KNOWLES ELECTRONICS HOLDINGS INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

]FORM 10-K

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE YEAR ENDED DECEMBER 31, 2002

OR

[ ] 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 (I.R.S. Employer
incorporation or organization) Identification Number)

1151 MAPLEWOOD DRIVE, 60143
ITASCA, ILLINOIS (Zip Code)
(Address of principal executive offices)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
630-250-5100

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

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 [X] No [ ]

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. [ ]

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

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, 2002

CONTENTS

1

PART I

ITEM 1. BUSINESS

OVERVIEW

We are a leading international manufacturer of technologically advanced
products in the hearing aid and automotive components markets. We also operate
in markets for acoustics and infrared technology products. 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
and low voltage integrated circuit design, electronic controls and sensors,
infrared technology and precision manufacturing. We have operations around the
world with the largest facilities in the United States, China and Malaysia. Our
2002 revenue, operating income and EBITDA, as reported, were $216.1 million,
$21.4 million and $32.3 million, respectively. Our 2002 adjusted EBITDA
(adjusted for the $16.7 million loss on sale of our Ruf operations) was $49.0
million. EBITDA is earnings before interest income and expense, income taxes,
and depreciation and amortization. 2002 operating income of $21.4 million plus
$10.9 million of depreciation and amortization equals EBITDA as reported of
$32.3 million. Through our three core business units, KE, Emkay and Automotive
Components, we manufacture and market products with strong market share
positions in several key 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 strong management
team. Our principal executive offices are located at 1151 Maplewood Drive,
Itasca, Illinois 60143, and our telephone number is (630) 250-5100.

OUR THREE BUSINESS UNITS

KE -- HEARING AID COMPONENTS

KE, which accounted for approximately 61% of our 2002 revenue, is our most
significant business unit. The KE business unit designs, manufactures and
markets subminiature acoustic transducers and other components for hearing aids.
KE is the world's largest manufacturer of hearing aid transducers, with what we
estimate to be approximately 80% of the worldwide market, and has 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. 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. We manufacture transducers for all
hearing aid categories, and also produce non-transducer hearing aid components
under the brand name Deltek. KE often customizes transducers to meet the
specifications of our customers, and in certain cases develops transducer
designs in partnership with our customers. KE provides data on the hearing aid
market to our customers through the publication MarkeTrak, and is a leader in
transducer technology with 38 scientists, engineers and technicians dedicated to
research and development. 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.

EMKAY -- ACOUSTIC AND INFRARED TECHNOLOGY

Emkay, which accounted for approximately 17% of our 2002 revenue, was
created in 1994 to explore non-hearing aid applications for our technology.
Emkay combines KE's transducer and acoustic expertise with its core competencies
in infrared technology and electronics to provide high technology solutions for
markets with high growth potential, including mobile and automotive
communications, entertainment systems, and telephony. Mobile communication
applications include PEDs (personal electronic devices), PDAs (personal digital
assistants), mobile phones, smart phones, 3G phones, and tablets. Emkay produces
and is developing a broad range of voice input solution (including ECMs
(electret condenser microphones), silicon microphones, specialty transducers,
custom microphone assemblies), and infrared remote controls primarily for sale
to original equipment manufacturers in these markets. Emkay has significant
in-house research and development capabilities, with 34 engineers and
technicians operating worldwide.

2

AUTOMOTIVE COMPONENTS

Results for our Automotive Components business unit combine two businesses,
SSPI, which produces diesel engine solenoids and electronic governors, and Ruf,
a leading producer of automotive position sensors which was sold in November
2002. Automotive Components accounted for approximately 22% (70% from SSPI and
30% from Ruf) of our 2002 revenue. The largest percentage of SSPI's sales
consists of solenoids for key start/stop operations of diesel engines used in
trucks (in countries outside the United States and Europe), tractors, turf
equipment, construction, generators and other industrial equipment. Solenoids
are two position linear actuators that are used mainly to start and stop diesel
engines by converting electrical energy into mechanical work. Electronic
governors, which control engine speed and power by adjusting the engine
throttle, represent a small but growing percentage of SSPI's business.

Ruf, headquartered near Munich, Germany, was founded in 1926, acquired by
Knowles in 1996 and the net assets were sold in November 2002. Ruf's business is
primarily based on sales of position sensors for automotive applications,
including passenger vehicles and light trucks.

COMPETITIVE STRENGTHS

Our strong financial record is attributable to the following competitive
strengths:

LEADING INTERNATIONAL MARKET POSITION AND STRONG CUSTOMER BASE

- We have been a market leader in hearing aid transducers for more than 30
years, and our worldwide market share is approximately 80%. We protect
our leading market share by maintaining strong relationships with all of
the key manufacturers in the hearing aid industry. We offer transducers
for all hearing aid categories and often customize models to meet the
specifications of individual hearing aid manufacturers.

- We have also been the market leader in solenoids for diesel engine
shutdown devices for over 20 years, and our worldwide market share is
approximately 65%. Customers of SSPI include most major industrial diesel
engine manufacturer and mobile equipment builders.

TECHNOLOGICAL EXPERTISE

- We believe that we are a technological leader in each of our business
units. We offer an advanced transducer product line that is the most
comprehensive in the hearing aid industry, setting the standard for both
miniaturization and performance, and have been a technology leader in the
transducer market for over 30 years. We are also at the forefront of the
MEMS (micro electro mechanical systems) acoustics market as a result of
our semiconductor knowledge and our 50 years of experience in acoustics.
We believe that we are the only microphone maker that also manufactures a
MEMS based surface mount silicon microphone. With our Automotive
Components unit, we have leveraged our technological expertise to create
innovative designs of solenoids and electronic governors for our
Automotive Components customers.

- To enhance our technological expertise, we emphasize research and
development investment. Our 2002 research and development expenditures
were $13.7 million, or 6.3% 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. We
believe these factors serve as barriers to entry to the hearing aid and
automotive components businesses.

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 8 manufacturing facilities in the United States, Austria,
Malaysia and China. We have a proven capability of moving manufacturing
to lower cost environ-
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ments. Our manufacturing facilities are not unionized, with the exception
of our facilities in China and Austria, which are required to be
unionized under local law. In March 2000, we announced plans to
consolidate our worldwide manufacturing operations. The consolidation
plan included outsourcing some activities performed in Itasca and Rolling
Meadows, Illinois. In addition, we ceased production at our United
Kingdom, Taiwanese and German manufacturing facilities. Production from
those operations was moved to China, Malaysia and Hungary. As of December
2002, the consolidation plan is complete and our headcount related to
operations that existed in March 2000 has been reduced by 20%.

- 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. Our KE and
Automotive Components business units use automated sub-assembly
operations and manual final assembly operations. We are also working to
develop automated final assembly equipment for select products. Emkay's
operations are subcontracted in part, providing us with cost structure
flexibility and allowing us to change capacity quickly based on product
demand.

GROWTH STRATEGY

Our principal objective is to increase revenues, cash flow and
profitability by strengthening our leading market positions in our core
businesses and applying our technological expertise to new growth opportunities
in related businesses. 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
80% 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:

- technological advances and improved customer satisfaction;

- improvement in the cosmetic appearance and reduction in stigma;

- growth in the elderly population;

- increasing use of binaural hearing aids; and

- increasing 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 multiple microphone hearing aids,
which provide better performance than single microphone hearing aids and require
three or four, 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.

LEVERAGE CORE ACOUSTIC EXPERTISE TO DEVELOP INNOVATIVE PRODUCTS FOR MARKETS
WITH HIGH GROWTH POTENTIAL

We expect to continue combining our core competency in acoustics with other
technologies such as wireless, micro-machining systems and digital signal
processing to provide technology solutions for high growth markets, including
mobile communications, computer telephony integration, telematics (voice
controlled wireless services delivered to an automobile environment) and home
entertainment systems. Emkay has developed several new technologies and products
for these markets, including:

SiSonic(TM) Silicon Microphone -- We have recently introduced what we
believe is the world's first solid state silicon microphone. Since the
SiSonic(TM) Silicon Microphone can withstand high temperatures,

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it can be mounted to printed circuit boards using automated pick and place
soldering equipment, thereby eliminating costly manual installations
currently required for many microphone applications. This microphone's
environmental robustness also enables it to perform in harsh environments
such as automobiles. Automotive applications include hands-free cellular
telephones, voice command and control systems.

Far-Field Microphone Array Technology -- To support the emerging
telematics market Emkay has developed a microphone array that uses digital
signal processing to enable clear processing of voice signals in a noisy
environment, such as an automobile. This technology will facilitate clear
voice communications, allow effective use of voice commands for vehicle
control systems, and enable the use of emerging telematic services through
voice command. In non-automotive applications this technology can improve
communication in noisy environments and provide a high quality signal input
to voice recognition systems.

ECMs (Electret Condenser Microphones) -- To offer the broadest line of
voice input, Emkay continues to work to introduce differentiated ECMs to
the marketplace. These products continue to expand the Knowles ability to
make ultra low cost microphones in high volume.

Custom Acoustic Assemblies -- A significant differentiator in the
voice input market, is Emkay's ability to utilize its acoustic engineering
expertise, coupled with its low cost manufacturing operations and supply
chain to create custom assemblies for the OEM and finished goods market.
This has allowed us to offer complete acoustic solutions.

Infrared Remote Control Products -- Remote controls for use with set
top boxes for digital television providers, for manufacturers of
entertainment devices, and for replacement markets including universal
remotes capable of controlling multiple entertainment devices.

STRENGTHEN CUSTOMER RELATIONSHIPS

Our business units have well-established customer relationships. We plan to
continue to strengthen our existing relationships and develop new relationships
through the following.

- KE often customizes its transducer models to design and manufacture
transducers that meet the specifications of individual hearing aid
manufacturers. KE and Emkay also conduct joint research and product
development with some of its customers. Emkay is also involved in
developing products with its customers.

- We act as a leading source of consumer data for the hearing aid industry.
We have conducted more than 30 market studies for our customers and
communicate our market data that identifies consumer needs to the hearing
aid industry through our MarkeTrak reports, other publications and
seminars.

- SSPI has a strong position in the international solenoid marketplace and
supplies over 250 customers. We anticipate that future growth of this
Automotive Components unit will come from leveraging our existing
relationships to introduce new products and services.

- Emkay continues to expand its geographical presence around the world in
order to better serve the OEM electronics market it serves.

MAINTAIN LOW COST AND HIGH QUALITY MANUFACTURING LEADERSHIP

We believe that we are the lowest cost producer of hearing aid transducers
due to our relatively large volume production and market share. KE has more than
25 years of experience operating in both Asia and Europe. 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. Approximately 82% of our manufacturing activity is located in China and
Malaysia to benefit from both their lower cost labor markets and proximity to
emerging product markets.

5

DEVELOP AUTOMOTIVE MICROPHONE BUSINESS

We believe the increasing focus on limiting the use of cellular phones
while operating automobiles (driven in part by existing and proposed legislation
at the state level) along with the growing popularity of voice driven navigation
systems will create demand for microphones and provide an opportunity for us to
expand.

PURSUE STRATEGIC ACQUISITIONS

Strategic acquisitions have been an important element in our growth and
efforts to enhance our leading market and technological positions. We will
continue to review attractive acquisition opportunities that preserve our
financing flexibility. We will focus on acquisitions that can:

- enhance existing product, process and technological capabilities;

- provide us with growth opportunities that complement our acoustic
expertise; and/or

- expand our presence in new geographic areas.

PRODUCTS

KE

KE primarily manufactures hearing aid transducers, including microphones
and receivers, that are sold to hearing aid manufacturers. KE offers transducers
for all types of hearing aids, from the smallest which completely fit in the
canal to the largest which are body-worn, and often customizes models to meet
the specifications of individual hearing aid manufacturers. KE also occasionally
conducts joint research and product development with some of its customers. In
addition to transducers, KE sells other hearing aid components under the brand
name Deltek, including trimmers, volume controls and connectors for hearing aid
manufacturers. These other products represented a very small percentage of our
sales in 2002.

KE also acts as a source of consumer data for the hearing aid industry. It
provides free market data to its customers through distribution of its
publication MarkeTrak and has conducted more than 30 market studies for its
customers.

EMKAY

Emkay produces and is developing a wide range of microphones, custom
acoustic assemblies, and infrared remote controls primarily for sale to original
equipment manufacturers. Major products are discussed below.

Microphones. Emkay has leveraged its microphone technology to create
devices for diverse applications. Emkay has completed the development and
initial introduction of a low cost silicon microphone based on traditional
semiconductor manufacturing processes. This technology offers significant
advantages over traditional microphones used in high volume mass market consumer
products such as cellular telephones and personal digital assistants (PDA's).
Key advantages include significantly reduced assembly costs and greater
tolerances in high temperature applications. The Company also markets
boom-mounted microphones for use in conference rooms, helmets, aerospace and
civil/military communications; high sensitivity condenser microphones for laptop
computers, wireless phones and modem accessories; computer monitor microphones;
lapel microphones; and noise canceling and waterproof microphones for headsets,
helmets and handsets.

Custom Acoustic Assemblies. Emkay manufactures a variety of acoustic
assemblies from wired and noise canceling headsets used for internet based
telephony and voice recognition to custom acoustic housings and attached leads
for microphones for the OEM market.

Infrared Remote Controls. Emkay has developed several infrared remote
control products, including remote controls for televisions and digital
broadcast services that provide Internet access. These products include an
infrared keyboard to facilitate email, internet browsing and shopping along with
remotes with gamepad features to facilitate playing electronic games provide by
the broadcast service provider. Emkay's
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remote controls have been introduced in Europe both in the retail market and as
a platform for sales to original equipment manufacturers in connection with
specific applications.

AUTOMOTIVE COMPONENTS

Diesel Engine Solenoids. SSPI produces solenoids used to control diesel
engines, as well as certain natural gas, liquid propane and gasoline engines, in
industrial, marine and construction applications. These products serve various
functions including key start/stop, throttle and choke control and emergency
engine shutdown. Solenoid kits made by SSPI include mounting hardware, brackets
and linkage accessories for connecting the solenoid to the engine and fuel
system. We rigorously test these kits to meet the highest industry standards.

Electronic Governors. SSPI's electronic governors are used to control the
speed and power of industrial engines used in applications such as electric
power generators, compressors, tractors, hydraulic pumps and man lifts. SSPI's
Advanced Proportional Engine Control System (APECS) addresses the increasingly
sophisticated equipment of its customers by comparing actual engine speed to the
desired operational parameters of the equipment using a digital microprocessor
and proprietary software and adjusting the throttle of the engine accordingly.

Position Sensors. This product line was sold in November 2002.

RESEARCH AND DEVELOPMENT

Our 2002 research and development expenditures were $13.7 million, or 6.3%
of net sales. We focus on leveraging our acoustic research for use by all three
of our business units. We are carrying out extensive research and development on
producing a silicon microphone using the emerging technology of the micro-
machining of silicon (also referred to as micro-electro mechanical systems). We
believe that we have a leading position in this application of micro-electro
mechanical systems and are continuing development of manufacturing processes
that will deliver production quantities. There is a team of ten engineers within
Emkay that is working on development of the silicon microphone.

KE

KE's research and development group consists of 38 scientists, engineers
and technicians located in Itasca, Illinois, focused on technologically improved
new product. KE believes that its ability to rapidly develop new transducers
with superior performance is critical to sustaining its market share and
margins. Applied research and advanced modeling lead to new and creative
products, which we believe gives KE a competitive advantage as hearing aid
manufacturers look for technology improvements in their components.

Planned new products and improvements include receivers with improved
maximum power output and reduced vibration sensitivity, significantly reduced
vibration with magnetic shield outer housing, screenless damping using
Ferrofluid(R), and microphone improvements with respect to a analog/digital
(A/D) signal converter, programmable digitally controlled gain amplifier,
co-joined ultra-thin microphone pairs, noise reduction, improved electrostatic
discharge thresholds and significantly reduced cellular telephone interference.

EMKAY

Emkay has developed a significant in-house research and development effort,
with 34 engineers and technicians. Over the next five years, Emkay will continue
to focus its research and development efforts on acoustics, radio frequency,
infrared, video image sensing, micro-electro mechanical systems and digital
signal processing products for the mobile communications, voice recognition,
digital television, computer telephony integration and telematics markets. Emkay
is also concentrating on the development of a "far field" microphone system
which employs an array of microphones that focuses on a particular speaker while
canceling other background noise. We have licensed digital sound processing
technology to further the

7

development of this microphone system. We expect to leverage this microphone
technology for the development of additional products for our KE and Automotive
Components units.

Emkay has decentralized research and development groups located in the
United States, Austria and Taiwan in order to coordinate closely with regional
sales and marketing teams, and more efficiently meet the demands of local
markets. Research and development efforts for micro-electro mechanical systems
for the production of silicon microphones, digital signal processing technology
and far field microphone technology is conducted in the United States, infrared
product development is conducted in Austria and wireless headset product
development is conducted in Taiwan.

AUTOMOTIVE COMPONENTS

SSPI. SSPI's advanced development group currently employs 18 engineers for
the design and development of new actuators and solenoids.

MANUFACTURING

We operate from eight manufacturing facilities in the United States,
Austria, 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, toward that end, we have
signed a letter of intent concerning a new facility in China.

In March 2000, we announced plans to consolidate our worldwide
manufacturing operations. The consolidation plan included outsourcing some
activities performed in Itasca and Rolling Meadows, Illinois. In addition, we
ceased production at our United Kingdom, Taiwanese and German manufacturing
facilities in 2000 and 2001. Production from those operations was moved to
China, Malaysia and Hungary. As of December 2002, the consolidation plan is
complete and our headcount related to operations that existed in March 2000 has
been reduced by 20%.

KE

KE operates manufacturing facilities in Illinois, Malaysia and China.
Several sub-assembly processes are automated, but transducer assembly is largely
manual. Manual transducer assembly has proven to be a cost-flexible production
method and KE's workforce is generally highly stable and semi-skilled. KE is
also working to develop automated final assembly equipment for select products.

The total production space available to KE is approximately 85% utilized
and our transducer manufacturing facilities are ISO 9000 certified.

EMKAY

Emkay's assembly processes for the SiSonic(TM) Silicon Microphone are
largely automated, and assembly operations of older products are largely manual
and performed by subcontractors in China and Taiwan. Capacity can be increased
as demand increases.

AUTOMOTIVE COMPONENTS

SSPI. Approximately 40% of SSPI's finished products are manufactured in
Niles, Illinois, with the remainder manufactured in the Suzhou, China facility.
Components such as coils and metal parts are primarily sourced in Asia for both
manufacturing facilities. All of SSPI's manufacturing facilities are ISO 9000
certified. In addition, the Niles manufacturing facility is QS 9000 certified
while the Suzhou facility has TS 16949 certification.

Ruf. The Ruf operations were sold in November 2002.

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SALES AND MARKETING

KE

KE sells directly to hearing aid manufacturers through its 31-member sales
group which operates from offices in Illinois, United Kingdom and Japan.
Australia is covered by an independent sales representative. Pricing of KE's
products is based on a volume/price grid in which volume discounts are provided
based on actual purchases. From time to time, KE reduces prices to meet
competition. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."

EMKAY

Emkay sells most of its products through a 37-member sales group to
original equipment manufacturers including Plantronics, Shure, Phillips
Electronics, IBM and HTC. Emkay's sales force and independent sales
representatives are located in the United States, United Kingdom, Germany,
France, Austria, Japan, Taiwan, China, Korea, and Australia. In addition, Emkay
products are available through catalog distributors in North America and Europe.

AUTOMOTIVE COMPONENTS

SSPI. Solenoids and electronic governors are generally sold directly to
manufacturers of diesel engines and mobile industrial equipment worldwide
through SSPI's direct sales force. SSPI maintains sales, distribution and
application support operations in Niles, Illinois, Burgess Hill, England, and
Suzhou, China. This direct distribution system is expected to continue due to
the specialized design of products for particular customers. SSPI's application
engineers often work in conjunction with its major customers to design
proprietary products for specific engine models. SSPI's Independent
representatives and distributors located in North America, Europe, Asia, South
America and Austrialia primarily provide service and support to the aftermarket.

Ruf. Ruf operations were sold in November 2002.

CUSTOMERS

KE

KE is the principal supplier of transducers to all of the major hearing aid
manufacturers, including GN Resound, Oticon, Phonak, Rion, Siemens, Sonic
Innovations, Starkey Laboratories and Widex. In 2002, KE's top ten customers
represented approximately 91% of sales with Siemens accounting for more than 10%
of both consolidated sales and accounts receivable.

EMKAY

Emkay's top customers for voice recognition products include Scansoft and
marketers of language learning software. Generally, customers for voice command
and control products include computer and communications original equipment
manufacturers and computer peripheral manufacturers. Top customers for Emkay's
products are Aswo International, High Tech Computer Corp., Plantronics, Shure,
Supportplus, Tatung and TW Electronics. In 2002, Emkay's top ten customers
represented approximately 42% of sales.

AUTOMOTIVE COMPONENTS

SSPI. SSPI provides engine control solenoids to every major diesel engine
manufacturer worldwide. Its top customers include Ingersoll Rand, Cummins,
Isuzu, Ford, John Deere, Yanmar, Kubota, Perkins, Caterpillar, Deutz, MWM and
Navistar. SSPI's top ten customers comprised 61% of its sales in 2002.

Ruf. The Ruf operations were sold in November 2002.

9

COMPETITION

KE

KE has held a major share of the transducer market for over 30 years, and
its worldwide market share was approximately 80% in 2002. KE's principal
competitor is SonionMicrotronic, which we believe had a significant portion of
the remaining market share in 2002. SonionMicrotronic generally prices their
products below our pricing levels and this difference has increased due to the
strength of the U.S. Dollar versus European currencies relative to exchange
rates prevailing in late 1998.

EMKAY

The voice recognition, digital television, computer telephony integration
and mobile communications markets are highly competitive and in many cases
highly fragmented. Many companies compete with Emkay in its targeted 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.

AUTOMOTIVE COMPONENTS

SSPI. As the leading global producer of diesel engine solenoids, SSPI had
worldwide unit market share of approximately 65% in 2002. SSPI also held a small
but growing share of the worldwide electronic governor market in 2002. SSPI
competes with a variety of U.S. and non-U.S. companies in these two markets.

Ruf. The Ruf operations were sold in November 2002.

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. The technology covered by these
patents range from the very latest in solid state, micro-machined microphone
technology to the now well-established Class D amplifier in hearing aid
transducers.

In addition to patents, we have more than 100 trademarks registrations and
applications for registration in 20 countries around the world and 8 registered
domain names for Internet web sites.

Although we have no registered copyrights, we have unregistered copyrights
in our original works of authorship. In addition, we have in excess of 150
unregistered trade names used to identify our products and a number of trade
secret processes used to design and manufacture our products.

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 two years.

EMPLOYEES

We had 2,225 employees as of December 31, 2002. Of these, approximately 60%
were production employees and approximately 40% were staff. Geographically, 445
of our employees are based in North America, 1,568 employees are based in Asia
and 212 employees are based in Europe. With the exception of employees in China
and Austria, who are required to be unionized under local law, none of our
employees are members of labor unions. 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

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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, KE maintains ISO 9001 and ISO 9002 quality
assurance certifications which subject KE's operations to periodic surveillance
audits.

INDUSTRY

We apply our acoustic technology capabilities in several markets, including
hearing aids and acoustic and infrared technology. In addition, we manufacture
diesel engine solenoid and electronic governors for the automotive components
market.

HEARING AID TRANSDUCERS

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.

Hearing aid manufacturers distribute their products through hearing aid
fitters, referred to as dispensers, which are either audiologists or hearing
instrument specialists. An audiologist has a masters degree in audiology and is
National Board Certified by the American Speech and Hearing Association Board.
Hearing instrument specialists are licensed and may or may not be National Board
Certified. Ear, nose and throat physicians' offices, hospitals and clinics
typically employ only audiologists, whereas retail settings employ both
audiologists and hearing instrument specialists.

Significant factors affecting demand for hearing aids include the
following:

- Technological advances. A number of technological advances made 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 microphones 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. Additionally, a few dispensers are introducing
after sales care of patients and their hearing aids, including personal
visits to older clients.

- Improvement in cosmetic appearance and reduction in stigma. Through
technological advances, some higher priced hearing aids have become so
small that they are virtually invisible, although
11

occlusion (ear blockage) in connection with their use must be managed. At
the same time, the stigma associated with hearing loss may be decreasing,
as there has been an increase in the number of baby boomers (between ages
45 to 54) who admitted to having a hearing loss.

- 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 per
hearing aid user instead of two).

- Undiagnosed hearing loss. We estimate that approximately 10% of the U.S.
population has some form of hearing loss, and that 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 hearing aids become more
affordable.

- Price sensitive market segments. The average price of hearing aids in
the United States was approximately $1,446 in 2001 according to a survey
in The Hearing Journal, making them too expensive for a large portion of
the elderly population who rely on fixed incomes. Several manufacturers
have entered the low price hearing aid market to explore opportunities in
this segment.

ACOUSTIC AND INFRARED TECHNOLOGY

The Emkay business unit began operations in 1994 leveraging our acoustic
and infrared competencies to target new growth markets within the digitally
enhanced and converging information technology (IT), telecomm and broadcasting
industries. Critical to the successful evolution of specific markets within
these industries will be the speed and quality of the acoustic, audio and data
input technology.

- Mobile Communications. Mobile communication devices continue to expand
in prevalence world wide, with over 390 million mobile phones sold in
2002. Currently the infrastructure is rapidly expanding to begin the
rollout of 3G applications such as streaming video and Internet access.
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.
Emkay is well positioned to capitalize on this market selling ECMs,
Silicon microphones, custom assemblies and software for elimination of
ambient noise.

- Automotive. Industry officials expect half of the cars manufactured in
the U.S., Japan and Western Europe to have in-vehicle communications and
entertainment systems by 2006. Using natural voice commands the user can
dial phone numbers, check e-mail, receive navigational information,
change radio stations, play CD disks and run third party software
applications. It is expected that every major automotive manufacturer
will offer in car telematic systems by 2006 and that 6 million users will
subscribe to telematic services offered by wireless carriers, car makers
or internet service providers by 2007.

12

Emkay has been aggressively promoting its range of acoustic components and
sub-assemblies for such hostile environments to suppliers and global automotive
manufacturers and has developed single and multiple microphone assemblies
(supported by noise reduction software techniques) for specific in vehicle
applications.

- Multi-Media. With the trend toward digital television provided by
broadcast, cable and satellite providers, new services previously that
were available only through personal computer ("PC") access to the
internet can now be accessed through television. The consumer can now
access on-line banking, on-line gaming, home shopping, e-mail, chat and
other integrated home entertainment without the need of a PC.

Emkay has developed a complete infrared ("IR") input transmission portfolio
of game pad, keyboard, pre-programmed and voice driven remote control to
simplify this on-line access. Further a unique IR-transmission system that
allows bi-directional communication for 4 individual game pads and an increase
of more than 40% battery life has been developed for OEM customers.

AUTOMOTIVE COMPONENTS

- Diesel Engine Solenoids. Solenoids are two position linear actuators
that are used mainly to start and stop diesel engines by controlling the
engine fuel system. We believe the worldwide diesel engine solenoid
market was approximately $38.0 million in 2002. Longer-lasting engines
and alternative technologies, developed principally in response to
stringent vehicle emissions regulations in the United States and Europe
are expected to reduce demand for solenoids in these markets on diesel
engines over 100 horse power. We expect this to be offset by the higher
market penetration of industrial diesel engines under 100 horse power
which will we believe will require less sophisticated emissions
technologies. The Asian markets for solenoids are forecasted to grow
substantially over the next 5 years. The economic growth of these
economies will drive increased demand for diesel engines and solenoids
used in construction, agricultural and industrial applications. These
markets have typically required less stringent emissions regulations.

- Electronic Governors. Electric engine governors control engine speed and
power by adjusting the engine throttle for varing parameters. The
worldwide market for electric governors is approximately $110 million.
Increased future demand is projected based on the increasing need for
precision speed management of small diesel and gas engines and the
increased use of advanced control drive-by-wire systems in small mobile
industrial equipment that use both diesel and gas engines.

13

ITEM 2. PROPERTIES

PROPERTIES

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

* With the exception of the Lisle, IL facility, the Company expects to renew
all leased facilities that expire in 2003.

** Land lease expires 09/18/2049.

ITEM 3. LEGAL MATTERS

The Company has no material pending or threatened litigation.

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

Not applicable.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Not applicable.

14

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

See accompanying notes.
15

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

(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" 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%.

(3) Net income from discontinued operations represents the activity of The
Finance Company of Illinois, an equipment financing business that was
distributed to our preexisting stockholders on June 29, 1999.

(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 and 2002, EBITDA includes
restructuring charges of $18,440, $317 and $2,158 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. Because EBITDA is not calculated under
GAAP, it may not be comparable to similarly titled measures reported by
other companies.

Reconciliation of operating income to EBITDA:

(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, 2000 by approximately $6.5 million.
Knowles earnings were inadequate to cover fixed charges for the twelve
months ended December 31, 2002 by approximately $12.6 million.

(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. 1998 and 1997 results
were increased by $1,402 and $478, 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 2003, 2004 and 2005 if the Ruf
operations meet certain financial targets.

(9) "EBITDA as adjusted" is defined as earnings before interest, taxes,
depreciation and amortization; and for the year 1999 recapitalization
expense; and for the year 2002 loss on sale of business. EBITDA as adjusted
is presented solely as a supplemental disclosure. For the years 2000, 2001
and 2002, EBITDA as adjusted includes restructure charges of $18,440, $317
and $2,158, respectively.

16

Reconciliation of EBITDA to EBITDA as adjusted:

17

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion should be read in conjunction with the "Selected
Consolidated Financial Data" and our consolidated financial statements and the
related notes included elsewhere in this report on Form 10-K.

OVERVIEW

We are a leading international manufacturer of technologically advanced
products in the hearing aid and automotive components markets. We also operate
in markets for acoustics and infrared technology products that have higher
growth potential. 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 sensors,
infrared technology and precision manufacturing in the United States and other
countries. We have numerous international operations with our largest facilities
in the United States, China, Malaysia and Austria. Our 2002 revenue, operating
income and EBITDA, as reported, were $216.1 million, $21.4 million and $32.3
million, respectively. Our 2002 operating income and EBITDA, adjusted for the
$16.7 loss on the sale of the Ruf operations, were $38.1 million and $49.0
million, respectively.

The Company borrowed $200 million under a Credit Agreement plus $153.2
million of 13 1/8% Senior Subordinated Notes associated with its
recapitalization June 30, 1999. On August 29, 2002, the Company issued $10
million of 10% Senior Subordinated Notes in a private placement. 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, 2002. In
March 2003, the Company refinanced the A facility under the Credit Agreement,
which represented $31.7 million of the outstanding debt as of March 31 pursuant
to a Limited Waiver and Fifth Amendment to the Credit Agreement (the "Fifth
Amendment") dated as of March 25, 2003. The Fifth Amendment revised the required
interest coverage ratio and leverage ratio for the period from March 31, 2003 to
June 29, 2007. The Fifth Amendment approved a new $35 million borrowing facility
(the "C Facility"), the proceeds of which were used to prepay the existing A
Facility as of March 31, 2003 and to pay certain fees to certain lenders
incurred in connection with such amendment. Any remaining proceeds may be used
for general corporate purposes. The C Facility has no amortization of principal
during the term of the facility, which matures on June 29, 2007 and accrues
interest at a fixed rate of 18 1/2%.

The Company is in compliance with its leverage and interest coverage
ratios, as defined in the Limited Amendment and Waiver to the Credit Agreement
dated March 25, 2003 and expects to be in compliance through December 31, 2003.

The Company had previously received an Amendment and Waiver dated May 10,
2002 to the Credit Agreement. This amendment waived our non-compliance with the
required ratios for the period ended March 31, 2002 and amended these required
ratios for the periods from March 31, 2002 through the first quarter of 2003.
This Amendment and Waiver restricted the Company's capital expenditures for
2002, as well as setting various other operating and financing requirements, all
of which the Company met through December 31, 2002.

BUSINESS SEGMENTS

The Company is organized into three business segments. They are as follows:

- KE-Hearing Aid Components. KE, our most significant business unit,
designs, manufactures and markets subminiature acoustic transducers and
other components for hearing aids. The transducer is the name given to
both the microphone and receiver in a hearing aid. KE is the world's
largest manufacturer of hearing aid transducers.

- Emkay-Acoustics and Infrared Technology. Emkay began business in 1994 to
explore non-hearing aid applications for our technology. Emkay combines
KE's transducer and acoustic expertise with its

18

core competencies in infrared technology and electronics to provide high
technology solutions for markets with high growth potential including
mobile phones, PDAs, and entertainment systems.

- Automotive Components(ACG). Our Automotive Components business unit is
comprised of Synchro-Start Products, Inc. ("SSPI"), which produces diesel
engine solenoids and electronic governors. On November 1, 2002 the
Company announced the sale of its Ruf Electronics operations ("Ruf"),
which previously represented 35% of the sales and a negligible portion of
the EBITDA of this segment.

The following table sets forth our net sales growth from each segment the
last three years.

The following table sets forth the approximate percentage of our net sales
from each segment.

The following table sets forth the percentage of our operating income from
each segment. The percentages for the year ended December 31, 2000 exclude
restructuring charges of $18.4 million; for the year ended December 31, 2001
exclude restructuring charges of $0.3 million and for the year ended December
31, 2002 exclude the loss on the sale of Ruf of $16.7 million and restructuring
charges of $2.2 million.

Net sales. We recognize net sales when title to the products transfers to
the customer, which typically is upon the shipment of products to the customers.

Growth in net sales for KE has generally been driven by demographics,
technological advances and improved hearing aids. There has been growing price
competition in KE's market over the last several years. KE believes that demand
for improved transducers and an expanding market for hearing aids will more than
offset any decline in existing transducer prices in 2003.

Net sales for Emkay have been driven by the emergence of new markets for
acoustic and infrared technologies and our penetration of those markets. The
market for Emkay's products has been growing substantially, due to technological
advances in and increased penetration of mobile phones, PDA type devices that
access the web, and a variety of specialty applications that require high
performance acoustic performance. Emkay 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.

Net sales from Automotive Components are primarily driven by the sale of
solenoids in both diesel engine applications and other commercial markets. Sales
of diesel engine solenoid products for use as

19

replacement parts fluctuate substantially from quarter to quarter, which can
have a noticeable effect on the operating income of the Automotive Components
segment. In the last several years, the diesel engine solenoid market has been
flat in the United States, declining in western Europe and growing in the rest
of the world. We expect net sales of these solenoids to grow slowly. Demand for
the Company's solenoids in other markets, including commercial locks and
security applications, are expected to grow more rapidly.

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 61% of our depreciation expense in 2002 and 58% in 2001 is reflected in
cost of sales.

Most of our direct labor is performed by a semi-skilled workforce.
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.
We have outsourced some manufacturing activities previously performed at our
Itasca, Illinois facility and we have outsourced all our manufacturing
activities of our Rolling Meadows, Illinois facility. In addition, we have
ceased production at our manufacturing facilities in the United Kingdom, Taiwan
and Germany. Production from those operations has been moved to China and
Malaysia. As a result of this consolidation our headcount related to operations
that existed in March 2000 have been reduced by 20%.

KE's material costs primarily relate to unprocessed materials or
commodities, including steel, copper wire, and magnet bar stock. KE purchases
certain integrated circuits, magnets and diaphragm assemblies customized
specifically for its products from outside suppliers, some of which are single
sourced. Emkay's materials costs generally relate to similar unprocessed
materials or commodities. Emkay has subcontracted some of its final assembly to
third parties. These costs are included in materials costs. Automotive
Components also purchases similar unprocessed materials and 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 the product lines of our
segments 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 Emkay, which is building a sales and product management
infrastructure to support future growth. We sell most of our products to
original equipment manufacturers and distributors, through internal sales forces
and outside sales agents.

General and administrative expense. Our general and administrative
expenses consist of personnel costs, legal, accounting and other professional
costs, management information systems and rent.

We have replaced certain management information systems, requiring
expenditures of approximately $10 million from 2000 through 2002. Approximately
$8 million was spent in 2001, of which $6.6 million was capitalized.

Other income (expense). Other income (expense) consists of interest
income, interest expense and miscellaneous expenses. Due to our
recapitalization, interest expense was $43.3 million in 2000, and $37.8 million
in 2001 and $34.1 million in 2002.

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. Income taxes were 129% of 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 $11.8 million of taxes
despite a pre-tax loss of $12.6 million primarily due to providing a valuation

20

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 due to the continued U.S. losses caused by the significant
interest expense associated with the Company's debt. Due to the distribution of
earnings between profitable foreign operations and a U.S. loss, income taxes are
expected to significantly exceed the statutory rate in 2003.

Foreign exchange exposure. Our revenues are primarily denominated in the
U.S. dollar, the Euro, 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 this 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.

ACCOUNTING METHOD CHANGE MADE IN 2001

As of October 1, 2001, the Company elected to change its inventory costing
method for domestic inventories from last in, first out (LIFO) to first in,
first out (FIFO). We made the change because we believe that FIFO reflects
current economics more accurately in a deflationary environment and is the
prevalent industry practice. The manufacturing restructuring program announced
in 2000 has reduced the direct labor content of the product significantly and
raw materials and components were stable in price. We also have made significant
changes in where various components and subassemblies are being manufactured and
therefore, we believe the FIFO method results in a better measurement of
operating results. There was no effect on the 2001 results as reported. However,
the 2000 gross margin, operating income, and EBITDA were lowered by $1.6
million, specifically for the KE Division by $1.2 million and for the ACG
division by $0.4 million. The 2000 net income was lowered $1.0 million.

CONSOLIDATED RESULTS OF OPERATIONS

The table below shows the principal line items from our historical
consolidated income statements, as a percentage of our net sales, for each of
the periods discussed below.

Operating income and EBITDA, as a percentage of net sales, as reported,
were 9.9% and 14.9%, respectively, for the year ended December 31, 2002.
Operating income and EBITDA, as a percentage of net sales, excluding the loss on
the sale of Ruf of $16.7 million, were 17.7% and 22.7%, respectively, for the
year ended December 31, 2002. Operating income and EBITDA, as a percentage of
net sales, as reported, were 19.1% and 25.2%, respectively, for the year ended
December 31, 2001.

21

YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001

The following table sets forth net sales by segment and segment net sales
as a percent of total sales.

Overall, consolidated net sales decreased 3% in 2002 compared to 2001. KE's
net sales decreased 5% in 2002 compared to 2001. The major cause was a reduction
in selling prices, caused by greater price competition in the industry and a
consolidation of customers. Unit sales of transducers increased by 5% but were
more than offset by a 9% reduction in average selling price. Emkay's net sales
increased 6% in 2002 over the prior year primarily due to increased sales of
microphones in applications outside of the Company's traditional hearing aid
market. Automotive Components' net sales declined 6% primarily due to the
November sale of Ruf operations.

The following table sets forth cost of sales by segment and segment cost of
sales as a percent of segment net sales.

Consolidated cost of sales increased by 1.3 percentage points as a percent
of sales in 2002 compared to the prior year. KE's cost of sales increased by 1.8
percentage points primarily due to lower average selling prices partially offset
by lower warranty costs. Emkay's cost of sales decreased by 2.0 percentage
points primarily due to reduced expenses associated with obsolete inventory. The
Automotive Components Group division cost of sales increased by 2.1 percentage
points due to higher freight and overhead costs at SSPI.

22

The following table sets forth operating income, excluding restructure
charges, by segment and segment operating income as a percentage of segment net
sales.

Excluding restructuring expenses and loss on the Ruf sale, operating income
declined by $2.7 million in 2002 compared to the prior year. Gross margin
decreased by $6.3 million due to the KE selling price and SSPI cost issues
discussed above. Offsetting these margin declines was a reduction in period
expenses of $3.6 million, including lower general and administrative, marketing
and sales and research and development expenses. The Company reduced operating
expenses by initiating a program to reduce discretionary spending on
non-essential programs.

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 creating a cash drain. The net loss from
the sale of Ruf was $16.7 million. The Company also recorded $2.2 million in
restructuring expenses in 2002, including a $1.2 million loss on the sale of a
facility in Taiwan. The balance of the restructuring expense was severance.

In connection with our recapitalization, we incurred $200 million of senior
debt and $153 million of senior subordinated debt in 1999. We incurred an
additional $10 million of senior subordinated debt in 2002. As a result,
interest expense was $34.1 million in 2002 compared to $37.8 million in 2001,
with the decrease primarily due to lower interest rates.

Income tax expense was $11.8 million this year compared to $6.5 million
last year. In 2002 the Company provided for $11.8 million of taxes despite a
pre-tax loss of $12.6 million primarily due to providing a valuation allowance
against the net U.S. deferred income tax assets. Due to the distribution of
earnings between profitable foreign operations and a U.S. loss, income taxes are
expected to significantly exceed the statutory rate in 2003.

23

YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000

The following table sets forth net sales by segment and segment net sales
as a percent of total sales.

Overall, consolidated net sales decreased 6% in 2001 compared to 2000. KE's
net sales decreased 1% in 2001 compared to 2000. The major cause was a
significant inventory reduction by our largest customer in the first half of the
year. As a result, first half KE sales were much weaker, while second half KE
sales were closer to the typical level. Emkay's net sales decreased 5% in 2001
compared to the prior year primarily due to decreased sales of voice recognition
headsets. Automotive Components' net sales declined 18% primarily due to very
weak construction and agriculture equipment related sales, lower service parts
orders and lower sales at three large customers.

The following table sets forth cost of sales by segment and segment cost of
sales as a percent of segment net sales.

Consolidated cost of sales decreased by 0.6 percentage points as a percent
of sales in 2001 compared to the prior year. However, there are noticeable
differences by division. KE's cost of sales increased by 0.5 percentage points.
This occurred because of quality costs associated with an outsourced part,
coupled with significant underabsorption (lower production levels did not fully
absorb overhead costs), and certain manufacturing inefficiencies. Emkay's cost
of sales increased by 5.7 percentage points due to surplus obsolete expense and
an unfavorable mix of lower margin infrared product sales versus higher margin
components and finished goods sales. The Automotive Components Group division
cost of sales declined by 5.1 percentage points due to the SSPI manufacturing
restructuring program and a favorable mix of higher margin SSPI sales versus
lower margin Ruf sales.

24

The following table sets forth operating income by segment and segment
operating income as a percentage of segment net sales.

Excluding restructuring expenses, operating income declined by $11.3
million. The sales volume decrease accounts for $6.3 million of the operating
income decline partially offset by the gross margin improvement of $1.4 million
for a net operating income decline at the gross margin level of $4.9 million.
The remaining $6.4 million of the operating income decline is due to higher
period expense which includes research and development, sales and marketing and
general and administrative. The increases in period expense were due to Emkay,
which increased almost $3 million, and to Corporate, which increased $4.4
million, partially offset by ACG, which had over a $1 million decline in period
expense. The Emkay increase was due primarily to higher research and development
expense for the silicon microphone and far field product lines and increased
sales and marketing expense for product management. The Corporate expense
increase primarily was for the new ERP system.

Corporate expense also increased for professional fees, some of which were
associated with our attempts to sell Ruf.

We announced a major restructuring in March 2000, resulting in a charge in
2000 of $18.4 million. We consolidated our worldwide manufacturing operations by
ending production at five manufacturing facilities and either outsourcing the
components or moving final assembly to lower cost locations in Malaysia, China
and Hungary. The restructuring expenses were essentially composed of severance
payments to terminated employees or outplacement expenses. The realized savings
from the restructuring program are approximately $15 million annually. These
benefits are reduced by the amount of cost increases that are paid to remaining
employees.

We reported operating income of $42.7 million in 2001 compared to operating
income of $35.9 million in 2000, which included significant restructuring
expenses. After adjusting out the restructuring expenses for both years, we had
adjusted operating income of $43.0 million in 2001 compared to $54.3 million in
2000. On an adjusted basis our operating income declined $11.3 million or 21% in
2001 compared to the prior year.

In connection with our recapitalization, we incurred $200 million of senior
debt and $153 million of senior subordinated debt. As a result, interest expense
was $37.8 million in 2001 compared to $43.3 million in 2000, with the decrease
primarily due to lower interest rates.

Income tax expense was $6.5 million in 2001 compared to a benefit of $1.6
million in 2000. The high effective tax rate in 2001 was caused by foreign taxes
not being offset by the benefit of the U.S. federal taxable loss this year,
while during the second half of 2000 the U.S. federal taxable income was high
enough to allow us to use the tax loss carryforward from the second half of
1999.

LIQUIDITY AND CAPITAL RESOURCES

We have historically used available funds for capital expenditures,
inventory, accounts receivable and acquisitions. These funds have been obtained
from operating activities and from lines of credit. In the future,

25

we will continue to have these needs, and we will also need to fund repayments
of principal under our term loans of approximately $3.0 million annually in 2003
through 2005, and increasing amounts thereafter. We also will have substantial
interest expense of approximately $35 to $40 million each year.

We are a holding company. Our subsidiaries conduct substantially all of our
consolidated operations and own substantially all of our consolidated assets.
Consequently, our cash flow and our ability to meet our debt service obligations
depends substantially upon the cash flow of our subsidiaries and the payment of
funds by our subsidiaries to us in the form of loans, dividends or otherwise.

In association with its recapitalization on June 30, 1999 the Company
borrowed $200 million under a bank credit agreement in two facilities, an A
Facility of $50 million and a B Facility of $150 million. On June 30, 1999, the
Company also borrowed $153.2 million under a senior subordinated note agreement.
The Company borrowed an additional $10 million in Senior Subordinated Debt in
August, 2002, as required under the Amendment and Waiver to the Credit Agreement
dated May 10, 2002 (see below).

The Company received approval for the Fifth Amendment dated March 25, 2003.
This agreement refinanced $31.7 million of the bank credit agreement, replacing
the original A Facility with a C Facility of debt and revised certain terms and
conditions of the Credit Agreement. Under this Fifth Amendment, the Company
received agreement from its lenders to waive compliance with the terms of
certain ratios of EBITDA through June 29, 2003 and to revise the terms of such
ratios thereafter. 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.

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

We expect to be able to comply with the required covenants through the term
of the agreement, June 29, 2007. 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 Fifth Amendment substantially revises the term of the Credit Agreement.
The interest rates were increased from 3.5 to 4 points above LIBOR for the
Revolving Credit Facility. The interest rates for the B Facility were increased
to 5 points above LIBOR. In addition, the agreement provides for additional
interest to accrue to the B Facility at the rate of approximately $420,000 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 refinancing provides for an interest rate on the C Facility that
totals 18.5%, a portion of which is payable in cash on a monthly basis. The
portion of interest that must be paid in cash on a monthly basis for the C
Facility is 13% for the year ending March 2004, with the cash portion of
interest increasing to 14% in the year ending March 2005 and by 1% per year
thereafter. The remainder of the interest on the C Facility shall, at the option
of the Company, be paid in cash or accrue and be added monthly to the
outstanding principal balance of the C Facility and paid at maturity, scheduled
for June, 2007. The Fifth Amendment also provided that interest on all revolving
credit loans and loans under the B Facility be paid monthly.

The Fifth Amendment dated March 25, 2003 reduced the Revolving Credit
Facility to $15 million and increased the quarterly amortization of the B
Facility to approximately $750,000 per quarter beginning June 30, 2003 through
June 30, 2006, with the balance paid in four quarterly principal payments from
September 30, 2006 to June 29, 2007. The Fifth Amendment also provides that in
the event the B Facility is

26

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 agreement also calls for the Company to pay an upfront fee of
approximately $350,000 to the B Facility lenders as well as certain fees to the
C Facility lenders.

The Fifth Amendment dated March 25, 2003 amends 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. This Fourth Amendment also limited
capital expenditures for the year 2002 to $15 million, decreased the Revolving
Credit Facility to $18.25 million and provided for certain other restrictions on
capital expenditures, acquisitions, and asset sales. 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. In connection with the Fourth Amendment, the
Company paid an up front fee of about $475,000 and the interest rate spreads
were increased 50 basis points.

Cash balances increased by $21.6 million in 2002 due to $29.5 million in
cash provided by operating activities that was only partly offset by $8.4
million used in investing and financing activities. In 2001, cash balances
decreased by $14.6 million as cash provided by operations of $9.4 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 $29.5 million compared to
$9.4 million in 2001. The favorable cash provided by operating activities was
despite an increase in net loss, which increased to $24.4 million in 2002
compared to a net loss of $1.5 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, $2.2 million of restructuring charges and a $6.3 million increase in
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. The
decrease in working capital was primarily due to $8.8 million reduction in
inventory and $6.3 million reduction in receivables, only partly offset by $3.9
million reduction in accrued restructuring expenses. Accrued interest payable
increased $2.1 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 $9.9 million, an
increase in inventory of $2.4 million and a decrease in accrued compensation and
benefits of $1.9 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 is 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 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.

27

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 for expenses related to the repurchase of
common stock. Net debt payments of $9.4 million were the primary financing
activities for 2001.

Net cash provided by operating activities was $9.4 million in 2001 compared
to $22.8 million in 2000. The net loss of $1.5 million in 2001 compared to a net
loss of $4.9 million in 2000. Most of the reduction in cash flow from operations
came from the fact that net income after adjustments for non-cash charges was
$7.2 million less in 2001 than 2000. Working capital was a net use of cash of
$7.6 million in 2001 compared to $1.4 million in 2000. In both years,
restructuring expense was the primary working capital use of cash. In 2001,
accrued compensation and benefits and other accrued liabilities were a use of
cash while in 2000 they were a source of cash due to higher accrued expense in
2000 and lower accrued expense in 2001.

Net cash used in investing activities was $17.6 million in 2001 compared to
$15.5 million in 2000. Investing activities for both years is primarily net
purchases of property, plant and equipment. 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 2001 were for new
product tooling and production equipment and automation, but IT hardware and
software and capitalization of Oracle consulting assistance to support the new
ERP system was $6.6 million in 2001 compared to $1.3 million in 2000.

Net cash used in financing activities was $6.2 million in 2001 as compared
to $12.2 million in 2000. Net debt payments of $5.3 million were the primary
financing activities for 2001, while the purchase price adjustment paid to the
prior owners of Knowles of $8.3 million was the primary financing activities for
2000.

The amount payable to our preexisting stockholders for the repurchase of
their common stock in our recapitalization was subject to a post-closing
adjustment. 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 2000.

The net of the cash flow provided by operations and used in investing and
financing activities resulted in a reduction of cash of $14.6 million in 2001
compared to a reduction in cash of $6.7 million in 2000.

The following table outlines various financial contractual obligations of
the Company (reflects March 2003 refinancing including the C Facility):

28

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 ("Recaptilization"). 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 82.5% 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
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.

29

THE CREDIT AGREEMENT

We entered into the Credit Agreement, dated as of June 28, 1999 and amended
and restated as of July 21, 1999, and further amended as of December 23, 1999,
April 10, 2000, December 12, 2001, May 10, 2002 and March 25, 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) an
approximately $137 million term loan facility ("B Facility") due in scheduled
principal payments that are completed as of June 29, 2007, (ii) a $35 million
term loan facility ("C Facility") due June 29, 2007 and (iii) a $15 million (as
amended December 12, 2001, May 10, 2002 and March 25, 2003) 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, 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, 2002.

On March 28, 2003 we repaid $9.53 million of aggregate principal of the A
and B Facilities in accordance with the excess cash provision of the amended
Credit Agreement.

REPAYMENT DATES

According to the revised terms provided in the Fifth Amendment dated March
25, 2003, and taking into account the effect of the March 28, 2003 prepayment,
the B Facility will amortize quarterly, with the following payments being made
at the end of each quarter during the following periods.

The C Facility is due and payable upon maturity on June 29, 2007.

The Revolving Facility is available as revolving credit advances or letters
of credit. Pursuant to the Fifth Amendment, 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.

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 $9.53 million was made on March 28,
2003 from excess cash flow. This prepayment was applied to prepay the B Facility
and the A Facility (which was not replaced by the C Facility until March 31,
2003). Indebtedness under the B Facility may be voluntarily prepaid by us in
whole or in part without premium or penalty, and indebtedness under the C
Facility may be voluntarily prepaid on or after April 1, 2004. Any voluntary and
certain

30

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 and March 25, 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, and March
25, 2003) or (2) the Alternate Base Rate plus an initial margin of 4%. The
interest margin may be reduced for advances under all three facilities if we, on
a consolidated basis, meet certain specified leverage ratio targets during a
period consisting of the prior four consecutive fiscal quarters. Any reduced
interest margin may be increased to the original interest margin if such
leverage ratios do not continue to be met. In addition, the Fifth Amendment
provides for additional interest to accrue to the B Facility at the rate of
approximately $420,000 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). 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.

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, 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 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 Credit Agreement also contains general covenants which restrict the
incurrence of debt and liens, the payment of dividends, the incurrence of
substantially all 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 and certain other activities and
transactions. In amendments to the Credit Agreement dated as of May 10, 2002,
the Company agreed to limit our capital expenditures to $15 million in 2002, and
to limit the net proceeds from asset sales that may be applied to acquire assets
in lieu of prepayment to $2.0 million and agreed not to make any acquisitions of
another company or business.

RECENT DEVELOPMENTS

The Company entered into a Fifth Amendment dated March 25, 2003. Based on
the terms and conditions of this agreement, we are in compliance with Credit
Agreement, as amended. As a result, we expect to make the interest payment on
our senior subordinated notes scheduled for April 15, 2003. The Company expects
to be in compliance with all the covenants in the amended Credit Agreement.
However, the Company's compliance with these covenants is dependent on Business
Risks and Conditions in the key markets in which

31

the Company operates. The inability to meet the required covenants could have a
material adverse effect on the Company's financial condition, results of
operations and liquidity.

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.

- COVENANTS

The Senior Subordinated Note Agreement also contains general covenants,
which restrict Limitation on Indebtedness, Limitation on Senior Subordinated
Indebtedness, Limitation on Restricted Payments, Limita-

32

tion 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
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

33

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.

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.

34

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,
2002, our inventory reserves were $7.7 million, or 20% of our $39.3 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 experience and expectation of future conditions. To the
extent we experience increased warranty claim activity or increased costs
associated with servicing those claims, our warranty accrual will increase
resulting in decreased gross profit.

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, 2002, we have recorded net deferred tax assets of
approximately $0.2 million, which includes a $52.3 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.

NEW ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board 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 will adopt SFAS No. 143 as of
January 1, 2003, and the impact of adoption of SFAS No. 143 is not expected to
have a 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 re 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. We do not anticipate
that the adoption of this statement will 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
will adopt the provisions of FIN No. 45 on January 1, 2003 for all new or
amended guarantees subsequent to that date.

35

Management does not anticipate that 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.

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 KE and Emkay
sales in the second and fourth quarter.

The following table sets forth net sales, costs and expenses, operating
income and net income by fiscal quarter.

NET SALES, COSTS AND EXPENSES, OPERATING INCOME AND NET INCOME BY QUARTER

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

(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" 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 costs in 2001 include a gain on the
sale of our U.K. facility and severance.

(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.

FORWARD LOOKING STATEMENTS

Certain of the statements that are contained in this report on Form 10-K
are "forward-looking" (as defined in the Private Securities Litigation Reform
Act of 1995). These forward-looking statements are based on information
currently available to the Company as of the date of this document. Actual
events and the Company's actual results may differ materially from what is
described in the forward-looking statements. Forward-looking statements are
typically identified by the words "believe", "expect", "anticipate", "intend",
"estimate", and similar expressions. The forward-looking statements contained in
this document involve risks and uncertainties including, but not limited to, the
following: changes in economic conditions, fluctuations in

36

currency exchange rates and interest rates; implementation of new software
systems; improvements in technology for complex voice recognition software;
dependence on our largest customers and key suppliers; competition; 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.

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 and the Euro. During 2002, approximately 75% of
our revenue was denominated in U.S. dollars, approximately 15% of our revenue
was denominated in Euros, and the balance was denominated in other foreign
currencies. During 2002, the average Euro exchange rate strengthened
approximately 5% versus the U.S. Dollar, and as a result our reported sales for
2002 was $1.6 million higher than it would have been at 2001 rates. During 2001,
the effect of exchange rates on our sales comparisons was smaller. Our expenses
are principally denominated in the same currencies in which we have sales,
allowing us to essentially hedge through offsetting revenue and expense
exposures. As a result, during 2002, our operating income and margins were not
significantly affected by the change in the Euro exchange rate. 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 and Euro. 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. The Company
recorded an exchange rate loss of $472,000 in 2002.

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 term loans of the Credit Agreement have
variable interest rates, and therefore, adjust to market conditions. An increase
of 1 percentage point in the interest rate of the loans under the Credit
Agreement would increase annual interest expense by approximately $1.8 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, 2002 to be $107 million based on current market prices.
We also have $10 million outstanding under 10% senior subordinated notes.

37

ITEM 8

KNOWLES ELECTRONICS HOLDINGS, INC.

CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000

CONTENTS

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

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, 2002, and 2001, 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, 2002. 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, 2002 and 2001, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2002, 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.

/s/ ERNST & YOUNG LLP

February 3, 2003
except for Note 4, as to
which the date is March 31, 2003

39

KNOWLES ELECTRONICS HOLDINGS, INC.

CONSOLIDATED BALANCE SHEETS

See accompanying notes.
40

KNOWLES ELECTRONICS HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes.
41

KNOWLES ELECTRONICS HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)

See accompanying notes.
42

KNOWLES ELECTRONICS HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes.
43

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND 2001
(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 Austrian, 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, 2002, the liquidation value of the outstanding
Series A-1 Preferred Stock is $229,819 and the liquidation value of the
outstanding Series A-2 Preferred stock is $28,728.

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, 2002,
amounted to $23,505. 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-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

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.

The amount payable to the preexisting common stockholders for the purchase
of their common stock in the Recapitalization was subject to a post-closing
adjustment which resulted in an additional payment of $8,316 by the Company to
the preexisting stockholders in 2000.

DESCRIPTION OF BUSINESS

The Company develops, manufactures, and supplies audio communications
components, primarily miniaturized electromagnetic microphones, and receivers
and ceramic and electret microphones used in hearing aids, microphones,
headsets, and accessories for the computer and communication industries. In
addition, the Company manufactures engine control and other devices for
industrial equipment and infrared remote control devices for the consumer
electronics market.

REVENUE RECOGNITION

Revenues from the Company's products are recognized when title to the
products transfers to the customer, which typically is upon the shipment of
products to the customers.

SHIPPING COSTS

Amounts invoiced to customers to cover shipping costs are included in
sales. The cost of shipping product to customers is included in cost of sales.

ACCRUED WARRANTY LIABILITY

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 each year are as
follows:

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.

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.

45

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

INVENTORIES

Inventories are stated at the lower of cost (first in, first out) or
market.

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 as it experienced reduced costs from offshore assembly operations and
expects continuing cost reductions. The cost of inventories on a LIFO basis at
December 31, 2001 was approximately equal to their replacement cost.
Accordingly, the Company believes that the FIFO method will result in a better
measurement of operating results. Additionally, FIFO is the prevalent method
used by other entities within the Company's industry. All previously reported
results have been restated to reflect the retroactive application of this
accounting change as required by generally accepted accounting principles. Due
principally to the reversal of the effect of LIFO reserve liquidations in prior
years, the net loss previously reported for 2000 was increased by $1,011.

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 obligations. The
fair value of the Senior Subordinated Notes was approximately $107 million at
December 31, 2002.

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.

PROPERTY, PLANT, AND EQUIPMENT

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. Approximately $11 million of assets held for disposal related to
Ruf are included in net property plant and equipment at December 31, 2001.

46

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

ACCUMULATED OTHER COMPREHENSIVE INCOME

The balance of accumulated other comprehensive income is $7,166 of
translation adjustment in 2001, and in 2002, $3,098 of translation adjustment
plus $3,737 of minimum pension liability.

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.

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.

NEW ACCOUNTING STANDARDS

In June 2001, the Financial Accounting Standards Board 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 will adopt SFAS No. 143 as of
January 1, 2003, and the impact of adoption of SFAS No. 143 is not expected to
have a 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 re 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. We do not anticipate
that the adoption of this statement will 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
will adopt the provisions of FIN No. 45 on January 1, 2003 for all new or
amended guarantees subsequent to that date.

47

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

RECLASSIFICATIONS

Certain prior years' amounts have been reclassified to conform to the 2002
financial statement presentation.

2. INVENTORY

Inventories are as follows:

3. INCOME TAXES

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

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

48

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The income tax provision (benefit) for the years ended December 31, 2002,
2001, and 2000 consists of the following:

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, 2002 and 2001, are as follows:

The Company had foreign net operating loss carryforwards of $47,559 at
December 31, 2002 that have an indefinite carryforward period. In addition, the
Company had federal net operating loss carryforwards of $36,465 at December 31,
2002 that begin to expire in 2021 and state net operating loss carry forwards of
$51,583 at December 31, 2002, that begin to expire in 2019. The Company's
foreign tax credit carryforward of

49

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

$17,131 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.

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 deferred foreign provision includes a
benefit for which a valuation allowance has been established for the year ended
December 31, 2002 and a charge of $5,441 and $7,050 for the years ended December
31, 2001 and 2000, respectively, for the anticipated tax liability on the
unremitted foreign earnings, which are not considered permanently reinvested.

4. NOTES PAYABLE

As part of the Recapitalization transaction, the Company entered into a
senior credit agreement dated as of 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 and March 25, 2003 with certain lenders (Senior
Credit Agreement). The credit agreement as amended consists of approximately
$195,000 (effective March 31, 2003), which provides for revolving loans of
$15,000 (Revolving Credit Facility) through June 30, 2006 (unless the Term B
Facility is paid in full prior to such date in which case the Revolving Credit
Facility will cease to exist and any amounts outstanding thereunder shall become
due and payable), a Term B Facility of $145,000 (Term B Facility), which matures
on June 29, 2007, and a Term C Facility of $35,000 (Term C Facility), which
matures on June 29, 2007. In addition, on June 30, 1999, the Company issued
Subordinated Bridge Notes (Bridge Notes) for $150,000 to certain lenders. The
Bridge Notes were subsequently repaid following the issuance by the Company of
$153,200 of 13 1/8% Senior Subordinated Notes (the 13 1/8% Notes). As required
by the May 10, 2002 Fourth Amendment to the credit agreement, the Company issued
$10 million of 10% Senior Subordinated Notes in a private placement to Key
Acquisition LLC.

The Revolving Credit facility bears interest, at the Company's option, at
either: (1) one-, two-, three-, or six-month LIBOR plus 4.0% (as amended March
25, 2003), or (2) the greater of the prime rate (4.25% at December 31, 2002), 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%
as of March 31, 2003. Under the Limited Waiver and Amendment dated March 25,
2003, the remaining balance of the Term A Facility was replaced by a $35 million
Term C Facility due June 29, 2007. The $33.5 million balance of the Term A
Facility that was outstanding at December 31, 2002 is classified based on the
terms of the replacement debt.

The Term B Facility bears interest, at the Company's option, at either: (1)
one-, two-, three-, or six-month LIBOR plus 5.00% (as of March 31, 2003), 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 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 B Facility is due on June 29, 2007, and is payable in quarterly
installments during the following periods as amended:

March 31, 2003.............................................. $ 352
June 30, 2003 to June 30, 2006.............................. 704
September 30, 2006 to June 29, 2007......................... 31,938

In December 2002 the Company prepaid $1,560 of principal under the Senior
Credit Agreement, as required, out of the proceeds from the sale of the Taiwan
facility.

50

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 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, 2002.

Our Austrian subsidiary has two long term debt borrowings: $1,145 is
payable in semi-annual installments from March 2003 through September 2006 and
bears interest of 4.95%; $593 is payable in semi-annual installments through
June 2006 and bears interest of 4.75%.

Short-term debt includes $2,120 drawn against a line of credit by our
Austrian subsidiary at an interest rate of 6%.

The balance under the Term A Facility, Term B Facility, 13 1/8% Senior
Subordinated Notes (13 1/8% Notes), 10% Senior Subordinated Notes (10% Notes)
and our Austrian subsidiary's long term debt as of December 31, 2002 and 2001,
is as follows:

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

2003........................................................ $ 12,452
2004........................................................ 3,270
2005........................................................ 3,270
2006........................................................ 65,655
2007........................................................ 95,550
Thereafter.................................................. 161,163
--------
$341,360
========

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.

51

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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. Certain covenants and restrictions were modified in
accordance with the amendment to the Senior Credit Agreement dated December 12,
2001. The Company was not in compliance with the required leverage ratio and
interest coverage ratio under the bank credit agreement as of March 31, 2002.
Additionally, the Company did not make the interest payment on the 13 1/8% Notes
scheduled for April 15, 2002 on that date. An Amendment and Waiver to the credit
agreement was obtained dated as of May 10, 2002 and the Company made the
interest payment on the 13 1/8% Notes that was scheduled for April 15, 2002 on
May 14, 2002. The Amendment and Waiver waived the Company's 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. This Amendment and Waiver also limited capital expenditures for the
year 2002 to $15 million, prevents any acquisitions of another company or
business, decreases the revolving credit facility to $18.25 million (from $25
million), caps at $2 million the amount of net cash proceeds from asset sales
that can be applied to buying new assets and required the Company to receive
additional funding of at least $10 million by September 3, 2002 to pay down the
outstanding balance on the revolving credit facility to $8.25 million. The
Company met the additional funding requirement of the Amendment and Waiver by
issuing $10 million of 10% Senior Subordinated Notes to an affiliate of Doughty
Hanson.

The Company was in compliance with all of its debt covenants at December
31, 2002. 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 million 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, provided for additional interest to accrue on the B Facility
at the rate of $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) modified the Term B Facility installment payments,
and reduced the Revolving Credit Facility to $15 million. The Company expects,
based on current operating forecasts, that the amendments to the covenants in
the Credit Agreement will enable it to remain in compliance with the covenants
of the Credit Agreement, as amended, through December 31, 2003, and provide
sufficient financial flexibility to meet its debt service requirements as well
as other operating needs. However, there can be no assurance of such compliance.
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.

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., Knowles Manufacturing Ltd., and Synchro Start
Products, Inc. The following tables present summarized balance sheet information
of the Company as of December 31, 2002 and 2001, and summarized income statement
and cash flow information for the years ended December 31, 2002, 2001, and 2000.
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

52

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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, 2002 and 2001, and for the three
years ended December 31, 2002, is as follows:

53

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

54

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

55

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

56

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

57

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5. OPERATING LEASES

The Company leases various manufacturing facilities and office space. Lease
terms are generally from two to five years. Future minimum payments under
operating leases with initial terms of one year or more are as follows:

Rent expense was $1,863, $2,210 and $2,846 for the years ended December 31,
2002, 2001, and 2000, respectively.

58

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. RETIREMENT PLANS

The Company has a defined-benefit plan covering approximately 90% of its
U.S. employees. 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 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. The Company's funding
of the plan is equal to the minimum contribution required by ERISA. The
following summarizes the activity related to the Company's domestic plan:

59

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company also has defined-benefit plans covering certain of its foreign
employees. The accrued pension liability related to these plans was $2,465 and
$1,954 at December 31, 2002 and 2001, respectively. The Company sold its Ruf
operations, including its pension liability, in November 2002. The Ruf
operations had an accrued pension liability of $1,238 at December 31, 2001.
Deferred pension assets related to these plans were $319 and $177 at December
31, 2002 and 2001, respectively. The Company recorded a minimum liability
related to the plan in the United Kingdom of $1,854 and $0 at December 31, 2002
and 2001. The net periodic benefit cost related to these plans was $385, $344
and $1,355 for the years ended December 31, 2002, 2001, and 2000, respectively.

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 2002, 2001,
and 2000 were $639, $731 and $481, respectively.

7. 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 337,689 and 316,733 as of December 31,
2002 and 2001 respectively. During 2002, 25,350 options were cancelled and
46,306 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.

8. SEGMENTS AND GEOGRAPHICAL INFORMATION

The Company's continuing business consists of three operating segments:
hearing aid components, acoustic and infrared technology, and automotive
components. These three operating segments were determined based on the
applications and markets for the Company's products.

60

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The hearing aid components operating segment utilizes the Company's
acoustic technologies to design, manufacture, and market components for hearing
aids. The acoustic and infrared technology operating segment utilizes the
Company's acoustic and infrared technologies to design, manufacture, and market
products for high growth markets, including voice recognition, and computer
telephony integration. The automotive component operating segment designs,
manufactures, and markets diesel engine solenoids, electronic governors, and
position sensors primarily for use in automobiles and trucks.

The Company uses the following financial information presented below to
assess performance and make resource allocation decisions:

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

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

The hearing aid components operating segment and the acoustic and infrared
technology operating segment utilize the same assets. The total assets of the
hearing aid components operating segment and the acoustic and infrared
technology operating segment as of December 31, 2002, 2001, and 2000 were
$134,396, $137,699 and $142,289, respectively. Depreciation expense associated
with these assets was $6,938, $8,244 and $8,219 for the years ended December 31,
2002, 2001, and 2000, respectively. Total capital expenditures for the hearing
aid components operating segment and the acoustic and infrared technology
operating segment were $6,497, $18,200 and $10,251 for the years ended December
31, 2002, 2001, and 2000, respectively. Due to the joint use of assets between
the hearing aid components operating segment and the acoustic and infrared
technology operating segment, allocations of various costs and expenses between
these two segments are made based on their respective revenues.

The total assets of the automotive components business unit were $12,794,
$31,757 and $32,815 as of December 31, 2002, 2001, and 2000, respectively.
Depreciation expense associated with these assets was $1,405, $2,656 and $3,095
for the years ended December 31, 2002, 2001, and 2000, respectively. The assets
of the Automotive Components segment were reduced by the sale of the Ruf
business in November 2002. The total capital expenditures for the automotive
component business unit were $1,930, $3,076 and $5,900 for the years ended
December 31, 2002, 2001, and 2000.

In 2002, the Company finalized the restructuring of its worldwide
manufacturing operations and recorded restructuring expenses of $2,158, which
affected the operating segments as follows: hearing aid components $740,
acoustic and infrared technology $1,471, automotive components $94, with the
remaining amount of ($147) impacting corporate. The charge for acoustic and
infrared technology 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. For the ten months ended October 2002, Ruf had sales of $14,183 and
an operating loss of $1,310.

61

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In 2001, the Company continued with restructuring of its worldwide
manufacturing operations and recorded restructuring expenses of $317, which
affected the operating segments as follows: hearing aid components ($3,292),
acoustic and infrared technology $357, automotive components $1,032, with the
remaining amount of $2,220 impacting corporate. The charge for hearing aid
components includes a gain on the sale of UK facility of $3,046.

In 2000, the Company announced a restructure of its worldwide manufacturing
operations and recorded restructuring expenses of $18,440, which affected the
operating segments as follows: hearing aid components $8,498, acoustic and
infrared technology $116, automotive components $5,988 with the remaining amount
of $3,838 impacting corporate.

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

62

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 61%, 59%
and 57%, of consolidated sales in 2002, 2001, and 2000 respectively. Revenues
from one customer accounted for approximately 15%, 12% and 15% of consolidated
revenues and 14% and 7% of consolidated accounts receivable in 2002 and 2001
respectively.

9. RESTRUCTURING EXPENSES

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 for 2000, 2001 and
2002.

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

At the five facilities where production was eliminated, the number of
positions eliminated at each facility and the final production date at each
facility are as follows: (1) Burgess Hill, United Kingdom; 133 positions; June
2000, (2) Itasca, Illinois; 262 positions; September 2000, (3) Taipei, Taiwan;
220 positions; March 2001, (4) Rolling Meadows, Illinois; 16 positions; March
2001, (5) Hohenkirchen, Germany; 180 positions; September 2001.

63

KNOWLES ELECTRONICS HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

10. DISPOSAL OF LONG LIVED ASSETS

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,
which was included in the Corporate segment. 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 2003, 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 in the
Acoustic and Infrared segment. Proceeds from the sale were $3,560.

64

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

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 four directors, two of whom are with Doughty Hanson (Kenneth Terry and Kevin
Luzak). Set forth below is certain information with respect to our directors and
officers.

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.

Kevin Luzak is a corporate director of Doughty Hanson & Co., Inc. Prior to
his current position, he served in various positions at Salomon Brothers Inc
from 1991 to 1998. Mr. Luzak currently serves on the Board of Directors of
Dunlop Standard Aerospace Group Limited, North American Membership Group, Inc.,
and Coastal Lumber Company, Inc.

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.

Patrick W. Cavanagh has managed SSPI since 1992 and Automotive Components
since its inception in 1996. From 1978 to 1992, prior to joining Knowles, he
held various domestic and international management positions at the Barber
Colman Company. He is a graduate of the Milwaukee School of Engineering.

65

Peter H. Stevens, Jr. joined Knowles in January, 2001 as Vice President,
General Manager of the EMKAY division and in 2002 became Vice President, General
Manager of the KE division. Prior to joining Knowles, he was Senior Vice
President, Western Region General Manager of Distribution Dynamics, an
integrated supply chain management company to the manufacturing industry. From
1990 to 1998, he served as Vice President General Manager of the U.S. operations
for Hirose Electric of Japan, a global manufacturer of electronic and fiber
optic connectors. He is a graduate of the University of California, Santa
Barbara and the University of California, Irvine.

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 September 1999. Mr. Petersen is a
graduate of Augustana College, holds a Master of Management degree from
Northwestern University, and is a certified public accountant.

ITEM 11. EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

The following table provides information concerning the compensation we
paid to our senior officers for 2002, 2001 and 2000:

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

(1) Reg Garratt resigned as Chairman effective December 31, 2002.

(2) Peter H. Stevens, Jr. joined Knowles January 29, 2001.

(3) 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.

(4) James F. Brace resigned effective September 1, 2002.

(5) Reimbursement for executive medical.

66

PENSION PLAN

The following table provides information concerning the estimated annual
pension benefit we pay to employees of KE and SSPI on their retirement, based
upon their years of service and their average monthly earnings prior to their
retirement (as described below).

Our pension plan, which became effective on July 1, 1963, is a
non-contributory defined benefit plan covering employees of the KE business unit
and SSPI. As of December 31, 2001, Reg G. Garratt, John Zei, Louis Morabito,
Patrick W. Cavanagh, and Peter H. Stevens, Jr. have 25, 3, 6, 10 and 2 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

67

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. 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 AND CHANGE IN CONTROL SEVERANCE PAY PLAN

On April 7, 1992, we entered into an employment agreement with Reg G.
Garratt. The agreement, which was amended and restated on March 15, 1998 and
amended verbally with Doughty Hanson prior to the closing of the
Recapitalization, provides for Mr. Garratt's employment as the chairman and
chief executive officer of Knowles until a replacement chief executive officer
is appointed. Mr. Garratt resigned effective December 31, 2002 and was paid the
remainder of his contract through December 31, 2003. During the term of his
employment and for two years thereafter, Mr. Garratt is restricted from
competing with Knowles or any of its subsidiaries and soliciting employees,
distributors and customers of Knowles or any of its subsidiaries. The employment
agreement also restricts Mr. Garratt from disclosing any confidential or
proprietary information relating to Knowles or any of its subsidiaries.

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 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.

Mr. Brace resigned effective September 1, 2002 and will receive his base
salary and benefit continuation through May 31, 2003. The Company repurchased
$200,000 of common stock for the price paid and exchanged the Note Receivable
for the $125,000 of common stock purchased with a loan.

Effective January, 2001, Peter H. Stevens, Jr. became the Vice President
and General Manager -- Emkay, with an annual salary of $210,000 and eligibility
to participate in certain bonus plans generally available for senior management
of Knowles. Effective September 15, 2002, Mr. Stevens became Vice President and
General Manager -- KE.

In connection with his employment, Mr. Stevens is eligible to receive
Common Stock in the amount of $200,000, of which $100,000 will be available as
part of his 2001 year-end incentive and the remaining $100,000 as part of the
his 2002 year-end incentive calculation.

68

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, 2003, 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.

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

(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 10.3% of currently outstanding shares of
common stock. Such stockholders have the right to elect one of our directors
pursuant to a stockholders' agreement with Key Acquisition, L.L.C. We have
no reason to believe that various members of the Knowles family and trusts
for the benefit of members of the Knowles family constitute a group, as that
term is in Section 13(d)(3) of the Exchange Act.

(2) Class A Common Stock

(3) Consists only of shares of Knowles owned by Key Acquisition, L.L.C., the
majority of whose membership interests are held by limited partnerships for
which Doughty Hanson acts as general partner.

69

SECURITY OWNERSHIP OF DIRECTORS AND MANAGEMENT

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.

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

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

70

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 TO JAMES F. BRACE

Knowles had loaned $50,000 to Mr. Brace, due on or before May 31, 2002,
which was repaid. Knowles had also loaned $125,000 to Mr. Brace to purchase
Knowles common stock at fair market value. Mr. Brace resigned effective
September 1, 2002 and will receive his base salary and benefit continuation
through May 31, 2003. The Company repurchased $200,000 of common stock for the
price paid and exchanged the Note Receivable for the $125,000 of common stock
purchased with the loan.

LOAN TO PETER H. STEVENS, JR.

In connection with the commencement of his employment, Knowles agreed to
loan Mr. Stevens up to $400,000 for a real estate bridge loan. The bridge loan
was repaid in full.

71

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.

ITEM 14. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures:

We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the Commission's rules and forms, and that such information is accumulated
and communicated to our management including our Chief Executive Officer and
Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure.

Within the 90 days prior to the filing date of this Report (the "Evaluation
Date"), we carried out an evaluation, under the supervision and with the
participation of the Company's management, including, John J. Zei, our Chief
Executive Officer, and James H. Moyle, our Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were
effective as of the Evaluation Date.

(b) Changes in internal controls:

There have been no significant changes in the Company's internal controls
or in other factors that could significantly affect these internal controls
subsequent to the evaluation date.

72

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

There were no reports on Form 8-K filed during the three months ended
December 31, 2002

73

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS

KNOWLES ELECTRONICS HOLDINGS, INC.

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(1) Foreign currency translation loss.

(2) Uncollectible accounts written off.

(3) Disposal of obsolete inventory.

(4) Uncollectible accounts written off, payments received of $120 and foreign
currency gain of $11.

(5) Disposal of obsolete inventory and foreign currency gain of $135.

(6) Uncollectible accounts written off.

(7) Disposal of obsolete inventory and foreign currency gain of $293.

74

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 31, 2003

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:

75

CERTIFICATION

I, John J. Zei, certify that:

1. I have reviewed this annual report on Form 10-K of Knowles Electronics
Holdings, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state any material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):

a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Date: March 31, 2003

By: /s/ JOHN J. ZEI
John J. Zei
President and Chief Executive
Officer

76

CERTIFICATION

I, James H. Moyle, certify that:

1. I have reviewed this annual report on Form 10-K of Knowles Electronics
Holdings, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state any material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):

a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Date: March 31, 2003

By: /s/ JAMES H. MOYLE
James H. Moyle
Vice President and Chief Financial
Officer

77

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)

78

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)