |  
|Loss from continuing operations, after tax     |  | $                | (30.9 | )                |  | $            | (18.0 | )            |  |          | (12.9 | )            |  | $ | (8.5 | ) |  | $ | (2.1 | ) |  | $ | (6.4 | )
|Income from discontinued operations, after tax |  |                  | 6.5   |                  |  |              |      |              |  |          | 6.5   |              |  |   | 7.0  |   |  |   |     |   |  |   | 7.0  |  
|                                               |  |                  |       |                  |  |              |       |              |  |          |       |              |  |   |      |   |  |   |      |   |  |   |      |  
|Net income (loss)                              |  | $                | (24.4 | )                |  | $            | (18.0 | )            |  | $        | (6.4  | )            |  | $ | (1.5 | ) |  | $ | (2.1 | ) |  | $ | 0.6  |  
|                                               |  |                  |       |                  |  |              |       |              |  |          |       |              |  |   |      |   |  |   |      |   |  |   |      |  

Income tax expense was $11.7 million in 2002
compared to $6.3 million in 2001. 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
tax provision in 2001 was higher than the statutory rate due to
the distribution of earnings between profitable foreign
operations, which create taxable expense, and a loss in U.S.,
which does not create an additional tax benefit.

Income from discontinued operations was
$6.5 million in 2002 and $7.0 million in 2001. This
represents the net income from the SSPI and the Ruwido
businesses in those periods.

The Company reported a net loss of
$24.4 million for 2002 due to the loss from continuing
operations, the tax provision and the loss on the sale of Ruf,
only partially offset by the income from discontinued
operations. In 2001, the Company reported a net loss of
$1.5 million due to the loss at Ruf and the tax provision,
partially offset by income from discontinued operations of
$7.0 million.

Seasonality and Quarterly Results of
Operations

Our sales have been subject to a small degree of
seasonality in the past several years. The second and fourth
quarters have been our strongest quarters. This seasonality of
our sales resulted primarily from stronger customer demand in
the second and fourth quarter. 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
seasonality is slightly distorted in the reported results due to
the inclusion of Ruf results up until its sale in November 2002.

23



---



##### Table of Contents



The following table sets forth selected financial
information by fiscal quarter.

SELECTED FINANCIAL INFORMATION BY
QUARTER  UNAUDITED(4)

|                                                         |  |           |      |          |  |           |      |          |  |           |      |          |  |           |       |          |  |   |      |   |  |   |      |   |  |   |      |   |  |   |      | 
|-------------------------------------------------------- |  | --------- | ---- | -------- |  | --------- | ---- | -------- |  | --------- | ---- | -------- |  | --------- | ----- | -------- |  | - | ---- | - |  | - | ---- | - |  | - | ---- | - |  | - | ---- | 
|                                                         |  | March 31, |      | June 30, |  | Sept. 30, |      | Dec. 31, |  | March 31, |      | June 30, |  | Sept. 30, |       | Dec. 31,
|                                                         |  | 2002      |      | 2002     |  | 2002      |      | 2002(3)  |  | 2003      |      | 2003     |  | 2003      |       | 2003    
|                                                         |  |           |      |          |  |           |      |          |  |           |      |          |  |           |       |         
|Net sales                                                |  | $         | 39.4 |          |  | $         | 44.3 |          |  | $         | 39.7 |          |  | $         | 40.7  |          |  | $ | 37.5 |   |  | $ | 38.9 |   |  | $ | 34.7 |   |  | $ | 42.9 | 
|Cost of sales                                            |  |           | 21.8 |          |  |           | 23.1 |          |  |           | 21.6 |          |  |           | 21.5  |          |  |   | 18.9 |   |  |   | 18.9 |   |  |   | 17.6 |   |  |   | 20.2 | 
|Research and development                                 |  |           | 3.0  |          |  |           | 3.4  |          |  |           | 2.4  |          |  |           | 2.9   |          |  |   | 2.3  |   |  |   | 2.9  |   |  |   | 2.5  |   |  |   | 2.5  | 
|Selling and marketing                                    |  |           | 2.6  |          |  |           | 2.6  |          |  |           | 2.1  |          |  |           | 2.2   |          |  |   | 2.1  |   |  |   | 2.3  |   |  |   | 2.3  |   |  |   | 2.5  | 
|General and administrative                               |  |           | 5.5  |          |  |           | 6.3  |          |  |           | 4.6  |          |  |           | 5.1   |          |  |   | 5.7  |   |  |   | 4.8  |   |  |   | 4.3  |   |  |   | 5.7  | 
|Loss on sale of business(1)                              |  |           |     |          |  |           | 8.7  |          |  |           | 4.2  |          |  |           | 3.8   |          |  |   |     |   |  |   |     |   |  |   |     |   |  |   |     | 
|Restructuring expense(2)                                 |  |           |     |          |  |           | 0.6  |          |  |           | 1.0  |          |  |           | 0.5   |          |  |   |     |   |  |   |     |   |  |   |     |   |  |   | 1.5  | 
|                                                         |  |           |      |          |  |           |      |          |  |           |      |          |  |           |       |          |  |   |      |   |  |   |      |   |  |   |      |   |  |   |      | 
|Operating income (loss)                                  |  | $         | 6.5  |          |  | $         | (0.4 | )        |  | $         | 3.8  |          |  | $         | 4.7   |          |  | $ | 8.5  |   |  | $ | 10.0 |   |  | $ | 8.0  |   |  | $ | 10.5 | 
|                                                         |  |           |      |          |  |           |      |          |  |           |      |          |  |           |       |          |  |   |      |   |  |   |      |   |  |   |      |   |  |   |      | 
|Income (loss) from continuing operations
    after taxes |  |           | (1.6 | )        |  |           | (9.2 | )        |  |           | (2.8 | )        |  |           | (17.3 | )        |  |   | (1.1 | ) |  |   | (0.7 | ) |  |   | (1.2 | ) |  |   | 3.7  | 
|Income from discontinued operations(5)                   |  |           | 1.2  |          |  |           | 1.4  |          |  |           | 1.4  |          |  |           | 2.5   |          |  |   | 1.1  |   |  |   | 25.6 |   |  |   | 1.1  |   |  |   | 0.1  | 
|                                                         |  |           |      |          |  |           |      |          |  |           |      |          |  |           |       |          |  |   |      |   |  |   |      |   |  |   |      |   |  |   |      | 
|Net income (loss)(6)                                     |  | $         | (0.4 | )        |  | $         | (7.8 | )        |  | $         | (1.4 | )        |  | $         | (14.8 | )        |  | $ | 0.0  |   |  | $ | 24.9 |   |  | $ | (0.1 | ) |  | $ | 3.8  | 
|                                                         |  |           |      |          |  |           |      |          |  |           |      |          |  |           |       |          |  |   |      |   |  |   |      |   |  |   |      |   |  |   |      | 
|Ruf Sales                                                |  |           | 5.4  |          |  |           | 4.3  |          |  |           | 4.5  |          |  |           | 3.8   |          |  |   |     |   |  |   |     |   |  |   |     |   |  |   |     | 
|                                                         |  |           |      |          |  |           |      |          |  |           |      |          |  |           |       |          |  |   |      |   |  |   |      |   |  |   |      |   |  |   |      | 
|Net sales excluding Ruf                                  |  | $         | 34.0 |          |  | $         | 40.0 |          |  | $         | 35.2 |          |  | $         | 36.9  |          |  | $ | 37.5 |   |  | $ | 38.9 |   |  | $ | 34.7 |   |  | $ | 42.9 | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The Loss on Sale of Business is
    related to the losses recorded on the sale of Ruf in November
    2002. For the quarters ended June 30 and September 30,
    2002, the loss represents the impairment of the Ruf assets
    recorded in those quarters.                                                                                                                                                                                                                                                                                                                                                                                                               
|   
|(2) | The Restructuring expenses in 2002
    relate 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, and China. These actions have
    reduced our global workforce by about 20%. In 2002 these
    expenses are related to the loss on the sale of a facility in
    Taiwan, and severance. The Restructuring expenses in 2003
    primarily relate to the closure of the Elgin, Illinois facility
    announced in November 2003.
|   
|(3) | The quarter ended December 31, 2002 includes
    a $1.7 million reduction of expenses to adjust depreciation
    and amortization expense and to adjust the warranty liability
    related to historical sales and claim experience.                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   
|(4) | Quarterly information for 2002 and 2003 has been
    restated to reflect the sales of the Synchro-Start and Infrared
    businesses in May and July 2003 respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   
|(5) | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   
|(6) | Net loss for the quarter ended December 31,
    2002 includes a tax provision to record a valuation allowance
    against deferred tax assets of approximately $11.7 million.
    Net income for the quarter ended December 31, 2003 includes
    a reduction of contingent tax liabilities of approximately
    $1.5 million.                                                                                                                                                                                                                                                                                                                                              

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.

24



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##### Table of Contents



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 Term 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 Tranche B loans
in July 2003.

As of December 31, 2003 the Companys
outstanding borrowing and repayment dates were as follows:

|                                                                                |  |       |         |           |  |        |        |        |  |         |         |  |  |   |         |  |  |   |         | 
|------------------------------------------------------------------------------- |  | ----- | ------- | --------- |  | ------ | ------ | ------ |  | ------- | ------- |  |  | - | ------- |  |  | - | ------- | 
|                                                                                |  |       |         | Less Than |  | 1 to 3 |        | 3 to 5 |  | After 5
|Contractual obligations                                                         |  | Total |         | 1 Year    |  | Years  |        | Years  |  | Years  
|                                                                                |  |       |         |           |  |        |        |        |  |        
|                                                                                |  |      
|                                                                                |  | $000s
|Credit Agreement dated June 28, 1999 and
    most recently amended May 28, 2003 |  |       |         |           |  |        |        |        |  |         |         |  |  |   |         |  |  |   |         | 
|Tranche B Portion                                                             |  | $     | 111,705 |           |  | $      | 5,762  |        |  | $       | 56,987  |  |  | $ | 48,956  |  |  | $ |        | 
|Tranche C Portion                                                             |  |       | 59,075  |           |  |        | 6,709  |        |  |         | 13,380  |  |  |   | 38,986  |  |  |   |        | 
|                                                                                |  |       |         |           |  |        |        |        |  |         |         |  |  |   |         |  |  |   |         | 
|Total credit agreement                                                          |  |       | 170,780 |           |  |        | 12,471 |        |  |         | 70,367  |  |  |   | 87,942  |  |  |   |        | 
|13 1/8% Senior Subordinated Notes due 2009                                      |  |       | 273,846 |           |  |        | 20,108 |        |  |         | 40,215  |  |  |   | 40,215  |  |  |   | 173,308 | 
|10% Senior Subordinated Notes due 2009                                          |  |       | 16,000  |           |  |        | 1,000  |        |  |         | 2,000   |  |  |   | 2,000   |  |  |   | 11,000  | 
|Operating leases                                                                |  |       | 4,357   |           |  |        | 523    |        |  |         | 801     |  |  |   | 642     |  |  |   | 2,391   | 
|Retention bonus                                                                 |  |       | 4,000   |           |  |        |       |        |  |         |        |  |  |   | 4,000   |  |  |   |        | 
|Pension contribution(1)                                                         |  | $     | 1,360   |           |  | $      | 1,360  |        |  | $       |        |  |  | $ |        |  |  | $ |        | 
|                                                                                |  |       |         |           |  |        |        |        |  |         |         |  |  |   |         |  |  |   |         | 
|Total                                                                           |  | $     | 470,343 |           |  | $      | 35,462 |        |  | $       | 113,383 |  |  | $ | 134,799 |  |  | $ | 186,699 | 
|                                                                                |  |       |         |           |  |        |        |        |  |         |         |  |  |   |         |  |  |   |         | 



|    |                                                                 
|--- | ----------------------------------------------------------------
|(1) | The pension contribution has not been estimated
    beyond 2004.

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, EBIDA excludes
up to $7.5 million in cash charges related to the
nonrecurring 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.

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##### Table of Contents



The required ratios as amended for future years
ends are as follows:

|                  |  |                |     |                   |  |  |      | 
|----------------- |  | -------------- | --- | ----------------- |  |  | ---- | 
|                  |  | Required       |     | Required Interest
|                  |  | Leverage Ratio |     | Coverage Ratio   
|                  |  |                |     |                  
|December 31, 2004 |  |                | 6.0 |                   |  |  | 1.45 | 
|December 31, 2005 |  |                | 5.5 |                   |  |  | 1.55 | 
|December 31, 2006 |  |                | 5.0 |                   |  |  | 1.65 | 

We expect to be able to comply with the required
covenants through December 31, 2004. 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
$142 million of credit as of December 31, 2003.
Included are undrawn revolving loans of $15 million
(Revolving Credit Facility) through June 30, 2006, a Term B
facility of $91.6 million which matures on June 29,
2007 and a Term C facility of $35.7 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 Term 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 Term C Facility bears
interest at a fixed rate of 18.5% of which 13% is payable in
cash, and the remainder, at the Companys option, payable
in cash or increased principal. The percentage rate that is
payable in cash increases 1.0 percentage point on
March 31 of each year. At December 31, 2003, the
weighted average interest rate was 6.2% for the B facility and
18.5% for the C facility.

The Credit Agreement as amended reduced the
Revolving Credit Facility to $15 million. Amendment Number
Six 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 C Facility is payable in full on
June 29, 2007.

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 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.

26



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##### Table of Contents





| |                        
| | -----------------------
| | 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. The net provided by operating activities in 2003 is
primarily the result of the net income from continuing
operations of $0.7 million, the net cash provided by
discontinued operating activities of $4.0 million and the
depreciation and amortization of $7.4 million. 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
$16.7 million non-cash loss on the sale of Ruf and the
$6.7 million non-cash loss from adjustments in deferred tax
valuations. The 2002 cash flow reflects cash generated by
reductions in working capital 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 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 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.



| |                           
| | --------------------------
| | Cash Flow 2002 versus 2001

Cash balances increased by $21.8 million in
2002 due to $29.7 million in cash provided by operating
activities from continuing operations that was only partly
offset by $4.9 million used in investing and
$3.6 million in financing activities. In 2001, cash
balances decreased by $14.3 million as cash provided by
operating activities of $9.8 million was offset by net cash
used in investing activities of $17.6 million and net cash
used in financing activities of $6.2 million.

Net cash provided by operating activities was
$29.7 million in 2002 compared to $9.8 million in
2001. The favorable cash provided by operating activities was
despite an increase in the net loss from continuing operations,
which increased to a $30.9 million loss in 2002 compared to
a net loss of $8.5 million in 2001. The increase in the net
loss in 2002 was largely comprised of the $16.6 million
non-cash loss on the sale of Ruf and $6.7 million non-cash
write-off of deferred income taxes. Most of the improvement in
cash flow from operations in 2002 compared to 2001 came from
improvements in working capital during 2002, especially the
$9.4 million reduction in inventory and $6.9 million
reduction in receivables, only partly offset by
$3.6 million reduction in accrued restructuring expenses.
Accrued interest payable increased $2.2 million in 2002,
reflecting the timing of interest payments under the Credit
Agreement. In 2001 several working capital items were a major
use of cash including a reduction in accrued restructuring
expenses of $8.7 million and an increase in inventory of
$5.2 million.

Net cash used in investing activities was
$4.9 million in 2002 compared to $17.6 million in
2001. Investing activities for both years are primarily
purchases and sales of property, plant and equipment. In 2002,
gross purchases of property, plant and equipment were
$8.4 million, partially offset by the sale of the Taiwan
building for $3.6 million. In 2001, gross purchases of
fixed assets were $21.3 million, partially offset by the
sale of the United Kingdom plant for $3.7 million. The
primary capital expenditures in 2002 were for new product

27



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##### Table of Contents



tooling and production equipment. In 2001
expenditures were for new product tooling and production
equipment and automation equipment, plus $6.6 million for
IT hardware and software and the capitalization of Oracle
consulting assistance to support the new ERP system. Such ERP
related expenditures were not significant in 2002.


Net cash used in financing activities was
$3.6 million in 2002 compared to $6.2 million in 2001.
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. In addition, the Company paid
$0.7 million in costs associated with the May 10, 2002
Amendment to the Credit Agreement and $0.4 million related
to common stock transactions. Net debt payments of
$9.4 million were the primary financing activities for 2001.

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 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.

The amount payable to our preexisting
stockholders for the repurchase of their common stock in our
recapitalization was subject to a post-closing adjustment
payable by Knowles to our preexisting stockholders or by our
preexisting stockholders to Key Acquisition. In June 2000, the
independent accountants appointed pursuant to the
recapitalization agreement determined that Knowles owed the
preexisting stockholders approximately $8.3 million of the
$13.3 million purchase price adjustment originally proposed
by the preexisting stockholders, plus approximately
$0.7 million in interest. The purchase price adjustment was
recorded as a reduction to stockholders equity in the
second quarter of 2000. In addition, Knowles agreed to indemnify
our preexisting stockholders for any damages they suffer as a
result of any breach of the various representations, warranties
and agreements made by Key Acquisition in connection with our
recapitalization.

In connection with the Recapitalization, a
syndicate of lenders led by The Chase Manhattan Bank and Morgan
Stanley Senior Funding, Inc. provided us with a
$250 million senior credit facility consisting of a
$50 million revolving credit facility, subject to certain
conditions, and $200 million in term loans. We also sold
$150 million of subordinated bridge notes to Morgan Stanley
Senior Funding, Inc. and The Chase Manhattan Bank, all of which
were repaid with proceeds from the senior subordinated offering
of October 15, 1999 and available cash. The
Recapitalization was financed with the term loans under the
senior credit facility and subordinated bridge notes as well as
a $214.2 million equity investment by Key Acquisition, certain
senior officers of Knowles and the Knowles family.

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, which
together form Doughty Hanson & Co. III. 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

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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, December 23, 1999, April 10, 2000,
December 12, 2001, May 10, 2002, March 25, 2003
and May 28, 2003 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 $91.6 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 $35.7 million term loan
facility (C 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
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. No
borrowing was outstanding under The Revolving Facility as of
December 31, 2003.

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.

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
equal quarterly amounts commencing on September 30, 2006.
The C Facility is due and payable upon maturity on June 29,
2007.

|                                                                |                    |                 |         |        | 
|--------------------------------------------------------------- | ------------------ | --------------- | ------- | ------ | 
|                                                                |                    | Amount in $000s
|                                                                |                    |                
|B tranche of Credit Agreement to be
    paid -                |                    |                 |         |       
|                                                                | September 30, 2006 |                 | $       | 22,440 | 
|                                                                | December 31, 2006  |                 |         | 23,054 | 
|                                                                | March 30, 2007     |                 |         | 23,054 | 
|                                                                | June 29, 2007      |                 |         | 23,052 | 
|C tranche of Credit Agreement to be
    paid on June 29, 2007 |                    |                 | 35,668  |       
|                                                                |                    |                 |         |       
|Total Credit Agreement Outstanding as of
    December 31, 2003  |                    | $               | 127,268 |       
|                                                                |                    |                 |         |       

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. In the Fourth Amendment dated as of
May 10, 2002, the Company was required to receive
additional funding of at least $10 million by
September 3, 2002. As a result, the Company entered into a
$10 million Note Purchase Agreement on August 28, 2002
with an affiliate of Doughty Hanson.

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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 B Facility and thereafter, beginning on April 1,
2004, under C 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. Pursuant to these
provisions, a prepayment in the amount of $9.5 million was
made on March 28, 2003 from excess cash flow. This
prepayment was applied to prepay the A Facility
$1.8 million and the B Facility $7.7 million. We may
voluntarily prepay the B facility in whole or in part without
premium or penalty. We may voluntarily prepay indebtedness under
the C Facility on or after April 1, 2004. Any voluntary and
certain mandatory prepayments of the C Facility are subject to a
prepayment penalty of 3%, 2.5% and 2% for the yearly periods
ending March 2005, March 2006 and March 2007, respectively.

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 April 10, 2000, December 12, 2001,
May 10, 2002, March 25, 2003 and May 28.2003) 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 April 10, 2000, December 12, 2001,
May 10, 2002, March 25, 2003 and May 28,2003) 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 C Facility will bear interest at 18.5%, a portion of which
is payable in cash on a monthly basis and a portion of which
may, at the Companys option, be payable upon maturity of
the loan, scheduled for June 29, 2007. The portion of
interest on the C Facility paid in cash monthly is 13% for the
year ending March 2004. The portion of interest on the C
Facility mandatorily payable in cash increases to 14% for the
year ending March 2005 and increases by 1% for each year
thereafter. The remainder of the C Facility interest shall, at
the option of the Company, be paid in cash or accrue and be
added to the outstanding principal balance of the C Facility
each month and paid at maturity, scheduled for June 29,
2007. At December 31, 2003, the weighted average interest
rate was 6.2% for the B facility and 18.5% for the C facility.

We will pay a commitment fee on the undrawn
portion of the Revolving Facility at a rate of 0.375% 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.

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.

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 substantially
all

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other additional debt (with the exception of the
Notes), 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.

The Companys registration became effective
September 13, 2000 and all the notes were exchanged for
registered notes on October 13, 2000. The penalty interest
accrued through that day and all but 13 days was paid with
the October 15, 2000 interest payment. The remaining interest
penalty was paid on the next interest payment date,
April 16, 2001.

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.

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| |          
| | ---------
| | 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. The Notes will mature on October 15,
2009. The Notes will 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

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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.



| |          
| | ---------
| | 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.

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.

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| |         
| | --------
| | 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, 2003, our
inventory reserves were $4.1 million, or 19% of our
$21.5 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 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.

At December 31, 2003, we recorded net
deferred tax liabilities of approximately $1 million, which
includes a $25.1 million valuation allowance. The Company
has provided a valuation allowance against the net U.S. deferred
tax assets due to the uncertainty of realization of those
assets. See footnote 5, Income Taxes.



| |                              
| | -----------------------------
| | New Accounting Pronouncements

In June 2001, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 143, Accounting for Asset
Retirement Obligations, which is effective for fiscal
years beginning after June 15, 2002. The Statement requires
legal obligations associated with the retirement of long-lived
assets to be recognized at their fair value at the time that the
obligations are incurred. Upon initial recognition of a
liability, that cost should be capitalized as part of the
related long-lived asset and

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allocated to expense over the useful life of the
asset. We adopted SFAS No. 143 as of January 1, 2003,
and there was no material impact on our financial position or
results of operations.


In June 2002, the Financial Accounting Standards
Board issued SFAS No. 146, Accounting for Cost Associated
with Exit or Disposal Activities, which changes the timing
of the recognition of restructuring charges. Liabilities for
restructuring costs will be required to be recognized when the
liability is incurred rather than when we commit to the plan.
SFAS No. 146 is effective for restructuring activity
initiated after December 31, 2002. The adoption of this
statement did not have a material impact on our financial
position, results of operations or cash flows.

In November 2002, the FASB issued FASB
Interpretation (FIN) No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN
No. 45 clarifies that a guarantor is required to recognize,
at the inception of a guarantee, a liability for the fair value
of the obligation undertaken in issuing the guarantee. We
adopted the provisions of FIN No. 45 on January 1,
2003 for all new or amended guarantees subsequent to that date.
The adoption of this statement did not have a material impact on
our financial position, results of operations or cash flows.

In May 2003, the FASB issued EITF No. 03-4,
Determining the Classification and Benefit Attribution
Method for a Cash Balance Pension Plan. EITF
03-4 defines a cash balance pension plan as a plan
that contains a defined principal-crediting rate as a percentage
of salary and a defined, non-contingent interest-crediting rate
that entitles participants to future interest credits at a
stated, fixed rate until retirement. EITF No. 03-4 requires
that cash balance pension plans be considered
defined benefit pension plans for the purpose of applying SFAS
No. 87, Employers Account for Pension. EITF
No. 03-4 also declares the traditional unit credit method
to be the appropriate cost attribution approach for cash
balance pension plans. Although the Companys U.S.
pension plan is a cash balance pension for certain
employees, the plan does not have the characteristics of the
cash balance pension plans covered by EITF 03-4. The
U.S. pension plan contains an interest-crediting rate that
entitles participants to future interest credits at a variable
rate until retirement. The adoption of EITF No. 03-4 has
not had a material impact on the Companys Consolidated
Financial Statements.

In May 2003, the 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. The Company will adopt
the provisions of SFAS 150 on January 1, 2004. 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 year financial
statements because an error was discovered that affects the
pension expense (income), related balance sheet accounts and
certain disclosures previously reported in our financial
statements. We have discovered that our United Kingdom
subsidiarys prepaid pension expense balance was misstated
as of December 31, 2000 by $2.1 million primarily due
to a curtailment gain associated with the restructuring of our
U.K. facility in 2000 that was not reflected. The net effect of
the correction of this non-cash error was to increase prepaid
pension expense and retained earnings as of December 31,
2000 by $2.1 million. Additionally, the U.K. subsidiary did
not properly reflect their required minimum pension liability as
of December 31, 2002. The net effect of this balance sheet
only error was to increase pension liability by
$4.5 million and reduce other comprehensive income
accordingly.

35



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##### Table of Contents





| |                        
| | -----------------------
| | 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:                 |  | 2003 |        | 2002 |  | 2001
|                                                |  |      |        |      |  |     
|Net sales                                       |  | $    | 26,513 |      |  | $    | 51,986 |  |  | $ | 50,605 | 
|                                                |  |      |        |      |  |      |        |  |  |   |        | 
|Income from discontinued operations             |  | $    | 1,102  |      |  | $    | 6,591  |  |  | $ | 7,255  | 
|Income tax expense                              |  |      | 170    |      |  |      | 46     |  |  |   | 219    | 
|                                                |  |      |        |      |  |      |        |  |  |   |        | 
|Income from discontinued operations, net of tax |  | $    | 932    |      |  | $    | 6,545  |  |  | $ | 7,036  | 
|                                                |  |      |        |      |  |      |        |  |  |   |        | 

The major classes of assets and liabilities for
the discontinued operations at December 31, 2002 were as
follows:

|                                               |  |              |        | 
|---------------------------------------------- |  | ------------ | ------ | 
|                                               |  | December 31,
|                                               |  | 2002        
|                                               |  |             
|Current assets                                 |  | $            | 23,942 | 
|Net property, plant and equipment              |  |              | 8,309  | 
|Miscellaneous other assets                     |  |              | 1,239  | 
|                                               |  |              |        | 
|Assets of discontinued operations              |  | $            | 33,490 | 
|                                               |  |              |        | 
|Accounts payable and other current liabilities |  | $            | 11,871 | 
|Notes payable                                  |  |              | 1,282  | 
|                                               |  |              |        | 
|Liabilities of discontinued operations         |  | $            | 13,153 | 
|                                               |  |              |        | 

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 

36



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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 2003, approximately 93% of our revenue
was denominated in U.S. dollars, approximately 4% 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, 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.

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 portion 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 $0.9 million.
The amounts outstanding under the C portion of the
Credit agreement have fixed interest rate of 18.5%. We have
estimated the fair value of the Tranche C loans under the
Credit Agreement to be $45 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, 2003 to be 106% of
their face value or $162 million based on current market
prices. We also have $10 million outstanding under 10%
senior subordinated notes.

37



---



##### Table of Contents






Item 8

KNOWLES ELECTRONICS
HOLDINGS, INC.

CONSOLIDATED FINANCIAL STATEMENTS

Years Ended December 31, 2003, 2002 and
2001


CONTENTS

|                                  |                                                                          |      |    |    | 
|--------------------------------- | ------------------------------------------------------------------------ | ---- | -- | -- | 
|                                  |                                                                          | Page
|                                  |                                                                          |     
|Report of Independent Auditors    |                                                                          |      | 39 |   
|Consolidated Financial Statements |                                                                          |      |    |   
|                                  | Consolidated Balance Sheets                                              |      |    | 40 | 
|                                  | Consolidated Statements of Operations                                    |      |    | 41 | 
|                                  | Consolidated Statements of Changes in
    Stockholders Equity (Deficit) |      |    | 42 | 
|                                  | Consolidated Statements of Cash Flows                                    |      |    | 43 | 
|                                  | Notes to Consolidated Financial Statements                               |      |    | 44 | 

38



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REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders

Knowles Electronics Holdings, Inc.


We have audited the accompanying consolidated
balance sheets of Knowles Electronics Holdings, Inc., as of
December 31, 2003, and 2002, 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, 2003. Our audits also included
the financial statement schedule listed in the index at
Item 15. 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
auditing standards generally accepted in the 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. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as 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., at December 31, 2003 and 2002, and the consolidated
results of its operations and its cash flows for each of the
three years in the period ended December 31, 2003, in
conformity with accounting principles generally accepted in the
United States. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.

As discussed in Note 2 to the Notes to
Consolidated Financial Statements, the Company has restated its
financial statements to correct an error in their accounting for
pensions.



| |                      
| | ---------------------
| | /s/ ERNST & YOUNG LLP

Chicago, Illinois

February 16, 2004


39



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KNOWLES ELECTRONICS HOLDINGS, INC.

CONSOLIDATED BALANCE SHEETS

|                                                                                                                                         |                                                                                                                                         |                      |          |             |         |   |          |          |        | 
|---------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------- | -------------------- | -------- | ----------- | ------- | - | -------- | -------- | ------ | 
|                                                                                                                                         |                                                                                                                                         |                      |          | Restated   
|                                                                                                                                         |                                                                                                                                         | December 31          |          | December 31
|                                                                                                                                         |                                                                                                                                         | 2003                 |          | 2002       
|                                                                                                                                         |                                                                                                                                         |                      |          |            
|                                                                                                                                         |                                                                                                                                         |                     
|                                                                                                                                         |                                                                                                                                         | (In thousands except
|                                                                                                                                         |                                                                                                                                         | share data)         
|ASSETS                                                                                                                                  
|Cash & cash equivalents                                                                                                                  |                                                                                                                                         | $                    | 11,227   |             |         | $ | 23,879   |         
|Accounts receivable, less allowance for doubtful
    accounts of $527 and $350                                                           |                                                                                                                                         |                      | 23,128   |             |         |   | 21,084   |         
|Inventories, net                                                                                                                         |                                                                                                                                         |                      | 17,373   |             |         |   | 19,620   |         
|Prepaid expenses and other                                                                                                               |                                                                                                                                         |                      | 5,023    |             |         |   | 4,757    |         
|Assets of discontinued operations                                                                                                        |                                                                                                                                         |                      |         |             |         |   | 33,490   |         
|                                                                                                                                         |                                                                                                                                         |                      |          |             |         |   |          |         
|                                                                                                                                         | Total current assets                                                                                                                    |                      |          | 56,751      |         |   |          | 102,830  |       
|Property, plant and equipment, at cost:                                                                                                  |                                                                                                                                         |                      |          |             |         |   |          |         
|                                                                                                                                         | Land                                                                                                                                    |                      |          | 2,787       |         |   |          | 2,787    |       
|                                                                                                                                         | Building and improvements                                                                                                               |                      |          | 19,273      |         |   |          | 18,215   |       
|                                                                                                                                         | Machinery and equipment                                                                                                                 |                      |          | 48,750      |         |   |          | 44,740   |       
|                                                                                                                                         | Furniture and fixtures                                                                                                                  |                      |          | 24,104      |         |   |          | 23,421   |       
|                                                                                                                                         | Construction in progress                                                                                                                |                      |          | 11,743      |         |   |          | 4,674    |       
|                                                                                                                                         |                                                                                                                                         |                      |          |             |         |   |          |         
|                                                                                                                                         |                                                                                                                                         | Subtotal             |          |             | 106,657 |   |          |          | 93,837 | 
|Accumulated depreciation                                                                                                                 |                                                                                                                                         |                      | (61,152  | )           |         |   | (55,073  | )       
|                                                                                                                                         |                                                                                                                                         |                      |          |             |         |   |          |         
|                                                                                                                                         | Net                                                                                                                                     |                      |          | 45,505      |         |   |          | 38,764   |       
|Other assets, net                                                                                                                        |                                                                                                                                         |                      | 3,149    |             |         |   | 1,187    |         
|Deferred finance costs, net                                                                                                              |                                                                                                                                         |                      | 7,168    |             |         |   | 8,058    |         
|                                                                                                                                         |                                                                                                                                         |                      |          |             |         |   |          |         
|                                                                                                                                         | Total assets                                                                                                                            |                      | $        | 112,573     |         |   | $        | 150,839  |       
|                                                                                                                                         |                                                                                                                                         |                      |          |             |         |   |          |         
|LIABILITIES AND STOCKHOLDERS EQUITY
    (DEFICIT)                                                                                      
|Accounts payable                                                                                                                         |                                                                                                                                         | $                    | 11,272   |             |         | $ | 10,861   |         
|Accrued compensation and employee benefits                                                                                               |                                                                                                                                         |                      | 8,681    |             |         |   | 4,602    |         
|Accrued interest payable                                                                                                                 |                                                                                                                                         |                      | 4,868    |             |         |   | 7,253    |         
|Accrued warranty and rebates                                                                                                             |                                                                                                                                         |                      | 5,902    |             |         |   | 8,344    |         
|Accrued restructuring costs                                                                                                              |                                                                                                                                         |                      | 1,490    |             |         |   | 1,197    |         
|Other liabilities                                                                                                                        |                                                                                                                                         |                      | 2,645    |             |         |   | 3,388    |         
|Income taxes                                                                                                                             |                                                                                                                                         |                      | 3,784    |             |         |   | 6,833    |         
|Deferred income taxes                                                                                                                    |                                                                                                                                         |                      | 968      |             |         |   | 541      |         
|Current portion of notes payable                                                                                                         |                                                                                                                                         |                      |         |             |         |   | 11,996   |         
|Liabilities of discontinued operations                                                                                                   |                                                                                                                                         |                      |         |             |         |   | 13,153   |         
|                                                                                                                                         |                                                                                                                                         |                      |          |             |         |   |          |         
|                                                                                                                                         | Total current liabilities                                                                                                               |                      |          | 39,610      |         |   |          | 68,168   |       
|Accrued pension liability                                                                                                                |                                                                                                                                         |                      | 12,350   |             |         |   | 14,649   |         
|Other noncurrent liabilities                                                                                                             |                                                                                                                                         |                      | 407      |             |         |   |         |         
|Notes payable                                                                                                                            |                                                                                                                                         |                      | 288,180  |             |         |   | 327,626  |         
|Preferred stock mandatorily redeemable in 2019
    including accumulating dividends of: $99,401 December 2003;
    $73,547 December 2002 |                                                                                                                                         |                      | 284,401  |             |         |   | 258,547  |         
|Stockholders equity (deficit):                                                                                                          |                                                                                                                                         |                      |          |             |         |   |          |         
|                                                                                                                                         | Common stock, Class A, $0.001 par value,
    1,052,632 shares authorized, outstanding: 957,500 December 2003;
    969,167 December 2002 |                      |          |            |         |   |          |         |       
|                                                                                                                                         | Common stock, Class B, $0.001 par value,
    52,632 shares authorized: none ever issued                                                 |                      |          |            |         |   |          |         |       
|                                                                                                                                         | Capital in excess of par value                                                                                                          |                      |          | 16,488      |         |   |          | 16,838   |       
|                                                                                                                                         | Accumulated deficit                                                                                                                     |                      |          | (520,826    | )       |   |          | (523,642 | )     
|                                                                                                                                         | Accumulated other comprehensive loss                                                                                                    |                      |          | (8,037      | )       |   |          | (11,347  | )     
|                                                                                                                                         |                                                                                                                                         |                      |          |             |         |   |          |         
|Total stockholders equity (deficit)                                                                                                     |                                                                                                                                         |                      | (512,375 | )           |         |   | (518,151 | )       
|                                                                                                                                         |                                                                                                                                         |                      |          |             |         |   |          |         
|Total liabilities and stockholders equity
    (deficit)                                                                                 |                                                                                                                                         | $                    | 112,573  |             |         | $ | 150,839  |         
|                                                                                                                                         |                                                                                                                                         |                      |          |             |         |   |          |         

See accompanying notes.

40



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KNOWLES ELECTRONICS HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                                       |                                                            |                         |         |         |   |      |         |         |   |   |         |         |  
|---------------------------------------------------------------------- | ---------------------------------------------------------- | ----------------------- | ------- | ------- | - | ---- | ------- | ------- | - | - | ------- | ------- | -
|                                                                       |                                                            |                        
|                                                                       |                                                            | Year Ended December 31,
|                                                                       |                                                            |                        
|                                                                       |                                                            | 2003                    |         | 2002    |   | 2001
|                                                                       |                                                            |                         |         |         |   |     
|                                                                       |                                                            |                        
|                                                                       |                                                            | (In thousands)         
|Net sales                                                              |                                                            | $                       | 154,042 |         |   | $    | 164,119 |         |   | $ | 173,116 |        
|Cost of sales                                                          |                                                            |                         | 75,594  |         |   |      | 87,970  |         |   |   | 90,705  |        
|                                                                       |                                                            |                         |         |         |   |      |         |         |   |   |         |        
|Gross margin                                                           |                                                            |                         | 78,448  |         |   |      | 76,149  |         |   |   | 82,411  |        
|Research and development expenses                                      |                                                            |                         | 10,225  |         |   |      | 11,735  |         |   |   | 12,845  |        
|Selling and marketing expenses                                         |                                                            |                         | 9,185   |         |   |      | 9,503   |         |   |   | 10,917  |        
|General and administrative expenses                                    |                                                            |                         | 20,547  |         |   |      | 21,478  |         |   |   | 23,503  |        
|Loss on sale of business                                               |                                                            |                         |        |         |   |      | 16,736  |         |   |   |        |        
|Restructuring expenses                                                 |                                                            |                         | 1,532   |         |   |      | 2,112   |         |   |   | (179    | )      
|                                                                       |                                                            |                         |         |         |   |      |         |         |   |   |         |        
|Operating income                                                       |                                                            |                         | 36,959  |         |   |      | 14,585  |         |   |   | 35,325  |        
|Other income (expense):                                                |                                                            |                         |         |         |   |      |         |         |   |   |         |        
|                                                                       | Interest income                                            |                         |         | 111     |   |      |         | 129     |   |   |         | 139     |  
|                                                                       | Interest expense                                           |                         |         | (35,835 | ) |      |         | (33,891 | ) |   |         | (37,666 | )
|                                                                       |                                                            |                         |         |         |   |      |         |         |   |   |         |        
|Income (loss) from continuing operations
    before
    income taxes   |                                                            |                         | 1,235   |         |   |      | (19,177 | )       |   |   | (2,202  | )      
|Income tax                                                             |                                                            |                         | 491     |         |   |      | 11,744  |         |   |   | 6,313   |        
|                                                                       |                                                            |                         |         |         |   |      |         |         |   |   |         |        
|Income (loss) from continuing operations
    after
    income taxes    |                                                            |                         | 744     |         |   |      | (30,921 | )       |   |   | (8,515  | )      
|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     |   |      |         | 6,545   |   |   |         | 7,036   |  
|                                                                       |                                                            |                         |         |         |   |      |         |         |   |   |         |        
|                                                                       | Income from discontinued operations after income
    taxes |                         |         | 27,926  |   |      |         | 6,545   |   |   |         | 7,036   |  
|                                                                       |                                                            |                         |         |         |   |      |         |         |   |   |         |        
|Net income (loss)                                                      |                                                            | $                       | 28,670  |         |   | $    | (24,376 | )       |   | $ | (1,479  | )      
|                                                                       |                                                            |                         |         |         |   |      |         |         |   |   |         |        

See accompanying notes.

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KNOWLES ELECTRONICS HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS EQUITY (DEFICIT)

|                                                                         |                                                                |                |   |            |  |             |        |          |  |               |          |       |  |   |   |   |  |   |         |        |   |   |          |        |  
|------------------------------------------------------------------------ | -------------------------------------------------------------- | -------------- | - | ---------- |  | ----------- | ------ | -------- |  | ------------- | -------- | ----- |  | - | - | - |  | - | ------- | ------ | - | - | -------- | ------ | -
|                                                                         |                                                                |                |   | Capital in |  |             |        | Cost of  |  | Accumulated   |          |      
|                                                                         |                                                                |                |   | Excess of  |  |             |        | Common   |  | Other         |          |      
|                                                                         |                                                                | Common         |   | Par        |  | Accumulated |        | Treasury |  | Comprehensive |          |      
|                                                                         |                                                                | Stock          |   | Value      |  | Deficit     |        | Shares   |  | Loss          |          | Total
|                                                                         |                                                                |                |   |            |  |             |        |          |  |               |          |      
|                                                                         |                                                                |               
|                                                                         |                                                                | (In thousands)
|Balance, December 31, 2000 as previously
    reported                    |                                                                | $              |  |            |  | $           | 17,263 |          |  | $             | (455,077 | )     |  | $ |  |   |  | $ | (6,803  | )      |   | $ | (444,617 | )     
|Prior period adjustments
    (see footnote 2)                            |                                                                |                |  |            |  |             |       |          |  |               | 2,110    |       |  |   |  |   |  |   |        |        |   |   | 2,110    |       
|                                                                         |                                                                |                |   |            |  |             |        |          |  |               |          |       |  |   |   |   |  |   |         |        |   |   |          |       
|Balance at December 31, 2000,
    as restated                            |                                                                | $              |  |            |  | $           | 17,263 |          |  | $             | (452,967 | )     |  | $ |  |   |  | $ | (6,803  | )      |   | $ | (442,507 | )     
|Net loss                                                                 |                                                                |                |  |            |  |             |       |          |  |               | (1,479   | )     |  |   |  |   |  |   |        |        |   |   | (1,479   | )     
|Other comprehensive income  foreign
    currency translation adjustment |                                                                |                |  |            |  |             |       |          |  |               |         |       |  |   |  |   |  |   | (363    | )      |   |   | (363     | )     
|                                                                         |                                                                |                |   |            |  |             |        |          |  |               |          |       |  |   |   |   |  |   |         |        |   |   |          |       
|Comprehensive loss                                                       |                                                                |                |  |            |  |             |       |          |  |               |         |       |  |   |  |   |  |   |        |        |   |   | (1,842   | )     
|Issuance of common stock                                                 |                                                                |                |  |            |  |             | 250    |          |  |               |         |       |  |   |  |   |  |   |        |        |   |   | 250      |       
|Repurchase stock                                                         |                                                                |                |  |            |  |             | (300   | )        |  |               |         |       |  |   |  |   |  |   |        |        |   |   | (300     | )     
|Preferred stock dividends                                                |                                                                |                |  |            |  |             |       |          |  |               | (21,367  | )     |  |   |  |   |  |   |        |        |   |   | (21,367  | )     
|Other                                                                    |                                                                |                |  |            |  |             |       |          |  |               | (14      | )     |  |   |  |   |  |   |        |        |   |   | (14      | )     
|                                                                         |                                                                |                |   |            |  |             |        |          |  |               |          |       |  |   |   |   |  |   |         |        |   |   |          |       
|Balance at December 31, 2001, as restated                                |                                                                | $              |  |            |  | $           | 17,213 |          |  | $             | (475,827 | )     |  | $ |  |   |  | $ | (7,166  | )      |   | $ | (465,780 | )     
|Net loss                                                                 |                                                                |                |  |            |  |             |       |          |  |               | (24,376  | )     |  |   |  |   |  |   |        |        |   |   | (24,376  | )     
|Other comprehensive income:                                              |                                                                |                |   |            |  |             |        |          |  |               |          |       |  |   |   |   |  |   |         |        |   |   |          |       
|                                                                         | Foreign currency translation adjustment                        |                |   |           |  |             |        |         |  |               |          |      |  |   |   |  |  |   |         | 4,068  |   |   |          | 4,068  |  
|                                                                         | Minimum pension liability
    pension adjustment net of tax(1) |                |   |           |  |             |        |         |  |               |          |      |  |   |   |  |  |   |         | (8,249 | ) |   |          | (8,249 | )
|                                                                         |                                                                |                |   |            |  |             |        |          |  |               |          |       |  |   |   |   |  |   |         |        |   |   |          |       
|Comprehensive loss                                                       |                                                                |                |  |            |  |             |       |          |  |               |         |       |  |   |  |   |  |   |        |        |   |   | (28,557  | )     
|Issue common stock                                                       |                                                                |                |  |            |  |             | 150    |          |  |               |         |       |  |   |  |   |  |   |        |        |   |   | 150      |       
|Repurchase stock                                                         |                                                                |                |  |            |  |             | (525   | )        |  |               |         |       |  |   |  |   |  |   |        |        |   |   | (525     | )     
|Preferred stock dividends                                                |                                                                |                |  |            |  |             |       |          |  |               | (23,505  | )     |  |   |  |   |  |   |        |        |   |   | (23,505  | )     
|Other                                                                    |                                                                |                |  |            |  |             |       |          |  |               | 66       |       |  |   |  |   |  |   |        |        |   |   | 66       |       
|                                                                         |                                                                |                |   |            |  |             |        |          |  |               |          |       |  |   |   |   |  |   |         |        |   |   |          |       
|Balance at December 31, 2002, as restated                                |                                                                | $              |  |            |  | $           | 16,838 |          |  | $             | (523,642 | )     |  | $ |  |   |  | $ | (11,347 | )      |   | $ | (518,151 | )     
|Net income                                                               |                                                                |                |  |            |  |             |       |          |  |               | 28,670   |       |  |   |  |   |  |   |        |        |   |   | 28,670   |       
|Other comprehensive income:                                              |                                                                |                |   |            |  |             |        |          |  |               |          |       |  |   |   |   |  |   |         |        |   |   |          |       
|                                                                         | Foreign currency translation adjustment                        |                |   |           |  |             |        |         |  |               |          |      |  |   |   |  |  |   |         | 1,543  |   |   |          | 1,543  |  
|                                                                         | Minimum pension liability
    pension adjustment net of tax    |                |   |           |  |             |        |         |  |               |          |      |  |   |   |  |  |   |         | 1,767  |   |   |          | 1,767  |  
|                                                                         |                                                                |                |   |            |  |             |        |          |  |               |          |       |  |   |   |   |  |   |         |        |   |   |          |       
|Comprehensive income                                                     |                                                                |                |  |            |  |             |       |          |  |               |         |       |  |   |  |   |  |   |        |        |   |   | 31,980   |       
|Repurchase stock                                                         |                                                                |                |  |            |  |             | (350   | )        |  |               |         |       |  |   |  |   |  |   |        |        |   |   | (350     | )     
|Preferred stock dividends                                                |                                                                |                |  |            |  |             |       |          |  |               | (25,854  | )     |  |   |  |   |  |   |        |        |   |   | (25,854  | )     
|                                                                         |                                                                |                |   |            |  |             |        |          |  |               |          |       |  |   |   |   |  |   |         |        |   |   |          |       
|Balance at December 31, 2003                                             |                                                                | $              |  |            |  | $           | 16,488 |          |  | $             | (520,826 | )     |  | $ |  |   |  | $ | (8,037  | )      |   | $ | (512,375 | )     
|                                                                         |                                                                |                |   |            |  |             |        |          |  |               |          |       |  |   |   |   |  |   |         |        |   |   |          |       



---



|    |                             
|--- | ----------------------------
|(1) | As restated  see footnote 2

See accompanying notes.

42



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##### Table of Contents



KNOWLES ELECTRONICS HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                                                                        |                                                               |                                   |         |       |        |      |         |        |        |   |         |        |        |  
|----------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------- | --------------------------------- | ------- | ----- | ------ | ---- | ------- | ------ | ------ | - | ------- | ------ | ------ | -
|                                                                                                                        |                                                               |                                  
|                                                                                                                        |                                                               | Year Ended December 31           
|                                                                                                                        |                                                               |                                  
|                                                                                                                        |                                                               | 2003                              |         | 2002  |        | 2001
|                                                                                                                        |                                                               |                                   |         |       |        |     
|                                                                                                                        |                                                               |                                  
|                                                                                                                        |                                                               | (In thousands)                   
|Operating Activities                                                                                                    |                                                               |                                   |         |       |        |      |         |        |        |   |         |       
|Income (loss) from continuing operations                                                                                |                                                               | $                                 | 744     |       |        | $    | (30,921 | )      |        | $ | (8,515  | )     
|Adjustments to reconcile income (loss) from
    continuing operations to net cash provided by operating
    activities: |                                                               |                                   |         |       |        |      |         |        |        |   |         |       
|                                                                                                                        | Depreciation and amortization                                 |                                   |         | 7,443 |        |      |         | 8,703  |        |   |         | 11,693 |       
|                                                                                                                        | Restructuring costs                                           |                                   |         | 1,532 |        |      |         | 942    |        |   |         | 1,132  |       
|                                                                                                                        | Loss on sale of business                                      |                                   |         |      |        |      |         | 16,626 |        |   |         |       |       
|                                                                                                                        | Amortization of deferred financing fees and debt
    discount |                                   |         | 2,388 |        |      |         | 1,434  |        |   |         | 2,133  |       
|                                                                                                                        | Inventory obsolescence provision                              |                                   |         | 1,416 |        |      |         | 2,391  |        |   |         | 2,663  |       
|                                                                                                                        | Deferred income taxes                                         |                                   |         | 427   |        |      |         | 6,733  |        |   |         | (121   | )     
|                                                                                                                        | Stock compensation expense                                    |                                   |         |      |        |      |         | 504    |        |   |         |       |       
|                                                                                                                        | (Gain) loss on disposal of fixed assets                       |                                   |         | 160   |        |      |         | 1,170  |        |   |         | (2,745 | )     
|                                                                                                                        | Change in assets and liabilities:                             |                                   |         |       |        |      |         |        |        |   |         |        |       
|                                                                                                                        |                                                               | Accounts receivable               |         |       | (2,044 | )    |         |        | 6,882  |   |         |        | 2,278  |  
|                                                                                                                        |                                                               | Inventories                       |         |       | 831    |      |         |        | 9,362  |   |         |        | (5,246 | )
|                                                                                                                        |                                                               | Other assets                      |         |       | 272    |      |         |        | 1,200  |   |         |        | (2,200 | )
|                                                                                                                        |                                                               | Accounts payable                  |         |       | 411    |      |         |        | (2,380 | ) |         |        | 4,928  |  
|                                                                                                                        |                                                               | Accrued restructuring costs       |         |       | (1,239 | )    |         |        | (3,574 | ) |         |        | (8,733 | )
|                                                                                                                        |                                                               | Accrued interest payable          |         |       | (1,717 | )    |         |        | 2,157  |   |         |        | 198    |  
|                                                                                                                        |                                                               | Accrued compensation and benefits |         |       | 2,719  |      |         |        | 132    |   |         |        | (1,813 | )
|                                                                                                                        |                                                               | Other current liabilities         |         |       | (3,273 | )    |         |        | (196   | ) |         |        | (2,139 | )
|                                                                                                                        |                                                               | Other noncurrent liabilities      |         |       | 833    |      |         |        | 1,426  |   |         |        | 211    |  
|                                                                                                                        |                                                               | Income taxes payable              |         |       | (3,763 | )    |         |        | 141    |   |         |        | 2,790  |  
|Net cash provided by discontinued operating
    activities                                                              |                                                               |                                   | 3,971   |       |        |      | 6,947   |        |        |   | 13,302  |       
|                                                                                                                        |                                                               |                                   |         |       |        |      |         |        |        |   |         |       
|Net cash provided by operating activities                                                                               |                                                               |                                   | 11,111  |       |        |      | 29,679  |        |        |   | 9,816   |       
|Investing Activities                                                                                                    |                                                               |                                   |         |       |        |      |         |        |        |   |         |       
|Proceeds from sales of businesses and equipment                                                                         |                                                               |                                   | 45,245  |       |        |      | 3,560   |        |        |   | 3,662   |       
|Purchases of property, plant, and equipment, net                                                                        |                                                               |                                   | (14,776 | )     |        |      | (8,427  | )      |        |   | (21,276 | )     
|                                                                                                                        |                                                               |                                   |         |       |        |      |         |        |        |   |         |       
|Net cash provided by (used in) investing
    activities                                                                 |                                                               |                                   | 30,469  |       |        |      | (4,867  | )      |        |   | (17,614 | )     
|Financing Activities                                                                                                    |                                                               |                                   |         |       |        |      |         |        |        |   |         |       
|Debt payments  long term                                                                                               |                                                               |                                   | (87,102 | )     |        |      | (10,541 | )      |        |   | (9,375  | )     
|Debt proceeds  long term                                                                                               |                                                               |                                   | 35,000  |       |        |      | 10,055  |        |        |   |        |       
|Debt proceeds (payments)  short term,
    net                                                                          |                                                               |                                   |        |       |        |      | (1,996  | )      |        |   | 4,034   |       
|Issuance of preferred stock and common stock                                                                            |                                                               |                                   |        |       |        |      |        |        |        |   | 125     |       
|Costs associated with debt                                                                                              |                                                               |                                   | (1,749  | )     |        |      | (681    | )      |        |   | (636    | )     
|Repurchase of common stock, net                                                                                         |                                                               |                                   | (350    | )     |        |      | (400    | )      |        |   | (300    | )     
|                                                                                                                        |                                                               |                                   |         |       |        |      |         |        |        |   |         |       
|Net cash used in financing activities                                                                                   |                                                               |                                   | (54,201 | )     |        |      | (3,563  | )      |        |   | (6,152  | )     
|Effect of exchange rate changes on cash                                                                                 |                                                               |                                   | (31     | )     |        |      | 600     |        |        |   | (312    | )     
|                                                                                                                        |                                                               |                                   |         |       |        |      |         |        |        |   |         |       
|Net increase (decrease) in cash and cash
    equivalents                                                                |                                                               |                                   | (12,652 | )     |        |      | 21,849  |        |        |   | (14,262 | )     
|Cash and cash equivalents at beginning of year                                                                          |                                                               |                                   | 23,879  |       |        |      | 2,030   |        |        |   | 16,292  |       
|                                                                                                                        |                                                               |                                   |         |       |        |      |         |        |        |   |         |       
|Cash and cash equivalents at end of year                                                                                |                                                               | $                                 | 11,227  |       |        | $    | 23,879  |        |        | $ | 2,030   |       
|                                                                                                                        |                                                               |                                   |         |       |        |      |         |        |        |   |         |       
|Cash paid for interest                                                                                                  |                                                               | $                                 | 36,276  |       |        | $    | 30,525  |        |        | $ | 35,335  |       
|                                                                                                                        |                                                               |                                   |         |       |        |      |         |        |        |   |         |       
|Cash paid for taxes                                                                                                     |                                                               | $                                 | 3,592   |       |        | $    | 5,131   |        |        | $ | 4,297   |       
|                                                                                                                        |                                                               |                                   |         |       |        |      |         |        |        |   |         |       

See accompanying notes.

43



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##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

December 31, 2003 and 2002


(In thousands)


1.     Accounting
Policies



| |                                               
| | ----------------------------------------------
| | Basis of Recapitalization and
    Presentation

The consolidated financial statements of Knowles
Electronics Holdings, Inc. (the Company) include all of its
subsidiaries, including British, French, German, Chinese,
Japanese, Malaysian, Singaporean and Taiwanese subsidiaries.
Significant intercompany and affiliate accounts and transactions
have been eliminated.

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, 2003, the
liquidation value of the outstanding Series A-1 Preferred
Stock is $252,800 and the liquidation value of the outstanding
Series A-2 Preferred stock is $31,601.

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, 2003, amounted to $25,854. 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.

44



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##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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, 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 common stockholders equity.



| |                 
| | ----------------
| | 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 2003 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.

45



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##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                   
| | ----------------------------------
| | 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 $442, $225 and $0 in 2003, 2002 and 2001
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 including option periods; 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 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
$162 million at December 31, 2003. The fair value of
the Term C loan and 10% Senior Subordinated Notes were
$45 million and $10 million respectively at
December 31, 2003.



| |                                         
| | ----------------------------------------
| | Accumulated Other Comprehensive
    Loss

The balance of accumulated other comprehensive
loss is $1,555 of translation adjustment plus $6,482 of minimum
pension liability in 2003, and in 2002, $3,098 of translation
adjustment plus $8,249 of minimum pension liability.

46



---



##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                    
| | -------------------
| | 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. Such revenue is based on fixed or determinable sales
prices and is recognized when collectibility is reasonably
assured.



| |               
| | --------------
| | 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 bases 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 June 2001, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 143, Accounting for Asset
Retirement Obligations, which is effective for fiscal
years beginning after June 15, 2002. The Statement requires
legal obligations associated with the retirement of long-lived
assets to be recognized at their fair value at the time that the
obligations are incurred. Upon initial recognition of a
liability, that cost should be capitalized as part of the
related long-lived asset and allocated to expense over the
useful life of the asset. We adopted SFAS No. 143 as of
January 1, 2003, and there was no material impact on our
financial position or results of operations.

In June 2002, the Financial Accounting Standards
Board issued SFAS No. 146, Accounting for Cost Associated
with Exit or Disposal Activities, which changes the timing
of the recognition of restructuring charges. Liabilities for
restructuring costs will be required to be recognized when the
liability is incurred rather than when we commit to the plan.
SFAS No. 146 is effective for restructuring activity
initiated after December 31, 2002. The adoption of this
statement did not have a material impact on our financial
position, results of operations or cash flows.

In November 2002, the FASB issued FASB
Interpretation (FIN) No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others.

47



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KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

FIN No. 45 clarifies that a guarantor
is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in
issuing the guarantee. We adopted the provisions of
FIN No. 45 on January 1, 2003 for all new or
amended guarantees subsequent to that date. The adoption of this
statement did not have a material impact on our financial
position, results of operations or cash flows.

In May 2003, the FASB issued EITF No. 03-4,
Determining the Classification and Benefit Attribution
Method for a Cash Balance Pension Plan.
EITF 03-4 defines a cash balance pension plan
as a plan that contains a defined principal-crediting rate as a
percentage of salary and a defined, non-contingent
interest-crediting rate that entitles participants to future
interest credits at a stated, fixed rate until retirement.
EITF No. 03-4 requires that cash balance
pension plans be considered defined benefit pension plans for
the purpose of applying SFAS No. 87, Employers
Account for Pension. EITF No. 03-4 also declares the
traditional unit credit method to be the appropriate cost
determination approach for cash balance pension
plans. Although the Companys U.S. pension plan is a
cash balance pension for certain employees, the plan
does not have the characteristics of the cash
balance pension plans covered by EITF 03-4. The U.S.
pension plan contains an interest-crediting rate that entitles
participants to future interest credits at a variable rate until
retirement. The Company uses a projected unit credit method for
cost determination for the cash balance pension. The
adoption of EITF No. 03-4 has not had a material impact on
the Companys Consolidated Financial Statements.

In May 2003, the 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. The
Company will adopt the provisions of SFAS 150 on January 1,
2004. 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.

2.     Restatement of
Financial Statements

The Company is restating its prior years
financial statements because an error was discovered that
affects the pension expense (income), related balance sheet
accounts and certain disclosures previously reported in our
financial statements. We have discovered that our United Kingdom
subsidiarys prepaid pension expense balance was misstated
as of December 31, 2000 by $2.1 million primarily due
to a curtailment gain associated with the restructuring of our
U.K. facility in 2000 that was not reflected. The net effect of
the correction of this non-cash error was to increase prepaid
benefit cost and retained earnings as of December 31, 2000
by $2.1 million. Additionally, the U.K. subsidiary did not
properly reflect their required minimum pension liability as of
December 31, 2002. The net effect of this balance sheet
only error was to increase pension liability by
$4.5 million and reduce other comprehensive income
accordingly.

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 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.

48



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KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 10. Segments and Geographical Information.

Summarized selected financial information for the
discontinued operations is as follows:

|                                                           |  |      |        |      |  |      |        |  |  |   |        | 
|---------------------------------------------------------- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------ | 
|For the year ended December 31:                            |  | 2003 |        | 2002 |  | 2001
|                                                           |  |      |        |      |  |     
|Net sales                                                  |  | $    | 26,513 |      |  | $    | 51,986 |  |  | $ | 50,605 | 
|                                                           |  |      |        |      |  |      |        |  |  |   |        | 
|Income (loss) from discontinued operations                 |  | $    | 1,102  |      |  | $    | 6,591  |  |  | $ | 7,255  | 
|Income tax expense                                         |  |      | 170    |      |  |      | 46     |  |  |   | 219    | 
|                                                           |  |      |        |      |  |      |        |  |  |   |        | 
|Income (loss) from discontinued operations,
    net of tax |  | $    | 932    |      |  | $    | 6,545  |  |  | $ | 7,036  | 
|                                                           |  |      |        |      |  |      |        |  |  |   |        | 

The major classes of assets and liabilities for
the discontinued operations at December 31, 2002 were as
follows:

|                                               |  |              |        | 
|---------------------------------------------- |  | ------------ | ------ | 
|                                               |  | December 31,
|                                               |  | 2002        
|                                               |  |             
|Current assets                                 |  | $            | 23,942 | 
|Net property, plant and equipment              |  |              | 8,309  | 
|Miscellaneous other assets                     |  |              | 1,239  | 
|                                               |  |              |        | 
|Assets of discontinued operations              |  | $            | 33,490 | 
|                                               |  |              |        | 
|Accounts payable and other current liabilities |  | $            | 11,871 | 
|Notes payable                                  |  |              | 1,282  | 
|                                               |  |              |        | 
|Liabilities of discontinued operations         |  | $            | 13,153 | 
|                                               |  |              |        | 

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 $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 and 2001
periods presented.

49



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KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

4.     Inventory

Inventories are as follows:

|                     |                                       |      |        |        |   |   |        |        |  
|-------------------- | ------------------------------------- | ---- | ------ | ------ | - | - | ------ | ------ | -
|                     |                                       | 2003 |        | 2002  
|                     |                                       |      |        |       
|Raw materials        |                                       | $    | 9,211  |        |   | $ | 10,230 |       
|Work in process      |                                       |      | 1,341  |        |   |   | 1,074  |       
|Finished goods       |                                       |      | 10,969 |        |   |   | 13,430 |       
|                     |                                       |      |        |        |   |   |        |       
|                     |                                       |      | 21,521 |        |   |   | 24,734 |       
|Less allowances for: |                                       |      |        |        |   |   |        |       
|                     | Obsolescence and net realizable value |      |        | (4,148 | ) |   |        | (5,114 | )
|                     |                                       |      |        |        |   |   |        |       
|                     |                                       | $    | 17,373 |        |   | $ | 19,620 |       
|                     |                                       |      |        |        |   |   |        |       

5.     Income
Taxes

Income (loss) from continuing operations
before income taxes consists of the following:

|                |  |      |         |      |  |      |         |   |  |   |        |  
|--------------- |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------ | -
|                |  | 2003 |         | 2002 |  | 2001
|                |  |      |         |      |  |     
|Domestic (U.S.) |  | $    | (17,396 | )    |  | $    | (30,946 | ) |  | $ | (9,679 | )
|Foreign         |  |      | 18,631  |      |  |      | 11,769  |   |  |   | 7,477  |  
|                |  |      |         |      |  |      |         |   |  |   |        |  
|                |  | $    | 1,235   |      |  | $    | (19,177 | ) |  | $ | (2,202 | )
|                |  |      |         |      |  |      |         |   |  |   |        |  

A reconciliation of income tax expense to the
statutory federal rate of 35% is as follows:

|                                               |                                      |                        |     |        |   |      |        |         |   |   |       |        |  
|---------------------------------------------- | ------------------------------------ | ---------------------- | --- | ------ | - | ---- | ------ | ------- | - | - | ----- | ------ | -
|                                               |                                      |                       
|                                               |                                      | Year Ended December 31
|                                               |                                      |                       
|                                               |                                      | 2003                   |     | 2002   |   | 2001
|                                               |                                      |                        |     |        |   |     
|Statutory federal income tax expense (benefit) |                                      | $                      | 432 |        |   | $    | (6,712 | )       |   | $ | (771  | )     
|Effects of:                                    |                                      |                        |     |        |   |      |        |         |   |   |       |       
|                                               | Foreign rate differential            |                        |     | (4,283 | ) |      |        | (10,633 | ) |   |       | (8,036 | )
|                                               | Taxes on unremitted foreign earnings |                        |     | 3,800  |   |      |        | (1,179  | ) |   |       | 5,441  |  
|                                               | Valuation allowance                  |                        |     | 2,286  |   |      |        | 29,574  |   |   |       | 9,345  |  
|                                               | Reduction of prior year taxes        |                        |     | (1,596 | ) |      |        |        |   |   |       |       |  
|                                               | Other, net                           |                        |     | (148   | ) |      |        | 694     |   |   |       | 334    |  
|                                               |                                      |                        |     |        |   |      |        |         |   |   |       |       
|                                               |                                      | $                      | 491 |        |   | $    | 11,744 |         |   | $ | 6,313 |       
|                                               |                                      |                        |     |        |   |      |        |         |   |   |       |       

50



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KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The income tax provision (benefit) for the
years ended December 31, 2003, 2002, and 2001 consists of
the following:

|                              |         |                        |       |        |   |      |        |       |   |   |       |       |  
|----------------------------- | ------- | ---------------------- | ----- | ------ | - | ---- | ------ | ----- | - | - | ----- | ----- | -
|                              |         |                       
|                              |         | Year Ended December 31
|                              |         |                       
|                              |         | 2003                   |       | 2002   |   | 2001
|                              |         |                        |       |        |   |     
|Current:                      |         |                        |       |        |   |      |        |       |   |   |       |      
|                              | Federal |                        | $     | (1,641 | ) |      | $      |      |   |   | $     | 1,464 |  
|                              | State   |                        |       |       |   |      |        |      |   |   |       |      |  
|                              | Foreign |                        |       | 1,006  |   |      |        | 5,432 |   |   |       | 4,961 |  
|                              |         |                        |       |        |   |      |        |       |   |   |       |      
|Total Current                 |         |                        | (635  | )      |   |      | 5,432  |       |   |   | 6,425 |      
|Deferred                      |         |                        |       |        |   |      |        |       |   |   |       |      
|                              | Federal |                        |       |       |   |      |        | 6,797 |   |   |       | (976  | )
|                              | State   |                        |       |       |   |      |        |      |   |   |       | 0     |  
|                              | Foreign |                        |       | 1,126  |   |      |        | (485  | ) |   |       | 864   |  
|                              |         |                        |       |        |   |      |        |       |   |   |       |      
|Total Deferred                |         |                        | 1,126 |        |   |      | 6,312  |       |   |   | (112  | )    
|                              |         |                        |       |        |   |      |        |       |   |   |       |      
|Total tax provision (benefit) |         | $                      | 491   |        |   | $    | 11,744 |       |   | $ | 6,313 |      
|                              |         |                        |       |        |   |      |        |       |   |   |       |      

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, 2003 and 2002, are as
follows:

|                               |                                          |             |         |         |   |   |         |         |  
|------------------------------ | ---------------------------------------- | ----------- | ------- | ------- | - | - | ------- | ------- | -
|                               |                                          |            
|                               |                                          | December 31
|                               |                                          |            
|                               |                                          | 2003        |         | 2002   
|                               |                                          |             |         |        
|Deferred tax assets:           |                                          |             |         |         |   |   |         |        
|                               | Non-U.S. net operating loss carryforward |             | $       | 910     |   |   | $       | 20,110  |  
|                               | U.S. net operating loss carryforward     |             |         | 6,018   |   |   |         | 15,206  |  
|                               | Foreign tax credits carryforward         |             |         | 17,632  |   |   |         | 17,131  |  
|                               | Pension                                  |             |         | 2,429   |   |   |         | 2,345   |  
|                               | Inventory                                |             |         | 1,484   |   |   |         | 2,401   |  
|                               | Accrued expenses                         |             |         | 3,893   |   |   |         | 7,290   |  
|                               | Other, net                               |             |         | 715     |   |   |         | 160     |  
|                               |                                          |             |         |         |   |   |         |        
|Total deferred tax assets      |                                          |             | 33,081  |         |   |   | 64,643  |        
|Deferred tax liabilities:      |                                          |             |         |         |   |   |         |        
|                               | Taxes on unremitted foreign earnings     |             |         | (10,259 | ) |   |         | (12,619 | )
|                               | Other deferred tax liabilities           |             |         | (2,466  | ) |   |         | (282    | )
|                               |                                          |             |         |         |   |   |         |        
|Total deferred tax liabilities |                                          |             | (12,725 | )       |   |   | (12,901 | )      
|Valuation allowance            |                                          |             | (21,322 | )       |   |   | (52,283 | )      
|                               |                                          |             |         |         |   |   |         |        
|Net deferred tax (liabilities) |                                          | $           | (968    | )       |   | $ | (541    | )      
|                               |                                          |             |         |         |   |   |         |        

The Company had foreign net operating loss
carryforwards of $3,466 and $47,559 at December 31, 2003
and 2002 that have an indefinite carryforward period. In
addition, the Company had state net operating loss carry
forwards of $48,378 at December 31, 2003, that begin to
expire in 2019. The Companys foreign tax

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KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

credit carryforward of $17,632 begins to expire
in 2004. The Company has provided a valuation allowance against
the net deferred tax assets due to the uncertainty of
realization of those assets.

During 2003, the Company wrote off $20,019 of
foreign net operating losses concurrent with the discontinuation
of certain foreign operations in recognition that the
possibility of receiving future tax benefits from those net
operating losses is highly unlikely. At December 31, 2002
the entire balance of $20,019 was offset by a valuation
allowance. As such, the net impact of the write off on the
Companys deferred tax assets and liabilities was zero.

The Companys future operating plan is to
repatriate all foreign earnings not needed for near term
investment in each country. As a result, a substantial portion
of the unremitted earnings of the affected foreign subsidiaries
is not considered permanently reinvested. The Company has
recorded a deferred tax liability for the anticipated tax
liability on the unremitted foreign earnings, which are not
considered permanently reinvested.

6.     Notes
Payable

As part of the Recapitalization transaction, the
Company entered into a Senior Credit Agreement dated
June 28, 1999 and amended and restated as of July 21, 1999,
and further amended as of December 23, 1999, April 10,
2000, December 12, 2001, May 10, 2002, March 25, 2003
and May 28, 2003 with certain lenders (Senior Credit
Agreement). The Company obtained a Limited Waiver and
Amendment dated as of March 25, 2003 under which the
remaining balance of the Term A Facility was repaid and
replaced by a $35,000 Term C Facility due June 29, 2007
with a fixed interest rate of 18.50%. The Limited Waiver and
Amendment waives the required interest coverage ratio and
leverage ratio from the effective date of the Amendment through
June 29, 2003 and amends these ratios for the remainder of
the Credit Agreement. The Limited Waiver and Amendment also
increased the Term B Facility interest rate and the
Revolving Credit Facility interest rate by 0.5 percentage
points, modified the Term B Facility installment payments,
and reduced the Revolving Credit Facility to $15,000.

The $15.0 million 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 Revolving Credit Facility expires on
June 30, 2006, 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. There were no
borrowings under this facility at December 31, 2003 and
2002.

The Term 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%. In addition, as of
March 31, 2003, the B Facility will accrue additional
interest at the rate of approximately $420 per year (subject to
reduction in the event of a prepayment of the B Facility), to be
paid at the maturity of the facility (or, in certain cases, 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.

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 Term C Facility bears interest at a
fixed rate of 18.5% of which 13% is payable in cash, and the
remainder, at the Companys option, payable in cash or
increased principal. The percentage rate that is

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KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

payable in cash increases 1.0 percentage
point on March 31 of each year. At December 31, 2003,
the interest rate was 6.1875% for the Term B Facility and
18.5% for the Term C Facility.

The Company prepaid $9,533 of principal under the
Senior Credit Agreement on March 28, 2003 as required by
the excess cash flow calculation.

The Company obtained Amendment Number Six and
Waiver, dated as of May 28, 2003, which approved the sale
of the Synchro-Start division and Ruwido
(infrared) division under certain conditions. The
Synchro-Start division sale required minimum net proceeds from
the sale of $42 million to be used to prepay Term B
Facility loans, provided that $10 million of the principal
repayment out of the net proceeds from the transaction would be
applied to the subsequent scheduled repayments, and any payments
in respect of excess cash flow, and the remaining net proceeds
would reduce the remaining scheduled Term B repayments
ratably. The sale of the Ruwido division would require a
prepayment of not less than $1 million made up of the sum
of the net proceeds received on the date of consummation plus
the amount of any optional prepayments. The Amendment Number Six
and Waiver also amended the definition of consolidated EBITDA to
exclude up to $7.5 million of cash restructuring charges
taken in 2003, 2004 and 2005 in connection with restructuring of
overhead costs. The Company completed the sale of the
Synchro-Start division May 30, 2003 and prepaid
$42 million of Term B facility loans. An additional
prepayment of $2.3 million was made in November 2003 based
on the final purchase price adjustment related to the
Synchro-Start sale. The Company completed the sale of the Ruwido
division July 29, 2003 and made the required
$1 million principal prepayment.

The Term 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                 |  |  | 22,440 | 
|December 31, 2006 to June 29, 2007 |  |  | 23,054 | 

The balance under the Term A Facility,
Term B Facility, Term C 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,
|                                       |  |             
|                                       |  | 2003         |         | 2002
|                                       |  |              |         |     
|Term A facility                        |  | $            |        |      |  | $ | 33,461  | 
|Term B facility                        |  |              | 91,600  |      |  |   | 144,998 | 
|Term C facility                        |  |              | 35,668  |      |  |   |        | 
|13 1/8% Senior Subordinated Notes, net |  |              | 150,912 |      |  |   | 151,163 | 
|10% Senior Subordinated Notes          |  |              | 10,000  |      |  |   | 10,000  | 
|                                       |  |              |         |      |  |   |         | 
|                                       |  |              | 288,180 |      |  |   | 339,622 | 
|Less: Current portion                  |  |              |        |      |  |   | 11,996  | 
|                                       |  |              |         |      |  |   |         | 
|Total long-term notes payable          |  | $            | 288,180 |      |  | $ | 327,626 | 
|                                       |  |              |         |      |  |   |         | 

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KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Included in the liabilities of discontinued
operations is the long-term debt of Ruwido, our Austrian
subsidiary as follows:

|                                                          |  |              |   |              |  |   |       | 
|--------------------------------------------------------- |  | ------------ | - | ------------ |  | - | ----- | 
|                                                          |  | December 31, |   | December 31,
|                                                          |  | 2003         |   | 2002        
|                                                          |  |              |   |             
|Austrian subsidiary long-term debt due September
    2006 |  | $            |  |              |  | $ | 1,145 | 
|Austrian subsidiary long-term debt due June 2006          |  |              |  |              |  |   | 593   | 
|                                                          |  |              |   |              |  |   |       | 
|                                                          |  |              |  |              |  |   | 1,738 | 
|Less: Current portion                                     |  |              |  |              |  |   | 456   | 
|                                                          |  |              |   |              |  |   |       | 
|Total long-term notes payable                             |  | $            |  |              |  | $ | 1,282 | 
|                                                          |  |              |   |              |  |   |       | 

Maturities of Notes Payable follows (including
Term B Facility and Term C Facility under the Credit
Agreement as amended March 25, 2003):



|     |  |   |         | 
|---- |  | - | ------- | 
|2004 |  | $ |        | 
|2005 |  |   |        | 
|2006 |  |   | 45,494  | 
|2007 |  |   | 81,774  | 
|2008 |  |   |        | 
|2009 |  |   | 163,200 | 
|     |  |   |         | 
|     |  | $ | 290,468 | 
|     |  |   |         | 

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 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
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.

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 passu to the 13 1/8% Notes.

The Companys Senior Credit Agreement
requires that the Company comply with certain covenants and
restrictions, including specific financial ratios that must be
maintained. As of December 31, 2003, 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., Emkay
Innovative Products, Inc. and Knowles Manufacturing Ltd. The
following tables present summarized balance sheet information of
the Company as of December 31, 2003 and 2002, and summarized

54



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KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

income statement and cash flow information for
the years ended December 31, 2003, 2002, and 2001. The
column labeled Parent Company represents the holding
company for each of the Companys direct subsidiaries which
are guarantors of the 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 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.

Summarized information as of December 31,
2003 and 2002, and for the three years ended December 31,
2003, is as follows:

|                                                         |  |                   |          |            |  |                |         |              |  |              |         |  |  |   |          |   |  |   |          |  
|-------------------------------------------------------- |  | ----------------- | -------- | ---------- |  | -------------- | ------- | ------------ |  | ------------ | ------- |  |  | - | -------- | - |  | - | -------- | -
|                                                         |  |                  
|                                                         |  | December 31, 2003
|                                                         |  |                  
|                                                         |  | Parent            |          | Guarantors |  | Non-Guarantors |         | Eliminations |  | Consolidated
|                                                         |  |                   |          |            |  |                |         |              |  |             
|Cash                                                     |  | $                 | 866      |            |  | $              | 5,627   |              |  | $            | 4,734   |  |  | $ |         |   |  | $ | 11,227   |  
|Accounts receivable                                      |  |                   |         |            |  |                | 29,333  |              |  |              | 60,541  |  |  |   | (66,746  | ) |  |   | 23,128   |  
|Inventories                                              |  |                   |         |            |  |                | 6,047   |              |  |              | 11,326  |  |  |   |         |   |  |   | 17,373   |  
|Assets of discontinued operations                        |  |                   |         |            |  |                |        |              |  |              |        |  |  |   |         |   |  |   |         |  
|Other current assets                                     |  |                   |         |            |  |                | 1,169   |              |  |              | 3,854   |  |  |   |         |   |  |   | 5,023    |  
|Net property, plant and equipment                        |  |                   |         |            |  |                | 25,609  |              |  |              | 19,896  |  |  |   |         |   |  |   | 45,505   |  
|Assets 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    |            |  |                |        |              |  |              |        |  |  |   |         |   |  |   | 7,168    |  
|Deferred income taxes                                    |  |                   |         |            |  |                |        |              |  |              |        |  |  |   |         |   |  |   |         |  
|Other non-current assets                                 |  |                   |         |            |  |                | 2,969   |              |  |              | 180     |  |  |   |         |   |  |   | 3,149    |  
|                                                         |  |                   |          |            |  |                |         |              |  |              |         |  |  |   |          |   |  |   |          |  
|Total assets                                             |  | $                 | 109,381  |            |  | $              | 429,328 |              |  | $            | 102,974 |  |  | $ | (529,110 | ) |  | $ | 112,573  |  
|                                                         |  |                   |          |            |  |                |         |              |  |              |         |  |  |   |          |   |  |   |          |  
|Accounts payable                                         |  | $                 |         |            |  | $              | 32,642  |              |  | $            | 45,376  |  |  | $ | (66,746  | ) |  | $ | 11,272   |  
|Accrued restructuring costs                              |  |                   |         |            |  |                | 1,490   |              |  |              |        |  |  |   |         |   |  |   | 1,490    |  
|Advances from parent                                     |  |                   | 217,164  |            |  |                | 90,385  |              |  |              | 350     |  |  |   | (307,899 | ) |  |   |         |  
|Liabilities of discontinued operations                   |  |                   |         |            |  |                |        |              |  |              |        |  |  |   |         |   |  |   |         |  
|Other current liabilities                                |  |                   | 4,875    |            |  |                | 15,761  |              |  |              | 5,244   |  |  |   |         |   |  |   | 25,880   |  
|Short-term debt                                          |  |                   |         |            |  |                |        |              |  |              |        |  |  |   |         |   |  |   |         |  
|Deferred income taxes                                    |  |                   |         |            |  |                |        |              |  |              | 968     |  |  |   |         |   |  |   | 968      |  
|Noncurrent liabilities                                   |  |                   |         |            |  |                | 9,043   |              |  |              | 3,714   |  |  |   |         |   |  |   | 12,757   |  
|Notes payable                                            |  |                   | 288,180  |            |  |                |        |              |  |              |        |  |  |   |         |   |  |   | 288,180  |  
|Preferred stock                                          |  |                   | 284,401  |            |  |                |        |              |  |              |        |  |  |   |         |   |  |   | 284,401  |  
|Stockholders 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  |  
|                                                         |  |                   |          |            |  |                |         |              |  |              |         |  |  |   |          |   |  |   |          |  

55



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##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                                         |  |                   |          |            |  |                |         |              |  |              |         |  |  |   |          |   |  |   |          |  
|-------------------------------------------------------- |  | ----------------- | -------- | ---------- |  | -------------- | ------- | ------------ |  | ------------ | ------- |  |  | - | -------- | - |  | - | -------- | -
|                                                         |  |                  
|                                                         |  | December 31, 2002
|                                                         |  |                  
|                                                         |  | Parent            |          | Guarantors |  | Non-Guarantors |         | Eliminations |  | Consolidated
|                                                         |  |                   |          |            |  |                |         |              |  |             
|Cash                                                     |  | $                 | 9,614    |            |  | $              | 7,578   |              |  | $            | 6,687   |  |  | $ |         |   |  | $ | 23,879   |  
|Accounts receivable                                      |  |                   |         |            |  |                | 28,512  |              |  |              | 45,217  |  |  |   | (52,645  | ) |  |   | 21,084   |  
|Inventories                                              |  |                   |         |            |  |                | 8,072   |              |  |              | 11,389  |  |  |   | 159      |   |  |   | 19,620   |  
|Other current assets                                     |  |                   |         |            |  |                | 2,204   |              |  |              | 2,553   |  |  |   |         |   |  |   | 4,757    |  
|Assets of discontinued operations                        |  |                   |         |            |  |                | 40,635  |              |  |              | 36,296  |  |  |   | (43,441  | ) |  |   | 33,490   |  
|Net property, plant and equipment                        |  |                   |         |            |  |                | 19,421  |              |  |              | 19,386  |  |  |   | (43      | ) |  |   | 38,764   |  
|Assets held for sale, net of impairment                  |  |                   |         |            |  |                |        |              |  |              |        |  |  |   |         |   |  |   |         |  
|Investment in and advances to subsidiaries               |  |                   | 101,347  |            |  |                | 217,071 |              |  |              | 425     |  |  |   | (318,843 | ) |  |   |         |  
|Deferred finance costs, net                              |  |                   | 8,058    |            |  |                |        |              |  |              |        |  |  |   |         |   |  |   | 8,058    |  
|Deferred income taxes                                    |  |                   |         |            |  |                |        |              |  |              |        |  |  |   |         |   |  |   |         |  
|Other non-current assets                                 |  |                   |         |            |  |                | 996     |              |  |              | 191     |  |  |   |         |   |  |   | 1,187    |  
|                                                         |  |                   |          |            |  |                |         |              |  |              |         |  |  |   |          |   |  |   |          |  
|Total assets                                             |  | $                 | 119,019  |            |  | $              | 324,489 |              |  | $            | 122,144 |  |  | $ | (414,813 | ) |  | $ | 150,839  |  
|                                                         |  |                   |          |            |  |                |         |              |  |              |         |  |  |   |          |   |  |   |          |  
|Accounts payable                                         |  | $                 |         |            |  | $              | 33,187  |              |  | $            | 29,465  |  |  | $ | (51,791  | ) |  | $ | 10,861   |  
|Accrued restructuring costs                              |  |                   |         |            |  |                | 1,045   |              |  |              | 152     |  |  |   |         |   |  |   | 1,197    |  
|Advances from parent                                     |  |                   | 137,293  |            |  |                | 45,373  |              |  |              | 2,650   |  |  |   | (185,316 | ) |  |   |         |  
|Other current liabilities                                |  |                   | 6,361    |            |  |                | 18,505  |              |  |              | 6,401   |  |  |   | (847     | ) |  |   | 30,420   |  
|Short-term debt                                          |  |                   | 11,996   |            |  |                |        |              |  |              |        |  |  |   |         |   |  |   | 11,996   |  
|Deferred income taxes                                    |  |                   |         |            |  |                |        |              |  |              | 541     |  |  |   |         |   |  |   | 541      |  
|Liabilities of discontinued operations                   |  |                   |         |            |  |                | 10,186  |              |  |              | 19,758  |  |  |   | (16,791  | ) |  |   | 13,153   |  
|Noncurrent liabilities                                   |  |                   |         |            |  |                | 10,101  |              |  |              | 4,548   |  |  |   |         |   |  |   | 14,649   |  
|Notes payable                                            |  |                   | 327,626  |            |  |                |        |              |  |              |        |  |  |   |         |   |  |   | 327,626  |  
|Preferred stock                                          |  |                   | 258,547  |            |  |                |        |              |  |              |        |  |  |   |         |   |  |   | 258,547  |  
|Stockholders equity (deficit)                           |  |                   | (622,804 | )          |  |                | 206,092 |              |  |              | 58,629  |  |  |   | (160,068 | ) |  |   | (518,151 | )
|                                                         |  |                   |          |            |  |                |         |              |  |              |         |  |  |   |          |   |  |   |          |  
|Total liabilities and stockholders equity
    (deficit) |  | $                 | 119,019  |            |  | $              | 324,489 |              |  | $            | 122,144 |  |  | $ | (414,813 | ) |  | $ | 150,839  |  
|                                                         |  |                   |          |            |  |                |         |              |  |              |         |  |  |   |          |   |  |   |          |  

56



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KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                                                 |                  |                                       |         |            |   |                |         |              |   |              |         |      |   |   |          |         |   |   |         |         |  
|---------------------------------------------------------------- | ---------------- | ------------------------------------- | ------- | ---------- | - | -------------- | ------- | ------------ | - | ------------ | ------- | ---- | - | - | -------- | ------- | - | - | ------- | ------- | -
|                                                                 |                  |                                      
|                                                                 |                  | Twelve Months Ended December 31, 2003
|                                                                 |                  |                                      
|                                                                 |                  | Parent                                |         | Guarantors |   | Non-Guarantors |         | Eliminations |   | Consolidated
|                                                                 |                  |                                       |         |            |   |                |         |              |   |             
|Net Sales                                                        |                  | $                                     |        |            |   | $              | 140,399 |              |   | $            | 165,808 |      |   | $ | (152,165 | )       |   | $ | 154,042 |        
|Cost of sales                                                    |                  |                                       |        |            |   |                | 84,311  |              |   |              | 142,411 |      |   |   | (151,128 | )       |   |   | 75,594  |        
|                                                                 |                  |                                       |         |            |   |                |         |              |   |              |         |      |   |   |          |         |   |   |         |        
|Gross margin                                                     |                  |                                       |        |            |   |                | 56,088  |              |   |              | 23,397  |      |   |   | (1,037   | )       |   |   | 78,448  |        
|Selling, research and administrative expenses                    |                  |                                       |        |            |   |                | 33,607  |              |   |              | 6,905   |      |   |   | (555     | )       |   |   | 39,957  |        
|Restructuring activity                                           |                  |                                       |        |            |   |                | 1,617   |              |   |              | (85     | )    |   |   |         |         |   |   | 1,532   |        
|                                                                 |                  |                                       |         |            |   |                |         |              |   |              |         |      |   |   |          |         |   |   |         |        
|Operating income                                                 |                  |                                       |        |            |   |                | 20,864  |              |   |              | 16,577  |      |   |   | (482     | )       |   |   | 36,959  |        
|Other income (expense):                                          |                  |                                       |         |            |   |                |         |              |   |              |         |      |   |   |          |         |   |   |         |        
|                                                                 | Interest income  |                                       |         |           |   |                |         | 134          |   |              |         | 46   |   |   |          | (69     | ) |   |         | 111     |  
|                                                                 | Interest expense |                                       |         | (36,231    | ) |                |         | (56          | ) |              |         | (117 | ) |   |          | 569     |   |   |         | (35,835 | )
|                                                                 | Dividend income  |                                       |         |           |   |                |         | 46,290       |   |              |         |     |   |   |          | (46,290 | ) |   |         |        |  
|                                                                 |                  |                                       |         |            |   |                |         |              |   |              |         |      |   |   |          |         |   |   |         |        
|Income (loss) from continuing operations before
    income taxes |                  |                                       | (36,231 | )          |   |                | 67,232  |              |   |              | 16,506  |      |   |   | (46,272  | )       |   |   | 1,235   |        
|Income taxes                                                     |                  |                                       |        |            |   |                | 1,500   |              |   |              | (1,991  | )    |   |   |         |         |   |   | (491    | )      
|                                                                 |                  |                                       |         |            |   |                |         |              |   |              |         |      |   |   |          |         |   |   |         |        
|Income (loss) from continuing operations after
    income taxes  |                  |                                       | (36,231 | )          |   |                | 68,732  |              |   |              | 14,515  |      |   |   | (46,272  | )       |   |   | 744     |        
|Income from discontinued operations after income
    taxes       |                  |                                       |        |            |   |                | 27,743  |              |   |              | 559     |      |   |   | (376     | )       |   |   | 27,926  |        
|                                                                 |                  |                                       |         |            |   |                |         |              |   |              |         |      |   |   |          |         |   |   |         |        
|Net income (loss)                                                |                  | $                                     | (36,231 | )          |   | $              | 96,475  |              |   | $            | 15,074  |      |   | $ | (46,648  | )       |   | $ | 28,670  |        
|                                                                 |                  |                                       |         |            |   |                |         |              |   |              |         |      |   |   |          |         |   |   |         |        

57



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KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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

58



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KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                                              |                    |                              |         |            |   |                |         |              |   |              |         |        |   |   |          |         |   |   |         |         |  
|------------------------------------------------------------- | ------------------ | ---------------------------- | ------- | ---------- | - | -------------- | ------- | ------------ | - | ------------ | ------- | ------ | - | - | -------- | ------- | - | - | ------- | ------- | -
|                                                              |                    |                             
|                                                              |                    | Year Ended December 31, 2001
|                                                              |                    |                             
|                                                              |                    | Parent                       |         | Guarantors |   | Non-Guarantors |         | Eliminations |   | Consolidated
|                                                              |                    |                              |         |            |   |                |         |              |   |             
|Net Sales                                                     |                    | $                            |        |            |   | $              | 136,809 |              |   | $            | 144,718 |        |   | $ | (108,411 | )       |   | $ | 173,116 |        
|Cost of sales                                                 |                    |                              |        |            |   |                | 85,470  |              |   |              | 112,437 |        |   |   | (107,202 | )       |   |   | 90,705  |        
|                                                              |                    |                              |         |            |   |                |         |              |   |              |         |        |   |   |          |         |   |   |         |        
|Gross margin                                                  |                    |                              |        |            |   |                | 51,339  |              |   |              | 32,281  |        |   |   | (1,209   | )       |   |   | 82,411  |        
|Selling, research and administrative expenses                 |                    |                              |        |            |   |                | 32,626  |              |   |              | 15,311  |        |   |   | (672     | )       |   |   | 47,265  |        
|Restructuring activity                                        |                    |                              |        |            |   |                | 2,220   |              |   |              | (2,399  | )      |   |   |         |         |   |   | (179    | )      
|                                                              |                    |                              |         |            |   |                |         |              |   |              |         |        |   |   |          |         |   |   |         |        
|Operating income                                              |                    |                              |        |            |   |                | 16,493  |              |   |              | 19,369  |        |   |   | (537     | )       |   |   | 35,325  |        
|Other income (expense):                                       |                    |                              |         |            |   |                |         |              |   |              |         |        |   |   |          |         |   |   |         |        
|                                                              | Interest income    |                              |         | 79         |   |                |         | 1,634        |   |              |         | 443    |   |   |          | (2,017  | ) |   |         | 139     |  
|                                                              | Interest expense   |                              |         | (37,653    | ) |                |         | (922         | ) |              |         | (1,003 | ) |   |          | 1,912   |   |   |         | (37,666 | )
|                                                              | Miscellaneous, net |                              |         |           |   |                |         |             |   |              |         |       |   |   |          |        |   |   |         |        |  
|                                                              | Dividend income    |                              |         |           |   |                |         | 29,804       |   |              |         |       |   |   |          | (29,804 | ) |   |         |        |  
|                                                              |                    |                              |         |            |   |                |         |              |   |              |         |        |   |   |          |         |   |   |         |        
|Income (loss) from continuing operations before
    taxes     |                    |                              | (37,574 | )          |   |                | 47,009  |              |   |              | 18,809  |        |   |   | (30,446  | )       |   |   | (2,202  | )      
|Income taxes                                                  |                    |                              |        |            |   |                | (796    | )            |   |              | (5,517  | )      |   |   |         |         |   |   | (6,313  | )      
|                                                              |                    |                              |         |            |   |                |         |              |   |              |         |        |   |   |          |         |   |   |         |        
|Income (loss) from continuing operations
    after income tax |                    |                              | (37,574 | )          |   |                | 46,213  |              |   |              | 13,292  |        |   |   | (30,446  | )       |   |   | (8,515  | )      
|Income from discontinued operations                           |                    |                              |        |            |   |                | 5,241   |              |   |              | 1,227   |        |   |   | 568      |         |   |   | 7,036   |        
|                                                              |                    |                              |         |            |   |                |         |              |   |              |         |        |   |   |          |         |   |   |         |        
|Net income (loss)                                             |                    | $                            | (37,574 | )          |   | $              | 51,454  |              |   | $            | 14,519  |        |   | $ | (29,878  | )       |   | $ | (1,479  | )      
|                                                              |                    |                              |         |            |   |                |         |              |   |              |         |        |   |   |          |         |   |   |         |        

59



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##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                                                   |  |                                       |         |            |  |                |         |              |  |              |         |   |  |   |         |   |  |   |         |  
|------------------------------------------------------------------ |  | ------------------------------------- | ------- | ---------- |  | -------------- | ------- | ------------ |  | ------------ | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                                   |  |                                      
|                                                                   |  | Twelve Months Ended December 31, 2003
|                                                                   |  |                                      
|                                                                   |  | Parent                                |         | Guarantors |  | Non-Guarantors |         | Eliminations |  | Consolidated
|                                                                   |  |                                       |         |            |  |                |         |              |  |             
|Net cash provided by (used in) continuing
    operating activities |  | $                                     | (34,418 | )          |  | $              | 45,705  |              |  | $            | 20,933  |   |  | $ | (25,080 | ) |  | $ | 7,140   |  
|Net cash provided by discontinued activities                       |  |                                       |        |            |  |                | 1,625   |              |  |              | 2,346   |   |  |   |        |   |  |   | 3,971   |  
|                                                                   |  |                                       |         |            |  |                |         |              |  |              |         |   |  |   |         |   |  |   |         |  
|Net cash provided by (used in) operating
    activities            |  |                                       | (34,418 | )          |  |                | 47,330  |              |  |              | 23,279  |   |  |   | (25,080 | ) |  |   | 11,111  |  
|Proceeds from sales of businesses and equipment                    |  |                                       |        |            |  |                | 45,245  |              |  |              |        |   |  |   |        |   |  |   | 45,245  |  
|Equity 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   |   |  |   | 30,469  |  
|Debt payments  long term                                          |  |                                       | (87,102 | )          |  |                |        |              |  |              |        |   |  |   |        |   |  |   | (87,102 | )
|Debt proceeds  long term                                          |  |                                       | 35,000  |            |  |                |        |              |  |              |        |   |  |   |        |   |  |   | 35,000  |  
|Debt proceeds (payments)  short term,
    net                     |  |                                       |        |            |  |                |        |              |  |              |        |   |  |   |        |   |  |   |        |  
|Common 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   |   |  |   |        |   |  |   | 23,879  |  
|                                                                   |  |                                       |         |            |  |                |         |              |  |              |         |   |  |   |         |   |  |   |         |  
|Cash and cash equivalents at end of period                         |  | $                                     | 866     |            |  | $              | 5,627   |              |  | $            | 4,734   |   |  | $ |        |   |  | $ | 11,227  |  
|                                                                   |  |                                       |         |            |  |                |         |              |  |              |         |   |  |   |         |   |  |   |         |  

60



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##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                                           |  |                              |         |            |  |                |         |              |  |              |        |   |  |   |         |   |  |   |         |  
|---------------------------------------------------------- |  | ---------------------------- | ------- | ---------- |  | -------------- | ------- | ------------ |  | ------------ | ------ | - |  | - | ------- | - |  | - | ------- | -
|                                                           |  |                             
|                                                           |  | Year Ended December 31, 2002
|                                                           |  |                             
|                                                           |  | Parent                       |         | Guarantors |  | Non-Guarantors |         | Eliminations |  | Consolidated
|                                                           |  |                              |         |            |  |                |         |              |  |             
|Net cash provided by continuing operating
    activities   |  | $                            | (30,495 | )          |  | $              | 56,719  |              |  | $            | 8,788  |   |  | $ | (12,280 | ) |  | $ | 22,732  |  
|Net cash provided by discontinued operating
    activities |  |                              |        |            |  |                | 8,026   |              |  |              | (1,079 | ) |  |   |        |   |  |   | 6,947   |  
|                                                           |  |                              |         |            |  |                |         |              |  |              |        |   |  |   |         |   |  |   |         |  
|Net cash provided by operating activities                  |  |                              | (30,495 | )          |  |                | 64,745  |              |  |              | 7,709  |   |  |   | (12,280 | ) |  |   | 29,679  |  
|Proceeds from sales of property                            |  |                              |        |            |  |                |        |              |  |              | 3,560  |   |  |   |        |   |  |   | 3,560   |  
|Equity contributions into subsidiaries                     |  |                              |        |            |  |                | (2,690  | )            |  |              |       |   |  |   | 2,690   |   |  |   |        |  
|Purchases of property, plant and equipment, net            |  |                              |        |            |  |                | (4,345  | )            |  |              | (4,082 | ) |  |   |        |   |  |   | (8,427  | )
|                                                           |  |                              |         |            |  |                |         |              |  |              |        |   |  |   |         |   |  |   |         |  
|Net cash 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     |   |  |   |        |   |  |   | 10,055  |  
|Debt 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    |   |  |   |        |   |  |   | 600     |  
|                                                           |  |                              |         |            |  |                |         |              |  |              |        |   |  |   |         |   |  |   |         |  
|Net change in cash and cash equivalents                    |  |                              | 9,609   |            |  |                | 7,338   |              |  |              | 4,902  |   |  |   |        |   |  |   | 21,849  |  
|                                                           |  |                              |         |            |  |                |         |              |  |              |        |   |  |   |         |   |  |   |         |  
|Cash and cash equivalents at beginning of period           |  |                              | 5       |            |  |                | 240     |              |  |              | 1,785  |   |  |   |        |   |  |   | 2,030   |  
|                                                           |  |                              |         |            |  |                |         |              |  |              |        |   |  |   |         |   |  |   |         |  
|Cash and cash equivalents at end of period                 |  | $                            | 9,614   |            |  | $              | 7,578   |              |  | $            | 6,687  |   |  | $ |        |   |  | $ | 23,879  |  
|                                                           |  |                              |         |            |  |                |         |              |  |              |        |   |  |   |         |   |  |   |         |  

61



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##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                                           |  |                              |         |            |  |                |         |              |  |              |         |   |  |   |         |   |  |   |         |  
|---------------------------------------------------------- |  | ---------------------------- | ------- | ---------- |  | -------------- | ------- | ------------ |  | ------------ | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                           |  |                             
|                                                           |  | Year Ended December 31, 2001
|                                                           |  |                             
|                                                           |  | Parent                       |         | Guarantors |  | Non-Guarantors |         | Eliminations |  | Consolidated
|                                                           |  |                              |         |            |  |                |         |              |  |             
|Net cash provided by continuing operating
    activities   |  | $                            | (35,113 | )          |  | $              | 60,117  |              |  | $            | 1,366   |   |  | $ | (29,856 | ) |  | $ | (3,486  | )
|Net cash provided by discontinued operating
    activities |  |                              |        |            |  |                | 8,739   |              |  |              | 4,563   |   |  |   |        |   |  |   | 13,302  |  
|                                                           |  |                              |         |            |  |                |         |              |  |              |         |   |  |   |         |   |  |   |         |  
|Net cash provided by operating activities                  |  |                              | (35,113 | )          |  |                | 68,856  |              |  |              | 5,929   |   |  |   | (29,856 | ) |  |   | 9,816   |  
|Proceeds from sales of property                            |  |                              |        |            |  |                | 182     |              |  |              | 3,480   |   |  |   |        |   |  |   | 3,662   |  
|Equity contributions into subsidiaries                     |  |                              |        |            |  |                | (8,002  | )            |  |              |        |   |  |   | 8,002   |   |  |   |        |  
|Purchases of property, plant and equipment, net            |  |                              |        |            |  |                | (13,674 | )            |  |              | (7,602  | ) |  |   |        |   |  |   | (21,276 | )
|                                                           |  |                              |         |            |  |                |         |              |  |              |         |   |  |   |         |   |  |   |         |  
|Net cash used in investing activities                      |  |                              |        |            |  |                | (21,494 | )            |  |              | (4,122  | ) |  |   | 8,002   |   |  |   | (17,614 | )
|Debt payments  long term                                  |  |                              | (9,375  | )          |  |                |        |              |  |              |        |   |  |   |        |   |  |   | (9,375  | )
|Debt proceeds  long term                                  |  |                              | 2,000   |            |  |                |        |              |  |              | 2,034   |   |  |   |        |   |  |   | 4,034   |  
|Common stock transactions                                  |  |                              | (175    | )          |  |                |        |              |  |              |        |   |  |   |        |   |  |   | (175    | )
|Intercompany loans                                         |  |                              | 36,228  |            |  |                | (35,588 | )            |  |              | (640    | ) |  |   |        |   |  |   |        |  
|Costs associated with debt                                 |  |                              | (636    | )          |  |                |        |              |  |              |        |   |  |   |        |   |  |   | (636    | )
|Intercompany dividends                                     |  |                              |        |            |  |                | (14,928 | )            |  |              | (14,928 | ) |  |   | 29,856  |   |  |   |        |  
|Equity contributions into subsidiaries                     |  |                              |        |            |  |                |        |              |  |              | 8,002   |   |  |   | (8,002  | ) |  |   |        |  
|                                                           |  |                              |         |            |  |                |         |              |  |              |         |   |  |   |         |   |  |   |         |  
|Net cash provided by (used in) financing
    activities    |  |                              | 28,042  |            |  |                | (50,516 | )            |  |              | (5,532  | ) |  |   | 21,854  |   |  |   | (6,152  | )
|Effect of exchange rate changes on cash                    |  |                              |        |            |  |                |        |              |  |              | (312    | ) |  |   |        |   |  |   | (312    | )
|                                                           |  |                              |         |            |  |                |         |              |  |              |         |   |  |   |         |   |  |   |         |  
|Net change in cash and cash equivalents                    |  |                              | (7,071  | )          |  |                | (3,154  | )            |  |              | (4,037  | ) |  |   |        |   |  |   | (14,262 | )
|                                                           |  |                              |         |            |  |                |         |              |  |              |         |   |  |   |         |   |  |   |         |  
|Cash and cash equivalents at beginning of period           |  |                              | 7,076   |            |  |                | 3,394   |              |  |              | 5,822   |   |  |   |        |   |  |   | 16,292  |  
|                                                           |  |                              |         |            |  |                |         |              |  |              |         |   |  |   |         |   |  |   |         |  
|Cash and cash equivalents at end of period                 |  | $                            | 5       |            |  | $              | 240     |              |  | $            | 1,785   |   |  | $ |        |   |  | $ | 2,030   |  
|                                                           |  |                              |         |            |  |                |         |              |  |              |         |   |  |   |         |   |  |   |         |  

62



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##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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:

|           |  |   |       | 
|---------- |  | - | ----- | 
|2004       |  | $ | 523   | 
|2005       |  |   | 501   | 
|2006       |  |   | 300   | 
|2007       |  |   | 322   | 
|2008       |  |   | 320   | 
|Thereafter |  |   | 2,391 | 
|           |  |   |       | 
|           |  | $ | 4,357 | 
|           |  |   |       | 

Rent expense was $866, $1,179 and $1,823 for the
years ended December 31, 2003, 2002, and 2001, 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.

63



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##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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, 2003 and
2002 as well as a statement of the funded status and balance
sheet reporting for these plans as of December 31, 2003 and
2002:

|                                          |                                                              |           |   |               |   |      |   |         |   |  |   |        |   |  |   |        |  
|----------------------------------------- | ------------------------------------------------------------ | --------- | - | ------------- | - | ---- | - | ------- | - |  | - | ------ | - |  | - | ------ | -
|                                          |                                                              |           |   |              
|                                          |                                                              | U.S. Plan |   | Foreign Plans
|                                          |                                                              |           |   |              
|                                          |                                                              | 2003      |   | 2002          |   | 2003 |   | 2002   
|                                          |                                                              |           |   |               |   |      |   |        
|Change in benefit obligation:             |                                                              |           |   |               |   |      |   |         |   |  |   |        |   |  |   |       
|                                          | Benefit obligation at beginning of year                      |           | $ | 65,223        |   |      | $ | 56,935  |   |  | $ | 11,870 |   |  | $ | 10,069 |  
|                                          | Service cost                                                 |           |   | 1,618         |   |      |   | 1,738   |   |  |   | 197    |   |  |   | 188    |  
|                                          | Interest cost                                                |           |   | 3,830         |   |      |   | 4,052   |   |  |   | 615    |   |  |   | 579    |  
|                                          | Plan participants contributions                              |           |   |              |   |      |   |        |   |  |   | 42     |   |  |   | 36     |  
|                                          | Plan amendment                                               |           |   |              |   |      |   | (103    | ) |  |   |       |   |  |   |       |  
|                                          | Curtailment(1)                                               |           |   | (3,641        | ) |      |   |        |   |  |   |       |   |  |   |       |  
|                                          | Actuarial loss (gain)                                        |           |   | 1,398         |   |      |   | 5,225   |   |  |   | 825    |   |  |   | 1,534  |  
|                                          | Foreign currency exchange rate change                        |           |   |              |   |      |   |        |   |  |   | 30     |   |  |   | 20     |  
|                                          | Benefits paid                                                |           |   | (3,118        | ) |      |   | (2,624  | ) |  |   | (437   | ) |  |   | (556   | )
|                                          |                                                              |           |   |               |   |      |   |         |   |  |   |        |   |  |   |       
|                                          | Benefit obligation at end of year                            |           | $ | 65,310        |   |      | $ | 65,223  |   |  | $ | 13,142 |   |  | $ | 11,870 |  
|                                          |                                                              |           |   |               |   |      |   |         |   |  |   |        |   |  |   |       
|Change in plan assets:                    |                                                              |           |   |               |   |      |   |         |   |  |   |        |   |  |   |       
|                                          | Fair value of plan assets at beginning of year               |           | $ | 44,160        |   |      | $ | 53,176  |   |  | $ | 7,774  |   |  | $ | 9,473  |  
|                                          | Adjustment to fair asset value disclosed                     |           |   |              |   |      |   | (4      | ) |  |   | 10     |   |  |   |       |  
|                                          | Actual return on plan assets                                 |           |   | 8,715         |   |      |   | (6,388  | ) |  |   | 1,427  |   |  |   | (1,461 | )
|                                          | Employer contributions                                       |           |   |              |   |      |   |        |   |  |   | 351    |   |  |   | 272    |  
|                                          | Plan participants contributions                              |           |   |              |   |      |   |        |   |  |   | 42     |   |  |   | 36     |  
|                                          | Foreign currency exchange rate change                        |           |   |              |   |      |   |        |   |  |   | 16     |   |  |   | 10     |  
|                                          | Benefits paid                                                |           |   | (3,118        | ) |      |   | (2,624  | ) |  |   | (437   | ) |  |   | (556   | )
|                                          |                                                              |           |   |               |   |      |   |         |   |  |   |        |   |  |   |       
|                                          | Fair value of plan assets at end of year                     |           | $ | 49,757        |   |      | $ | 44,160  |   |  | $ | 9,184  |   |  | $ | 7,774  |  
|                                          |                                                              |           |   |               |   |      |   |         |   |  |   |        |   |  |   |       
|Funded status                             |                                                              |           |   |               |   |      |   |         |   |  |   |        |   |  |   |       
|                                          | Funded status                                                |           | $ | (15,553       | ) |      | $ | (21,063 | ) |  | $ | (3,958 | ) |  | $ | (4,096 | )
|                                          | Unrecognized actuarial (gain) loss                           |           |   | 6,542         |   |      |   | 13,069  |   |  |   | 5,958  |   |  |   | 6,310  |  
|                                          | Unrecognized transition asset                                |           |   |              |   |      |   |        |   |  |   | 92     |   |  |   | 100    |  
|                                          | Unrecognized prior service cost                              |           |   | 275           |   |      |   | 505     |   |  |   |       |   |  |   |       |  
|                                          |                                                              |           |   |               |   |      |   |         |   |  |   |        |   |  |   |       
|                                          | Accrued pension cost before additional minimum
    liability |           |   | (8,736        | ) |      |   | (7,489  | ) |  |   | 2,092  |   |  |   | 2,315  |  
|                                          | Additional minimum liability                                 |           |   | (950          | ) |      |   | (2,387  | ) |  |   | (5,806 | ) |  |   | (6,366 | )
|                                          |                                                              |           |   |               |   |      |   |         |   |  |   |        |   |  |   |       
|                                          | Accrued pension cost after additional minimum
    liability  |           | $ | (9,686        | ) |      | $ | (9,876  | ) |  | $ | (3,714 | ) |  | $ | (4,051 | )
|                                          |                                                              |           |   |               |   |      |   |         |   |  |   |        |   |  |   |       
|Amounts recognized in the balance sheets: |                                                              |           |   |               |   |      |   |         |   |  |   |        |   |  |   |       
|                                          | Prepaid benefit cost                                         |           | $ |              |   |      | $ |        |   |  | $ |       |   |  | $ |       |  
|                                          | Accrued benefit cost                                         |           |   | (9,686        | ) |      |   | (9,876  | ) |  |   | (3,714 | ) |  |   | (4,051 | )
|                                          | Intangible assets                                            |           |   | 275           |   |      |   | 505     |   |  |   |       |   |  |   |       |  
|                                          | Accumulated other comprehensive income                       |           |   | 675           |   |      |   | 1,883   |   |  |   | 5,806  |   |  |   | 6,366  |  
|                                          |                                                              |           |   |               |   |      |   |         |   |  |   |        |   |  |   |       
|                                          | Net amount recognized                                        |           | $ | (8,736        | ) |      | $ | (7,488  | ) |  | $ | 2,092  |   |  | $ | 2,315  |  
|                                          |                                                              |           |   |               |   |      |   |         |   |  |   |        |   |  |   |       



---



|    |                                                                           
|--- | --------------------------------------------------------------------------
|(1) | Curtailment relates to the sale of the
    Synchro-Start business in 2003.

64



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##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The funded status of the Companys defined
benefit pension plans at December 31, 2003, 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 $6.5 million in the Consolidated Balance
Sheet at December 31, 2003. 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, 2003
and 2002 was:

|                               |  |           |        |               |  |      |        |      |  |   |        |  |  |   |        | 
|------------------------------ |  | --------- | ------ | ------------- |  | ---- | ------ | ---- |  | - | ------ |  |  | - | ------ | 
|                               |  |           |        |              
|                               |  | U.S. Plan |        | Foreign Plans
|                               |  |           |        |              
|                               |  | 2003      |        | 2002          |  | 2003 |        | 2002
|                               |  |           |        |               |  |      |        |     
|Projected benefit obligation   |  | $         | 65,310 |               |  | $    | 65,223 |      |  | $ | 13,142 |  |  | $ | 11,870 | 
|Accumulated benefit obligation |  |           | 59,443 |               |  |      | 54,036 |      |  |   | 12,899 |  |  |   | 11,825 | 
|Fair value of plan assets      |  |           | 49,757 |               |  |      | 44,160 |      |  |   | 9,184  |  |  |   | 7,774  | 

The following table provides the components of
net periodic benefit costs for the plans for the years ended
December 31, 2003, 2002 and 2001:

|                                         |                                       |           |   |               |   |      |   |        |   |      |   |        |   |  |   |      |   |  |   |      |   |  |   |      |  
|---------------------------------------- | ------------------------------------- | --------- | - | ------------- | - | ---- | - | ------ | - | ---- | - | ------ | - |  | - | ---- | - |  | - | ---- | - |  | - | ---- | -
|                                         |                                       |           |   |              
|                                         |                                       | U.S. Plan |   | Foreign Plans
|                                         |                                       |           |   |              
|                                         |                                       | 2003      |   | 2002          |   | 2001 |   | 2003   |   | 2002 |   | 2001  
|                                         |                                       |           |   |               |   |      |   |        |   |      |   |       
|Components of net periodic benefit cost: |                                       |           |   |               |   |      |   |        |   |      |   |        |   |  |   |      |   |  |   |      |   |  |   |     
|                                         | Service cost                          |           | $ | 1,618         |   |      | $ | 1,738  |   |      | $ | 1,774  |   |  | $ | 239  |   |  | $ | 224  |   |  | $ | 255  |  
|                                         | Interest cost                         |           |   | 3,830         |   |      |   | 4,052  |   |      |   | 3,828  |   |  |   | 615  |   |  |   | 579  |   |  |   | 608  |  
|                                         | Expected return on plan assets        |           |   | (4,431        | ) |      |   | (4,729 | ) |      |   | (4,668 | ) |  |   | (582 | ) |  |   | (726 | ) |  |   | (853 | )
|                                         | Amortization of prior service cost    |           |   | 92            |   |      |   | 111    |   |      |   | 229    |   |  |   |     |   |  |   |     |   |  |   |     |  
|                                         | Amortization of transitional asset    |           |   |              |   |      |   |       |   |      |   |       |   |  |   | 10   |   |  |   | 3    |   |  |   | (21  | )
|                                         | Recognized actuarial (gain) or loss   |           |   |              |   |      |   | (312   | ) |      |   | (491   | ) |  |   | 326  |   |  |   | 121  |   |  |   | 21   |  
|                                         | Expected contributions from employees |           |   |              |   |      |   |       |   |      |   |       |   |  |   | (42  | ) |  |   | (36  | ) |  |   | (45  | )
|                                         |                                       |           |   |               |   |      |   |        |   |      |   |        |   |  |   |      |   |  |   |      |   |  |   |     
|                                         | Net periodic benefit cost             |           | $ | 1,109         |   |      | $ | 860    |   |      | $ | 672    |   |  | $ | 566  |   |  | $ | 165  |   |  | $ | (35  | )
|                                         |                                       |           |   |               |   |      |   |        |   |      |   |        |   |  |   |      |   |  |   |      |   |  |   |     
|                                         | FAS 88 curtailment cost               |           |   | 138           |   |      |   |       |   |      |   |       |   |  |   |     |   |  |   |     |   |  |   |     |  
|                                         |                                       |           |   |               |   |      |   |        |   |      |   |        |   |  |   |      |   |  |   |      |   |  |   |     
|                                         | Total expense                         |           | $ | 1,247         |   |      | $ | 860    |   |      | $ | 672    |   |  | $ | 566  |   |  | $ | 165  |   |  | $ | (35  | )
|                                         |                                       |           |   |               |   |      |   |        |   |      |   |        |   |  |   |      |   |  |   |      |   |  |   |     

The following table presents the assumptions used
in determining benefit obligations as of December 31, 2003,
2002 and 2001 and the net periodic costs amounts for the years
ended December 31, 2003, 2002 and 2001:

|                                                                     |                                |           |  |               |  |      |  |       |  |      |  |       |  |  |  |       |  |  |  |       |  |  |  |       | 
|-------------------------------------------------------------------- | ------------------------------ | --------- |  | ------------- |  | ---- |  | ----- |  | ---- |  | ----- |  |  |  | ----- |  |  |  | ----- |  |  |  | ----- | 
|                                                                     |                                |           |  |              
|                                                                     |                                | U.S. Plan |  | Foreign Plans
|                                                                     |                                |           |  |              
|                                                                     |                                | 2003      |  | 2002          |  | 2001 |  | 2003  |  | 2002 |  | 2001 
|                                                                     |                                |           |  |               |  |      |  |       |  |      |  |      
|Weighted-average assumption for benefit
    obligations at year end: |                                |           |  |               |  |      |  |       |  |      |  |       |  |  |  |       |  |  |  |       |  |  |  |      
|                                                                     | Discount rate                  |           |  | 6.00%         |  |      |  | 6.60% |  |      |  | 7.25% |  |  |  | 5.27% |  |  |  | 5.32% |  |  |  | 5.89% | 
|                                                                     | Rate of compensation increase  |           |  | 4.90%         |  |      |  | 4.90% |  |      |  | 5.20% |  |  |  | 4.17% |  |  |  | 3.72% |  |  |  | 4.00% | 
|Weighted-average assumption for net periodic cost
    for the year:  |                                |           |  |               |  |      |  |       |  |      |  |       |  |  |  |       |  |  |  |       |  |  |  |      
|                                                                     | Discount rate                  |           |  | 6.60%         |  |      |  | 7.25% |  |      |  | 7.50% |  |  |  | 5.32% |  |  |  | 5.89% |  |  |  | 6.00% | 
|                                                                     | Expected return on plan assets |           |  | 8.00%         |  |      |  | 8.00% |  |      |  | 8.00% |  |  |  | 7.51% |  |  |  | 7.55% |  |  |  | 7.79% | 
|                                                                     | Rate of compensation increase  |           |  | 4.90%         |  |      |  | 5.20% |  |      |  | 6.00% |  |  |  | 3.72% |  |  |  | 4.00% |  |  |  | 4.45% | 

65



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##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table reflects the U.S. pension
plans actual asset allocation as of December 31, 2003
and 2002, and target allocation as of December 31, 2003:

|                  |  |        |     |        |  |        |     |   |  |  |     |  
|----------------- |  | ------ | --- | ------ |  | ------ | --- | - |  |  | --- | -
|                  |  |        |     | Actual |  | Actual
|Asset category    |  | Target |     | 2003   |  | 2002  
|                  |  |        |     |        |  |       
|Equity securities |  |        | 70  | %      |  |        | 72  | % |  |  | 66  | %
|Debt securities   |  |        | 30  | %      |  |        | 28  | % |  |  | 34  | %
|Real estate       |  |        | 0   | %      |  |        | 0   | % |  |  | 0   | %
|Other             |  |        | 0   | %      |  |        | 0   | % |  |  | 0   | %
|                  |  |        |     |        |  |        |     |   |  |  |     |  
|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 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 2003, 2002 and 2001 were $470,
$482 and $568, respectively.

9.     Stock
Options

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 options
that had been granted and were outstanding were 263,058 and
337,689 as of December 31, 2003 and 2002 respectively.
During 2003, 87,631 options were cancelled and 13,000 options
were granted. 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.

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.

66



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##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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:

|     |                                  |                |   |             |  |       |   |        |   |  |   |         |    
|---- | -------------------------------- | -------------- | - | ----------- |  | ----- | - | ------ | - |  | - | ------- | ---
|     |                                  |                |   | Ruf         |  |      
|     |                                  | Microacoustics |   | Electronics |  | Total
|     |                                  |                |   |             |  |      
|2003 |                                  |                |   |             |  |       |   |        |   |  |   |        
|     | Revenues from external customers |                | $ | 154,042     |  |       | $ |       |   |  | $ | 154,042 |    
|     | Operating income (loss)          |                |   | 36,959      |  |       |   |       |   |  |   | 36,959  | (1)
|2002 |                                  |                |   |             |  |       |   |        |   |  |   |        
|     | Revenues from external customers |                | $ | 149,936     |  |       | $ | 14,183 |   |  | $ | 164,119 |    
|     | Operating income (loss)          |                |   | 32,631      |  |       |   | (1,310 | ) |  |   | 31,321  |    
|2001 |                                  |                |   |             |  |       |   |        |   |  |   |        
|     | Revenues from external customers |                | $ | 155,117     |  |       | $ | 17,999 |   |  | $ | 173,116 |    
|     | Operating income (loss)          |                |   | 37,450      |  |       |   | (2,125 | ) |  |   | 35,325  |    



---



|    |                                                                                                                           
|--- | --------------------------------------------------------------------------------------------------------------------------
|(1) | A reconciliation of segment operating income
    (loss) and assets to the Companys consolidated totals
    follows below.

The total assets of the microacoustics operating
segment as of December 31, 2003, 2002 and 2001 were
$112,573, $117,349 and $128,827, respectively. Depreciation
expense associated with these assets was $7,443, $8,236 and
$9,938 for the years ended December 31, 2003, 2002, and
2001, respectively. Total capital expenditures for the
microacoustic operating segment were $14,776, $6,734 and $18,563
for the years ended December 31, 2003, 2002, and 2001,
respectively.

The total assets of the Ruf Electronics business
unit were $0, $0 and $18,303 as of December 31, 2003, 2002,
and 2001, respectively. Depreciation expense associated with
these assets was $0, $467 and $1,755 for the years ended
December 31, 2003, 2002, and 2001, respectively. The assets
of the Ruf Electronics were sold in November 2002. The total
capital expenditures for the Ruf Electronics business unit were
$0, $1,693 and $2,713 for the years ended December 31,
2003, 2002, and 2001.

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.

In 2001, the Company continued with restructuring
of its worldwide manufacturing operations announced in 2000 and
recorded restructuring expenses of ($179), which affected the
operating segments as follows: microacoustics ($968) and Ruf
Electronics $789. The charge for microacoustics includes a gain
on the sale of UK facility of $3,046.

67



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##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following is a reconciliation of segment
operating income and assets to the Companys consolidated
totals:

|                                     |                                                                  |                         |         |         |   |      |         |         |   |   |         |         |  
|------------------------------------ | ---------------------------------------------------------------- | ----------------------- | ------- | ------- | - | ---- | ------- | ------- | - | - | ------- | ------- | -
|                                     |                                                                  |                        
|                                     |                                                                  | Year Ended December 31,
|                                     |                                                                  |                        
|                                     |                                                                  | 2003                    |         | 2002    |   | 2001
|                                     |                                                                  |                         |         |         |   |     
|Profit or Loss                       |                                                                  |                         |         |         |   |      |         |         |   |   |         |        
|                                     | Total operating income for reportable segments                   |                         | $       | 36,959  |   |      | $       | 31,321  |   |   | $       | 35,325  |  
|                                     | Loss on sale of business                                         |                         |         |        |   |      |         | (16,736 | ) |   |         |        |  
|                                     |                                                                  |                         |         |         |   |      |         |         |   |   |         |        
|                                     | Total consolidated operating income                              |                         |         | 36,959  |   |      |         | 14,585  |   |   |         | 35,325  |  
|                                     | Other expense                                                    |                         |         | (35,724 | ) |      |         | (33,762 | ) |   |         | (37,527 | )
|                                     |                                                                  |                         |         |         |   |      |         |         |   |   |         |        
|                                     | Income (loss) from continuing operations before
    income taxes |                         | $       | 1,235   |   |      | $       | (19,177 | ) |   | $       | (2,202  | )
|                                     |                                                                  |                         |         |         |   |      |         |         |   |   |         |        
|Assets                               |                                                                  |                         |         |         |   |      |         |         |   |   |         |        
|                                     | Microacoustic                                                    |                         | $       | 112,573 |   |      | $       | 117,349 |   |   |         |         |  
|                                     | Discontinued                                                     |                         |         |        |   |      |         | 33,490  |   |   |         |         |  
|                                     |                                                                  |                         |         |         |   |      |         |         |   |   |         |        
|                                     | Total consolidated assets                                        |                         | $       | 112,573 |   |      | $       | 150,839 |   |   |         |         |  
|                                     |                                                                  |                         |         |         |   |      |         |         |   |   |         |        
|Geographic Information               |                                                                  |                         |         |         |   |      |         |         |   |   |         |        
|Revenues (based invoicing location): |                                                                  |                         |         |         |   |      |         |         |   |   |         |        
|                                     | United States                                                    |                         | $       | 88,022  |   |      | $       | 81,551  |   |   | $       | 107,160 |  
|                                     | Germany                                                          |                         |         |        |   |      |         | 14,183  |   |   |         | 17,999  |  
|                                     | United Kingdom                                                   |                         |         | 50,293  |   |      |         | 52,661  |   |   |         | 36,679  |  
|                                     | Other geographic areas                                           |                         |         | 15,727  |   |      |         | 15,724  |   |   |         | 11,278  |  
|                                     |                                                                  |                         |         |         |   |      |         |         |   |   |         |        
|                                     |                                                                  | $                       | 154,042 |         |   | $    | 164,119 |         |   | $ | 173,116 |        
|                                     |                                                                  |                         |         |         |   |      |         |         |   |   |         |        
|Long Lived Assets                    |                                                                  |                         |         |         |   |      |         |         |   |   |         |        
|                                     | United States                                                    |                         | $       | 28,578  |   |      | $       | 20,334  |   |   |         |         |  
|                                     | Malaysia                                                         |                         |         | 11,489  |   |      |         | 10,650  |   |   |         |         |  
|                                     | China                                                            |                         |         | 6,591   |   |      |         | 6,732   |   |   |         |         |  
|                                     | Taiwan                                                           |                         |         | 1,528   |   |      |         | 1,650   |   |   |         |         |  
|                                     | Other geographic areas                                           |                         |         | 468     |   |      |         | 585     |   |   |         |         |  
|                                     |                                                                  |                         |         |         |   |      |         |         |   |   |         |        
|                                     |                                                                  | $                       | 48,654  |         |   | $    | 39,951  |         |   |   |         |        
|                                     |                                                                  |                         |         |         |   |      |         |         |   |   |         |        



| |                
| | ---------------
| | 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 80%, 81% and 81%, of
consolidated sales in 2003, 2002, and 2001 respectively.
Revenues from one customer accounted for approximately 24%, 20%
and 18% of consolidated revenues in those same years and 19% and
21% of consolidated accounts receivable at December 31,
2003 and 2002 respectively.

68



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##### Table of Contents



KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

11.     Restructuring
Expenses



| |                                              
| | ---------------------------------------------
| | November 2003 Elgin, Illinois
    Restructure

The Company announced the closure of its Elgin,
Illinois facility in November of 2003, which it expects to
complete in September of 2004. Operations will be shifted to
facilities in China, Malaysia and Itasca, Illinois, with 74
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.



| |                                     
| | ------------------------------------
| | March 2000 Worldwide
    Restructure

The Company announced a major restructuring in
March 2000 under which the Company consolidated its worldwide
manufacturing operations by ending production at five
manufacturing facilities and either outsourced component
production or moved final assembly to lower cost locations in
Malaysia, China and Hungary. The following table presents the
restructure costs and payments related to the March 2000
Restructure for 2003, 2002, 2001 and 2000.

|              |                                                           |             |   |             |   |  |   |        |  
|------------- | --------------------------------------------------------- | ----------- | - | ----------- | - |  | - | ------ | -
|              |                                                           |             |   | Accrued    
|              |                                                           | Restructure |   | Restructure
|              |                                                           | Expense     |   | Liability  
|              |                                                           |             |   |            
|2000 Activity |                                                           |             |   |             |   |  |   |       
|              | Employee severance and outplacement                       |             | $ | 18,079      |   |  | $ | 18,079 |  
|              | Pension curtailment                                       |             |   | (3,221      | ) |  |   |       |  
|              | Employee severance and outplacement payments              |             |   |            |   |  |   | (6,805 | )
|              |                                                           |             |   |             |   |  |   |       
|              | Balance December 31, 2000                                 |             | $ | 14,858      |   |  |   | 11,274 |  
|              |                                                           |             |   |             |   |  |   |       
|2001 Activity |                                                           |             |   |             |   |  |   |       
|              | Employee severance and outplacement                       |             |   | 1,363       |   |  |   | 1,363  |  
|              | Employee outplacement costs                               |             |   | 645         |   |  |   |       |  
|              | Gain on sale of United Kingdom facility                   |             |   | (3,046      | ) |  |   |       |  
|              | Facility closure costs and loss an disposal of
    assets |             |   | 199         |   |  |   |       |  
|              | Inventory write-off                                       |             |   | 660         |   |  |   |       |  
|              | Employee severance and outplacement payments              |             |   |            |   |  |   | (8,544 | )
|              | Foreign currency translation                              |             |   |            |   |  |   | (349   | )
|              |                                                           |             |   |             |   |  |   |       
|              | Balance December 31, 2001                                 |             | $ | (179        | ) |  |   | 3,744  |  
|              |                                                           |             |   |             |   |  |   |       
|2002 Activity |                                                           |             |   |             |   |  |   |       
|              | Employee severance and outplacement                       |             |   | 567         |   |  |   | 567    |  
|              | Inventory write-off                                       |             |   | 375         |   |  |   |       |  
|              | Loss on sale of Taiwan facility                           |             |   | 1,170       |   |  |   |       |  
|              | Employee severance and outplacement payments              |             |   |            |   |  |   | (3,109 | )
|              | Foreign currency translation                              |             |   |            |   |  |   | (5     | )
|              |                                                           |             |   |             |   |  |   |       
|              | Balance December 31, 2002                                 |             | $ | 2,112       |   |  |   | 1,197  |  
|              |                                                           |             |   |             |   |  |   |       

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KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|              |                                              |             |    |             |  |   |    |        |  
|------------- | -------------------------------------------- | ----------- | -- | ----------- |  | - | -- | ------ | -
|              |                                              |             |    | Accrued    
|              |                                              | Restructure |    | Restructure
|              |                                              | Expense     |    | Liability  
|              |                                              |             |    |            
|2003 Activity |                                              |             |    |             |  |   |    |       
|              | Employee severance and outplacement          |             |    | 53          |  |   |    | 53     |  
|              | Employee severance and outplacement payments |             |    |             |  |   |    | (1,239 | )
|              |                                              |             |    |             |  |   |    |       
|              |                                              | $           | 53 |             |  | $ | 11 |       
|              |                                              |             |    |             |  |   |    |       

Of the total positions that were planned to be
eliminated in the March 2000 restructuring, 678, 976, 1,072 and
1,072 had cumulatively been eliminated as of December 31,
2000, 2001, 2002 and 2003 respectively. The remaining liability
balance was paid out in January 2004.

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. 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.

The foregoing summary of the indemnities made by
the Company in connection with the sale of the Synchro-Start
business is qualified in its entirety by reference to the 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 with the Securities
and Exchange Commission June 16, 2003.

Ruwido (Infrared) Divestiture
Indemnifications.In connection with
the sale of the Ruwido business, the Company has agreed to
indemnify certain liabilities, losses or claims up to a total of
$100. The Company believes that any claim would not have a
material impact on the Companys financial position.

The foregoing summary of the indemnities made by
the Company in connection with the sale of the Ruwido business
is qualified in its entirety by reference to the 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
Exhibit 10.27, a copy of which was attached as an exhibit
to the Form 10-Q for the period ended June 30, 2003.

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.

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.

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KNOWLES ELECTRONICS
HOLDINGS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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.

Changes in the Companys accrual for
warranty during the years ended December 31, 2003 and 2002
are as follows:

|                                                         |  |      |        |      |  |   |        |  
|-------------------------------------------------------- |  | ---- | ------ | ---- |  | - | ------ | -
|                                                         |  | 2003 |        | 2002
|                                                         |  |      |        |     
|Beginning balance                                        |  | $    | 4,438  |      |  | $ | 5,375  |  
|Settlements made during the period                       |  |      | (1,321 | )    |  |   | (2,210 | )
|Provision for warranty liability on sales                |  |      | 1,601  |      |  |   | 2,301  |  
|Adjustments in estimates for pre-existing
    warranties |  |      | (2,436 | )    |  |   | (1,028 | )
|                                                         |  |      |        |      |  |   |        |  
|Ending balance                                           |  | $    | 2,282  |      |  | $ | 4,438  |  
|                                                         |  |      |        |      |  |   |        |  

Adjustments in pre-existing warranties in 2003
and 2002 were due to substantial improvements in the warranty
experience of the Company after 2001.

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.

71



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|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|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, 2003. 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, 2003, that have materially affected,
or are reasonably likely to materially affect, the
Companys internal control over financial reporting.




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 (Kenneth Terry,
Christopher Wallis and David Chalom). Set forth below is certain
information with respect to our directors and officers.

|                      |  |     |    |          |  |                                                            
|--------------------- |  | --- | -- | -------- |  | -----------------------------------------------------------
|Name                  |  | Age |    | Position
|                      |  |     |    |         
|Kenneth John Terry    |  |     | 39 |          |  | Class A Director, Chairman of the Board                    
|Christopher Wallis    |  |     | 45 |          |  | Class A Director                                           
|David Chalom          |  |     | 28 |          |  | Class A Director                                           
|James E. Knowles      |  |     | 73 |          |  | Class B Director                                           
|John J. Zei           |  |     | 59 |          |  | President and Chief Executive Officer, Class B
    Director
|James H. Moyle        |  |     | 51 |          |  | Executive Vice President and
    Chief Financial Officer   
|Louis T. Morabito     |  |     | 59 |          |  | Vice President of Operations                               
|Jeffrey S. Niew       |  |     | 37 |          |  | Vice President and General Manager of Knowles
    Acoustics
|Dennis R. Kirchhoefer |  |     | 54 |          |  | Vice President Research & Development                      
|Stephen D. Petersen   |  |     | 45 |          |  | Vice President Finance and Secretary                       

Kenneth John Terry is a principal with Doughty
Hanson & Co. Limited. Mr. Terry currently serves
on the Board of Directors of Dunlop Standard Aerospace Group
Limited, Ilford Imaging Limited, Impress Group B.V., RHM
Limited, LM Group Holdings A/ S. He is a graduate of University
of Leeds.

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.

David Chalom joined Doughty Hanson in September
1999, focusing on private equity transactions in North America.
Prior to joining Doughty Hanson, Mr. Chalom worked for two
years in the Investment

72



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##### Table of Contents



Banking department of Salomon Smith Barney in New
York and London, focusing on Leveraged Finance and High Yield
Origination. Mr. Chalom has a B.Sc. Economics degree in
Finance from the Wharton School of the University of
Pennsylvania.


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.

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 Manage, 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.

73



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| |               
| | --------------
| | 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 this Form 10-K and copies are
available upon request.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation



| |                           
| | --------------------------
| | Summary Compensation Table

The following table provides information
concerning the compensation we paid to our senior officers for
2003, 2002 and 2001:

|                            |                                       |      |      |                     |  |              |         |              |  |              |         |                 |  |   |        |     |  |   |   |   |  |   |         |         | 
|--------------------------- | ------------------------------------- | ---- | ---- | ------------------- |  | ------------ | ------- | ------------ |  | ------------ | ------- | --------------- |  | - | ------ | --- |  | - | - | - |  | - | ------- | ------- | 
|                            |                                       |      |      |                     |  | Long-Term    |         |             
|                            |                                       |      |      | Annual Compensation |  | Compensation |         |             
|                            |                                       |      |      |                     |  | Securities   |         |             
|                            |                                       |      |      |                     |  | Other Annual |         | Underlying   |  | All Other   
|Name and Principal Position |                                       | Year |      | Salary              |  | Bonus        |         | Compensation |  | Options/SARs |         | Compensation(1)
|                            |                                       |      |      |                     |  |              |         |              |  |              |         |                
|John J. Zei                 |                                       |      | 2003 |                     |  | $            | 440,884 |              |  | $            | 686,973 |                 |  | $ |       |     |  | $ |  |   |  | $ | 8,325   |        
|                            | President and Chief Executive Officer |      |      | 2002                |  |              |         | 430,533      |  |              |         | 300,000         |  |   |        |    |  |   |   |  |  |   |         | 282,480 | 
|                            |                                       |      |      | 2001                |  |              |         | 417,194      |  |              |         | 125,000         |  |   |        |    |  |   |   |  |  |   |         | 6,058   | 
|                           
|James H. Moyle              |                                       |      | 2003 |                     |  |              | 275,522 |              |  |              | 468,516 |                 |  |   |       |     |  |   |  |   |  |   | 366,480 |        
|                            | Executive Vice President &            |      |      | 2002                |  |              |         | 127,413      |  |              |         |                |  |   |        |    |  |   |   |  |  |   |         | 23,598  | 
|                            | Chief Financial Officer               |      |      | 2001                |  |              |         |             |  |              |         |                |  |   |        |    |  |   |   |  |  |   |         |        | 
|                           
|Louis T. Morabito           |                                       |      | 2003 |                     |  |              | 171,840 |              |  |              | 199,959 |                 |  |   | 11,073 | (2) |  |   |  |   |  |   | 7,477   |        
|                            | Vice President of Operations          |      |      | 2002                |  |              |         | 161,720      |  |              |         |                |  |   |        |    |  |   |   |  |  |   |         | 6,904   | 
|                            |                                       |      |      | 2001                |  |              |         | 158,850      |  |              |         | 50,000          |  |   |        |    |  |   |   |  |  |   |         | 5,830   | 
|                           
|Jeffrey S. Niew             |                                       |      | 2003 |                     |  |              | 178,391 |              |  |              | 171,128 |                 |  |   |       |     |  |   |  |   |  |   | 3,886   |        
|                            | Vice President & General Manager      |      |      | 2002                |  |              |         | 146,247      |  |              |         |                |  |   |        |    |  |   |   |  |  |   |         | 3,912   | 
|                            | Knowles Acoustics                     |      |      | 2001                |  |              |         | 125,941      |  |              |         | 10,233          |  |   |        |    |  |   |   |  |  |   |         | 4,024   | 
|                           
|Dennis R. Kirchhoefer       |                                       |      | 2003 |                     |  |              | 161,357 |              |  |              | 103,373 |                 |  |   |       |     |  |   |  |   |  |   | 5,577   |        
|                            | Vice President R&D                    |      |      | 2002                |  |              |         | 143,603      |  |              |         | 50,000          |  |   |        |    |  |   |   |  |  |   |         | 4,159   | 
|                            |                                       |      | 2001 |                     |  |              | 139,264 |              |  |              | 20,000  |                 |  |   |       |     |  |   |  |   |  |   | 4,644   |        



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                    
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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 fourth in the chart.
|   
|(2) | Short-term disability compensation.                                                                                                                                                                                                                                                                                                                                                                                

74



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|                      |                                       |      |      |         |  |               |     |           |  |             |       |       |  |   |       |       |  |   |         |        | 
|--------------------- | ------------------------------------- | ---- | ---- | ------- |  | ------------- | --- | --------- |  | ----------- | ----- | ----- |  | - | ----- | ----- |  | - | ------- | ------ | 
|                      |                                       |      |      |         |  | Knowles       |     | Life      |  | Relocation/
|                      |                                       |      |      | Special |  | 401(k) Plan   |     | Insurance |  | Moving     
|Executive             |                                       | Year |      | Bonus   |  | Contributions |     | Premiums  |  | Expenses   
|                      |                                       |      |      |         |  |               |     |           |  |            
|John J. Zei           |                                       |      | 2003 |         |  | $             |    |           |  | $           | 6,000 |       |  | $ | 2,325 |       |  | $ |        |       
|                      | President and Chief Executive Officer |      |      | 2002    |  |               |     | 275,000   |  |             |       | 5,500 |  |   |       | 1,980 |  |   |         |       | 
|                      |                                       |      |      | 2001    |  |               |     |          |  |             |       | 5,250 |  |   |       | 808   |  |   |         |       | 
|                     
|James H. Moyle        |                                       |      | 2003 |         |  |               |    |           |  |             | 4,705 |       |  |   | 1,242 |       |  |   | 360,533 | (1)   
|                      | Executive Vice President &            |      |      | 2002    |  |               |     |          |  |             |       | 612   |  |   |       | 518   |  |   |         | 22,468 | 
|                      | Chief Financial Officer               |      |      | 2001    |  |               |     |          |  |             |       |      |  |   |       |      |  |   |         |       | 
|                     
|Louis T. Morabito     |                                       |      | 2003 |         |  |               |    |           |  |             | 5,155 |       |  |   | 2,322 |       |  |   |        |       
|                      | Vice President of Operations          |      |      | 2002    |  |               |     |          |  |             |       | 4,582 |  |   |       | 2,322 |  |   |         |       | 
|                      |                                       |      |      | 2001    |  |               |     |          |  |             |       | 5,250 |  |   |       | 580   |  |   |         |       | 
|                     
|Jeffrey S. Niew       |                                       |      | 2003 |         |  |               |    |           |  |             | 3,601 |       |  |   | 285   |       |  |   |        |       
|                      | Vice President & General Manager      |      |      | 2002    |  |               |     |          |  |             |       | 3,912 |  |   |       |      |  |   |         |       | 
|                      | Knowles Acoustics                     |      |      | 2001    |  |               |     |          |  |             |       | 4,024 |  |   |       |      |  |   |         |       | 
|                     
|Dennis R. Kirchhoefer |                                       |      | 2003 |         |  |               |    |           |  |             | 5,177 |       |  |   | 400   |       |  |   |        |       
|                      | Vice President R&D                    |      |      | 2002    |  |               |     |          |  |             |       | 4,159 |  |   |       |      |  |   |         |       | 
|                      |                                       |      | 2001 |         |  |               | 550 |           |  |             | 3,968 |       |  |   | 126   |       |  |   |        |       



---



|    |                                            
|--- | -------------------------------------------
|(1) | Relocation expenses and gross-up for taxes.



| |                         
| | ------------------------
| | 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
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           |  | $ | 600,000 | 
|James H. Moyle        |  |   | 400,000 | 
|Louis T. Morabito     |  |   | 300,000 | 
|Jeffrey S. Niew       |  |   | 300,000 | 
|Dennis R. Kirchhoefer |  |   | 300,000 | 

75



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| |                                                           
| | ----------------------------------------------------------
| | Long-Term Incentive Plans 
    Awards In Last Fiscal Year

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 or     |  | Estimated future payouts under non-stock
|                      |  | shares, units or |    | other period until |  | price-based plans (in thousands)(1)     
|                      |  | other rights     |    | maturation or      |  |                                         
|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

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 Enhancement                                                                                                                                                                                              
|Liquidity Event Proceeds                           |  | Bonus Pool                                                                                                                                                                                                     
|                                                   |  |                                                                                                                                                                                                                
|Less than $212 million                             |  | None                                                                                                                                                                                                           
|Exceed $212 million but less than
    $275 million |  | $10.0 million                                                                                                                                                                                                  
|Equal $275 million                                 |  | $12.65 million                                                                                                                                                                                                 
|Exceed $275 million                                |  | $12.65 million plus 5% of the proceeds
    in 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.

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| |             
| | ------------
| | 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 Service
|             |  |                 
|Renumeration |  | 15               |        | 20 |  | 25 |        | 30 |  | 35
|             |  |                  |        |    |  |    |        |    |  |   
|$125,000     |  | $                | 34,000 |    |  | $  | 45,000 |    |  | $  | 56,000 |  |  | $ | 56,000 |  |  | $ | 56,000 | 
|150,000      |  |                  | 41,000 |    |  |    | 55,000 |    |  |    | 69,000 |  |  |   | 69,000 |  |  |   | 69,000 | 
|175,000      |  |                  | 48,000 |    |  |    | 64,000 |    |  |    | 80,000 |  |  |   | 80,000 |  |  |   | 80,000 | 
|200,000      |  |                  | 48,000 |    |  |    | 64,000 |    |  |    | 80,000 |  |  |   | 80,000 |  |  |   | 80,000 | 
|225,000      |  |                  | 48,000 |    |  |    | 64,000 |    |  |    | 80,000 |  |  |   | 80,000 |  |  |   | 80,000 | 
|250,000      |  |                  | 48,000 |    |  |    | 64,000 |    |  |    | 80,000 |  |  |   | 80,000 |  |  |   | 80,000 | 
|275,000      |  |                  | 48,000 |    |  |    | 64,000 |    |  |    | 80,000 |  |  |   | 80,000 |  |  |   | 80,000 | 
|300,000      |  |                  | 48,000 |    |  |    | 64,000 |    |  |    | 80,000 |  |  |   | 80,000 |  |  |   | 80,000 | 
|325,000      |  |                  | 48,000 |    |  |    | 64,000 |    |  |    | 80,000 |  |  |   | 80,000 |  |  |   | 80,000 | 
|350,000      |  |                  | 48,000 |    |  |    | 64,000 |    |  |    | 80,000 |  |  |   | 80,000 |  |  |   | 80,000 | 
|400,000      |  |                  | 48,000 |    |  |    | 64,000 |    |  |    | 80,000 |  |  |   | 80,000 |  |  |   | 80,000 | 
|450,000      |  |                  | 48,000 |    |  |    | 64,000 |    |  |    | 80,000 |  |  |   | 80,000 |  |  |   | 80,000 | 
|500,000      |  |                  | 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, 2003, John Zei,
James Moyle, Louis Morabito, Jeffery Niew, and Dennis
Kirchhoefer. have 3, 1, 7, 3 and 11 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, with an
annual salary of $325,000, a signing bonus of $25,000 payable on
the date Mr. Zei commenced his

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employment with Knowles, and eligibility to
participate in certain bonus plans generally available for
senior management employees. Mr. Zei succeeded
Mr. Garratt as Chief Executive Officer of Knowles on
April 1, 2000.


In connection with the commencement of his
employment, Knowles has 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 an
annual salary of $265,000 and 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.



| |                          
| | -------------------------
| | 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.

|                                        |                                  |              |         |          |  |  |      |   | 
|--------------------------------------- | -------------------------------- | ------------ | ------- | -------- |  |  | ---- | - | 
|                                        |                                  | Amount       |         |         
|                                        |                                  | Beneficially |         | Percent 
|Name and Address of Beneficial Owner(1) |                                  | Owned(2)     |         | of Class
|                                        |                                  |              |         |         
|Key Acquisition, L.L.C.                 |                                  |              | 800,000 |          |  |  | 83.6 | %
|                                        | c/o Doughty Hanson & Co. Limited |              |         |          |  |  |      |   | 
|                                        | Times Place, 45 Pall Mall,       |              |         |          |  |  |      |   | 
|                                        | London SW1Y 5JG, England         |              |         |          |  |  |      |   | 
|                                       
|Doughty Hanson & Co. Limited(3)         |                                  |              | 800,000 |          |  |  | 83.6 | %
|                                        | Times Place, 45 Pall Mall,       |              |         |          |  |  |      |   | 
|                                        | London SW1Y 5JG, England         |              |         |          |  |  |      |   | 



---



|    |                                                                                                                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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 10.4% of currently

78



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| |                                                                                                                                                                                                                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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.

SECURITY OWNERSHIP OF DIRECTORS AND
MANAGEMENT

|                                                                     |  |                |                    |              |  |          |        |  |  |  |     | 
|-------------------------------------------------------------------- |  | -------------- | ------------------ | ------------ |  | -------- | ------ |  |  |  | --- | 
|                                                                     |  |                |                    | Amount       |  |         
|                                                                     |  |                |                    | Beneficially |  | Percent 
|Name of Beneficial Owner                                             |  | Title of Class |                    | Owned        |  | of Class
|                                                                     |  |                |                    |              |  |         
|James E. Knowles                                                     |  |                | Class A Common     |              |  |          | 9,947  |  |  |  | 1.0 | 
|                                                                     |  |                | Series A Preferred |              |  |          | 2,045  |  |  |  | 0.2 | 
|Kenneth John Terry                                                   |  |                |                   |              |  |          |       |  |  |  |    | 
|Christopher Wallis                                                   |  |                |                   |              |  |          |       |  |  |  |    | 
|David Chalom                                                         |  |                |                   |              |  |          |       |  |  |  |    | 
|John J. Zei                                                          |  |                | Class A Common     |              |  |          | 16,667 |  |  |  | 1.7 | 
|James H. Moyle                                                       |  |                |                   |              |  |          |       |  |  |  |    | 
|Louis T. Morabito                                                    |  |                | Class A Common     |              |  |          | 5,000  |  |  |  | 0.5 | 
|Jeffery S. Niew                                                      |  |                | Class A Common     |              |  |          | 833    |  |  |  | 0.0 | 
|Dennis R. Kirchhoefer                                                |  |                | Class A Common     |              |  |          | 1,667  |  |  |  | 0.2 | 
|Stephen D. Petersen                                                  |  |                | Class A Common     |              |  |          | 3,333  |  |  |  | 0.3 | 
|Combined holdings of directors and executive
    officers as a group |  |                | Class A Common     |              |  |          | 67,447 |  |  |  | 7.0 | 
|                                                                     |  |                | Series 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.

|                                                                 |  |                      |         |                  |  |                      |    |   |  |  |         | 
|---------------------------------------------------------------- |  | -------------------- | ------- | ---------------- |  | -------------------- | -- | - |  |  | ------- | 
|                                                                 |  | Number of securities |         |                  |  | Number of           
|                                                                 |  | to be issued upon    |         |                  |  | securities remaining
|                                                                 |  | exercise of          |         | Weighted average |  | available for future
|                                                                 |  | outstanding options  |         | exercise price   |  | issuance            
|                                                                 |  |                      |         |                  |  |                     
|Equity compensation plans not approved by
    securities holders |  |                      | 263,058 |                  |  |                      | (a | ) |  |  | 111,942 | 
|                                                                 |  |                      |         |                  |  |                      |    |   |  |  |         | 



---



|    |                                                                                                
|--- | -----------------------------------------------------------------------------------------------
|(a) | The weighted average exercise price is based on
    an IPO transaction and is not determinable.

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##### Table of Contents








|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions



| |                                                     
| | ----------------------------------------------------
| | Distribution of the Equipment Financing
    Business

On June 29, 1999, Knowles equipment
financing business (The Financial Corporation of Illinois),
including certain parcels of real estate, were distributed to
our preexisting stockholders, in redemption of 10% of the stock
owned by those stockholders. James E. Knowles, one of our
directors, is a stockholder of, and currently serves as the
president of, The Financial Corporation of Illinois.



| |                                      
| | -------------------------------------
| | Service and Commission
    Agreements

In connection with the Recapitalization, we
entered into a Service Agreement dated June 23, 1999 (the
Service Agreement) with Doughty Hanson & Co.
Managers Limited (DHCM), a subsidiary of Doughty
Hanson & Co. Limited, pursuant to which DHCM received a fee
of $3,000,000 upon the successful completion of the
Recapitalization for financial advisory services related to the
Recapitalization. The Service Agreement made available the
resources of DHCM concerning a variety of financial and
operational matters including advice and assistance in
negotiating the purchase of shares owned by the Knowles family.

Also in connection with the Recapitalization, we
entered into a Commission Agreement dated June 23, 1999
(the Commission Agreement) with DHCM pursuant to
which DHCM received a total aggregate commission of $2,000,000
upon the successful completion of the Recapitalization for its
services in arranging the equity financing for the
Recapitalization.



| |                                                     
| | ----------------------------------------------------
| | 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 69,167 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.

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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:

|                   |  |      |       |      |  |   |       | 
|------------------ |  | ---- | ----- | ---- |  | - | ----- | 
|                   |  | 2003 |       | 2002
|                   |  |      |       |     
|Audit fees         |  | $    | 437   |      |  | $ | 601   | 
|Audit-related fees |  | $    | 307   |      |  | $ | 198   | 
|Tax fees           |  | $    | 361   |      |  | $ | 299   | 
|All other fees     |  | $    |      |      |  | $ |      | 
|                   |  |      |       |      |  |   |       | 
|                   |  | $    | 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

|   |  |                     |  |                                                                                                                                                                                                                                                                      |  |      |    | 
|-- |  | ------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|   |  |                     |  |                                                                                                                                                                                                                                                                      |  | Page
|   |  |                     |  |                                                                                                                                                                                                                                                                      |  |     
|a) |  | 1.                  |  | Financial Statements                                                                                                                                                                                                                                                |  |      |    | 
|   |  |                     |  | Consolidated balance sheets 
    December 31, 2003 and 2002                                                                                                                                                                                                         |  |      | 40 | 
|   |  |                     |  | Consolidated statements of operations for each of
    the three years in the period ended December 31, 2003                                                                                                                                                          |  |      | 41 | 
|   |  |                     |  | Consolidated statements of changes in
    stockholders equity for each of the three years in the
    period ended December 31, 2003                                                                                                                                 |  |      | 42 | 
|   |  |                     |  | Consolidated statements of cash flows for each of
    the three years in the period ended December 31, 2003                                                                                                                                                          |  |      | 43 | 
|   |  |                     |  | Notes to consolidated financial statements                                                                                                                                                                                                                           |  |      | 44 | 
|   |  | 2.                  |  | Schedules                                                                                                                                                                                                                                                            |  |      |    | 
|   |  |                     |  | The following consolidated financial schedule of
    Knowles Electronics Holdings, Inc. is included in response to
    Item 15(a.) II  Valuation and Qualifying Accounts                                                                                            |  |      | 82 | 
|   |  |                     |  | All 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 thereto. |  |      |    | 
|   |  |                     |  | Signatures                                                                                                                                                                                                                                                           |  |      | 83 | 
|   |  | 3.                  |  | Index to Exhibits                                                                                                                                                                                                                                                    |  |      | 84 | 
|b) |  | Reports on Form 8-K |  |                                                                                                                                                                                                                                                                      |  |     

There were no reports on Form 8-K filed
during the three months ended December 31, 2003

81



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##### Table of Contents



SCHEDULE II  VALUATION AND
QUALIFYING ACCOUNTS

KNOWLES ELECTRONICS HOLDINGS, INC.

|                             |                                                           |            |   |           |  |           |   |              |   |            |   |     |      |  |   |       |     |  |   |       | 
|---------------------------- | --------------------------------------------------------- | ---------- | - | --------- |  | --------- | - | ------------ | - | ---------- | - | --- | ---- |  | - | ----- | --- |  | - | ----- | 
|                             |                                                           |            |   |           |  |           |   |             
|                             |                                                           |            |   | Additions |  |           |   |             
|                             |                                                           |            |   |           |  |           |   |             
|                             |                                                           |            |   | Charge to |  | Charge to |   |              |   |           
|                             |                                                           | Balance at |   | Costs     |  | Other     |   |              |   | Balance at
|                             |                                                           | Beginning  |   | and       |  | Accounts  |   | Deductions  |   | End of    
|                             |                                                           | of Period  |   | Expenses  |  | Describe  |   | Describe     |   | Period    
|                             |                                                           |            |   |           |  |           |   |              |   |           
|Year ended December 31, 2003 |                                                           |            |   |           |  |           |   |              |   |            |   |     |      |  |   |       |     |  |   |      
|                             | Reserves and allowances deducted from asset
    accounts: |            |   |           |  |           |   |              |   |            |   |     |      |  |   |       |     |  |   |       | 
|                             | Allowance for doubtful accounts                           |            | $ | 350       |  |           | $ | 247          |   |            | $ | (6  | )(1) |  | $ | 64    | (2) |  | $ | 527   | 
|                             | Allowance for obsolete inventory                          |            |   | 5,114     |  |           |   | 1,416        |   |            |   | (9  | )(1) |  |   | 2,373 | (3) |  |   | 4,148 | 
|Year ended December 31, 2002 |                                                           |            |   |           |  |           |   |              |   |            |   |     |      |  |   |       |     |  |   |      
|                             | Reserves and allowances deducted from asset
    accounts: |            |   |           |  |           |   |              |   |            |   |     |      |  |   |       |     |  |   |       | 
|                             | Allowance for doubtful accounts                           |            |   | 647       |  |           |   | (180         | ) |            |   | (1  | )(4) |  |   | 116   | (6) |  |   | 350   | 
|                             | Allowance for obsolete inventory                          |            |   | 7,817     |  |           |   | 2,391        |   |            |   | 133 | (5)  |  |   | 5,227 | (7) |  |   | 5,114 | 
|Year ended December 31, 2001 |                                                           |            |   |           |  |           |   |              |   |            |   |     |      |  |   |       |     |  |   |      
|                             | Reserves and allowances deducted from asset
    accounts: |            |   |           |  |           |   |              |   |            |   |     |      |  |   |       |     |  |   |       | 
|                             | Allowance for doubtful accounts                           |            |   | 1,110     |  |           |   | 26           |   |            |   |     |      |  |   | 489   | (8) |  |   | 647   | 
|                             | Allowance for obsolete inventory                          |            |   | 7,099     |  |           |   | 2,663        |   |            |   |     |      |  |   | 1,945 | (9) |  |   | 7,817 | 



---



|    |                                    
|--- | -----------------------------------
|(1) | Foreign currency translation gain. 
|   
|(2) | Uncollectible accounts written off.
|   
|(3) | Disposal of obsolete inventory.    
|   
|(4) | Foreign currency translation gain. 
|   
|(5) | Foreign currency translation loss. 
|   
|(6) | Uncollectible accounts written off.
|   
|(7) | Disposal of obsolete inventory.    
|   
|(8) | Uncollectible accounts written off.
|   
|(9) | Disposal of obsolete inventory.    

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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. ZEI

| |                                          
| | -----------------------------------------
| |                                          
| | John J. Zei                              
| | President and Chief Executive
    Officer

Dated: March 25, 2004

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. ZEIJohn J. Zei                 |  | President and Chief Executive
    Officer Class B Director |  | March 25, 2004
|                                          
|/s/ JAMES H. MOYLEJames H. Moyle           |  | Vice President and
    Chief Financial Officer             |  | March 25, 2004
|                                          
|/s/ KENNETH JOHN TERRYKenneth John Terry   |  | Class A Director                                           |  | March 25, 2004
|                                          
|/s/ CHRISTOPHER WALLISChristopher Wallis   |  | Class A Director                                           |  | March 25, 2004
|                                          
|/s/ STEPHEN D. PETERSENStephen D. Petersen |  | Vice President Finance and
    Secretary                   |  | March 25, 2004

83



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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.,
    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 10.3
    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)                                                                                                                                                                                                                                                                                                                                                              

85



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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, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|10.28 |  |  |  | Knowles Electronics Holdings, Inc. Value
    Enhancement Incentive Plan dated December 12, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|12.1  |  |  |  | Calculation of Ratio of Earnings to Fixed Charges                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|14.1  |  |  |  | Code of Ethics                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

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|     |  |   |  |                                                                        
|---- |  | - |  | -----------------------------------------------------------------------
|21.1 |  |  |  | List of Subsidiaries                                                   
|31.1 |  |  |  | Rule 13a-14 and 15d-14 Certification of the Chief
    Executive Officer
|31.2 |  |  |  | Rule 13a-14 and 15d-14 Certification of the Chief
    Financial Officer

87