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Filed pursuant to Rule 424(b)(3)
Registration Nos. 333-40076, 333-40076-01,
333-40076-02, 333-40076-03,
333-40076-04 and 333-40076-05.
PROSPECTUS
Exchange offer for
$153,200,000
[Knowles Logo]
Knowles Electronics Holdings, Inc.
13 1/8% SENIOR SUBORDINATED NOTES DUE 2009
Guaranteed on a Senior Subordinated Basis by Knowles Intermediate Holding, Inc.,
Emkay Innovative Products, Inc., Knowles Manufacturing Ltd., Synchro-Start
Products, Inc. and Knowles Electronics, LLC and our Future Domestic Subsidiaries
------------------------
TERMS OF THE EXCHANGE OFFER
-- We are offering to exchange the notes that we sold in private and offshore
offerings for new registered exchange notes.
-- The exchange offer expires at 5:00 p.m., New York City time on October 19,
2000 unless extended.
-- Tenders of outstanding notes may be withdrawn at any time prior to the
expiration of the exchange offer.
-- All outstanding notes that are validly tendered and not validly withdrawn
will be exchanged.
-- We believe that the exchange of notes will not be a taxable exchange for
U.S. federal income tax purposes.
-- We will not receive any proceeds from the exchange offer.
-- The terms of the notes to be issued are identical to the outstanding notes,
except for the transfer restrictions and registration rights relating to
the outstanding notes.
INVESTING IN THE NOTES ISSUED IN THE EXCHANGE OFFER INVOLVES RISKS. SEE "RISK
FACTORS" BEGINNING ON PAGE 8.
WE ARE NOT MAKING AN OFFER TO EXCHANGE NOTES IN ANY JURISDICTION WHERE THE OFFER
IS NOT PERMITTED.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THE NOTES TO BE DISTRIBUTED IN THE
EXCHANGE OFFER OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
------------------------
The date of this Prospectus is September 19, 2000.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Summary............................... 3
Risk Factors.......................... 8
Use of Proceeds....................... 16
The Exchange Offer.................... 16
The Recapitalization and Ownership of
Capital Stock....................... 25
Capitalization........................ 27
Unaudited Pro Forma Condensed
Consolidated Statement of
Operations.......................... 28
Selected Consolidated Financial
Data................................ 31
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 33
Industry.............................. 44
</TABLE>
<TABLE>
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PAGE
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<S> <C>
Business.............................. 47
Management............................ 58
Principal Stockholders................ 64
Related Party Transactions............ 65
Description of Other Indebtedness..... 66
Description of the Exchange Notes..... 68
Registration Rights Agreement......... 101
United States Federal Tax
Considerations for Non-U.S.
Holders............................. 103
Plan of Distribution.................. 104
Legal Matters......................... 104
Experts............................... 104
Index to Financial Statements......... F-1
</TABLE>
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SUMMARY
KNOWLES
Knowles Electronics Holdings, Inc., together with its subsidiaries, is 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 high growth potential.
Affiliates of Doughty Hanson & Co. own approximately 81.4% of our common stock.
THE EXCHANGE OFFER
On October 1, 1999, we issued $153,200,000 principal amount of 13 1/8%
Senior Subordinated Notes due 2009 to Morgan Stanley & Co. and Chase Securities
in private and offshore offerings. These initial purchasers sold the notes to
institutional investors and non-U.S. persons in transactions exempt from the
registration requirements of the Securities Act of 1933. The notes are
guaranteed by all five of our domestic subsidiaries: Knowles Intermediate
Holding, Inc., Emkay Innovative Products, Inc., Knowles Manufacturing Ltd.,
Synchro-Start Products, Inc. and Knowles Electronics, LLC.
Registration Rights Agreement
When we issued the initial notes, we entered into a Registration Rights
Agreement in which we agreed, among other things, to use our best efforts to
complete the exchange offer for the initial notes on or prior to April 28, 2000.
The exchange offer was not completed by that date because the post-closing
adjustment payable to our preexisting stockholders for the repurchase of their
common stock in our recapitalization had not yet been determined. We and the
preexisting stockholders were unable to agree as to the amount of the
adjustment. As a result, independent accountants, separate from our auditors,
were appointed as arbitrators pursuant to our recapitalization agreement to
determine the amount of the adjustment. We did not want to exchange the new
notes for the old notes until the post-closing adjustment was determined, which
occurred in June 2000. Because we did not complete the exchange offer by April
28, 2000, the interest rate on the initial notes increased by 0.5% per annum on
that date. The exchange offer will satisfy the requirements of the Registration
Rights Agreement such that we will no longer be required to pay additional
interest from the date the exchange offer is completed.
The Exchange Offer
Under the terms of the exchange offer, you are entitled to exchange the
initial notes for registered exchange notes with substantially identical terms.
You should read the discussion under the heading "Description of the Exchange
Notes" for further information regarding the exchange notes. As of this date,
there are $153,200,000 aggregate principal amount of the initial notes
outstanding. The initial notes may be tendered only in integral multiples of
$1,000.
Resale of Exchange Notes
We believe that the exchange notes issued in the exchange offer may be
offered for resale, resold or otherwise transferred by you without compliance
with the registration and prospectus delivery provisions of the Securities Act
of 1933, provided that:
-- you are acquiring the exchange notes in the ordinary course of your
business,
-- you are not participating, do not intend to participate and have no
arrangement or understanding with any person to participate in the
distribution of the exchange notes and
-- you are not an "affiliate" of ours.
If any of the foregoing are not true and you transfer any exchange note
without delivering a prospectus meeting the requirements of the Securities Act
or without an exemption from the registration requirements of the Securities
Act, you may incur liability under the Securities Act. We do not assume or
indemnify you against this liability.
If you are a broker-dealer and receive exchange notes for your own account
in exchange for initial notes that you acquired as a result of market making or
other trading activities, you must acknowledge that you will deliver a
prospectus meeting the requirements of the Securities Act in connection with any
resale of the exchange notes. A broker-dealer may use this prospectus for an
offer to resell, resale or other transfer of the exchange notes.
Consequences of Failure to Exchange Initial Notes
If you do not exchange your initial notes for exchange notes, you will no
longer be able to force us to register the initial notes under the Securities
Act. In addition, you will not be able to offer or sell the initial notes
unless:
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-- the offer or sale is registered under the Securities Act or
-- you offer or sell them under an exemption from the requirements of, or
in a transaction not subject to, the Securities Act.
Expiration Date
The exchange offer will expire at 5:00 p.m., New York City time, on October
19, 2000, unless we decide to extend the expiration date.
Interest on the Exchange Notes
The exchange notes will accrue interest at 13 1/8% per year, beginning on
the last date we paid interest on the initial notes you exchanged. We will pay
interest on the exchange notes on April 15 and October 15 of each year through
the maturity date of October 15, 2009.
Procedures for Tendering Initial Notes
If you wish to accept the exchange offer, you must:
-- complete, sign and date the letter of transmittal or a facsimile of it
and
-- send the letter of transmittal accompanying this prospectus and all
other documents required by it, including the initial notes to be
exchanged, to The Bank of New York, as exchange agent. Alternatively,
you can tender your initial notes by following the procedures for
book-entry transfer described in this prospectus.
Withdrawal Rights
You may withdraw the tender of your initial notes at any time prior to 5:00
p.m., New York City time, on the expiration date. To withdraw, you must send a
written or facsimile transmission notice of withdrawal to the exchange agent at
its address set forth herein under "The Exchange Offer -- Exchange Agent" by
5:00 p.m., New York City time, on the expiration date.
Acceptance of Initial Notes and Delivery of Exchange Notes
If all of the conditions to the exchange offer are satisfied or waived, we
will accept any and all initial notes that are properly tendered in the exchange
offer prior to 5:00 p.m., New York City time, on the expiration date. We will
deliver the exchange notes promptly after the expiration date.
Tax Considerations
We believe that the exchange of initial notes for exchange notes will not
be a taxable exchange for federal income tax purposes. You should consult your
tax adviser about the tax consequences of this exchange as they apply to your
individual circumstances.
Exchange Agent
The Bank of New York is serving as exchange agent for the exchange offer.
Fees and Expenses
We will bear all expenses related to consummating the exchange offer and
complying with the Registration Rights Agreement.
DESCRIPTION OF EXCHANGE NOTES
Issuer
Knowles Electronics Holdings, Inc.
Notes Offered
$153,200,000 principal amount of 13 1/8% Senior Subordinated Notes due 2009
in denominations of $1,000 and integral multiples of $1,000. The form and terms
of the exchange notes are the same as the form and terms of the initial notes,
except that the offering and distribution of the exchange notes will be
registered under the Securities Act. Therefore, the exchange notes will not bear
legends restricting their transfer and will not be entitled to registration
under the Securities Act. The exchange notes will evidence the same debt as the
initial notes and both the initial notes and the exchange notes are governed by
the same indenture.
Maturity
October 15, 2009.
Interest Payment Dates
April 15 and October 15 of each year.
Sinking Fund
None.
Optional Redemption
At any time on or after October 15, 2004, we may redeem any of the exchange
notes. The initial redemption price will be $163,254,516 plus accrued interest.
The redemption price of the exchange notes will decline each year starting
October 15, 2005 and will be 100% of their principal amount, plus accrued
interest, beginning October 15, 2007.
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In addition, at any time and from time to time prior to October 15, 2002, we may
redeem up to $53,620,000 of the principal amount of the exchange notes with the
proceeds of offerings of equity in our company at a redemption price of
113.125%, plus accrued and unpaid interest.
Change of Control
Upon a change of control, we will be required to make an offer to purchase
the exchange notes. The purchase price will equal the 101% of their principal
amount plus accrued interest.
Exchange Note Guarantees
Some of our subsidiaries will guarantee the exchange notes. If we cannot
make payments on the exchange notes when they are due, the guarantor
subsidiaries are obligated to make them.
Ranking
The exchange notes and the guarantees will be subordinated to all our and
our guarantor subsidiaries' existing and future debt, including our credit
facility, except for trade payables and debt that expressly provides that it is
not senior to the notes and the guarantees. The notes also will be effectively
subordinated to all liabilities of our subsidiaries that are not guarantors. At
June 30, 2000, the notes and the guarantees would have been expressly
subordinated to $200 million of our and our guarantor subsidiaries' senior
indebtedness and effectively subordinated to $55.7 million of liabilities of our
subsidiaries that are not guarantors.
USE OF PROCEEDS
We will not receive any cash proceeds from the issuance of the exchange
notes.
FORWARD-LOOKING STATEMENTS
Information contained in this prospectus, such as information with respect
to our plans and strategy for our business and its financing, includes forward-
looking statements. For a discussion of important factors that could cause
actual results to differ materially from the forward-looking statements, see
"Risk Factors."
PRINCIPAL EXECUTIVE OFFICE
Our headquarters are located at 1151 Maplewood Drive, Itasca, Illinois
60143 and our telephone number is (630) 250-5100.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-4 under the Securities Act relating to the exchange offer.
This prospectus does not contain all of the information included in the
registration statement. We have filed agreements and other documents discussed
in this prospectus as exhibits to the registration statement. Statements
regarding these agreements and other documents are qualified by reference to the
actual documents.
Following the exchange offer, we will be required to file periodic reports
and other information with the SEC under the Securities Exchange Act of 1934. In
the indenture governing the exchange notes, we have agreed to file with the SEC
financial and other information for public availability. In addition, the
indenture governing the exchange notes requires us to deliver to you, or to The
Bank of New York for forwarding to you, copies of all reports that we file with
the SEC without any cost to you. We will also furnish such other reports as we
may determine or as the law requires.
You may read and copy the registration statement, including the attached
exhibits, and any reports, statements or other information that we file at the
SEC's public reference room at 450 Fifth Street, N.W. Washington, D.C. 20549.
You can request copies of these documents, upon payment of a duplicating fee, by
writing the SEC. Please call the SEC at 1-800-SEC-0330 for further information
on the operation of the public reference rooms. Our SEC filings will also be
available to the public on the SEC Internet site (http://www.sec.gov).
You should rely only on the information provided in this prospectus. No
person has been authorized to provide you with different information. None of
Knowles Electronics Holdings, Inc. or any of its subsidiaries, or Doughty Hanson
& Co. or any of our other affiliates, is responsible for, or is making any
representation to you concerning, our further performance or the accuracy or
completeness of this prospectus.
The information in this prospectus is accurate as of the date on the front
cover. You should not assume that the information contained in this prospectus
is accurate as of any other date.
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SUMMARY CONSOLIDATED FINANCIAL DATA
We have derived the summary historical financial data for each of the
calendar years in the three year period ended December 31, 1999 from historical
consolidated financial statements that have been audited by Ernst & Young LLP
and are included in this prospectus. We have derived the summary historical
financial data for the six month periods ended June 30, 1999 and 2000 from our
unaudited historical consolidated financial statements which are included in
this prospectus and include all adjustments, consisting of an accrual for
restructuring expenses and normal recurring accruals, necessary to fairly
present the data for these periods. The operating results for the six months
ended June 30, 2000 do not necessarily indicate the results that may be expected
for the entire year. You should read the data presented below in conjunction
with the historical consolidated financial statements and the related notes
included in the back of this prospectus and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
We have derived the summary pro forma financial data for the year ended
December 31, 1999 from our unaudited pro forma condensed consolidated statement
of operations included in this prospectus. The pro forma financial information
gives effect to our recapitalization and related transactions and the offering
of the notes and the application of the proceeds as if these transactions
occurred on January 1, 1999. The unaudited pro forma financial information is
not necessarily indicative of either future results of operations or results
that might have been achieved if these transactions had been consummated as of
these dates. You should read the pro forma data presented below in conjunction
with "Unaudited Pro Forma Condensed Consolidated Statement of Operations."
The ratio of total debt to EBITDA for the pro forma year ended December 31,
1999 has been computed by dividing total indebtedness as of December 31, 1999 by
pro forma EBITDA for the year ended December 31, 1999.
Knowles' earnings were inadequate to cover fixed charges for the pro forma
year ended December 31, 1999 by approximately $6.0 million. Knowles' earnings
were inadequate to cover fixed charges for the six months ended June 30, 2000 by
approximately $13.3 million.
The "Recapitalization expenses" referred to in the summary consolidated
financial data 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.
"EBITDA" has been calculated as earnings before interest, taxes,
depreciation, amortization, miscellaneous income/expense, and, for the six
months ended June 30, 2000, expenses relating to our restructuring announced in
March 2000, and for the six months ended June 30, 1999 and twelve months ended
December 31, 1999, our recapitalization expenses. 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.
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)).
We announced a major restructuring in March 2000, resulting in a first
quarter charge of $20.1 million. We are consolidating 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, and we expect to reduce our global
workforce by about 20%.
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.
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<TABLE>
<CAPTION>
SIX MONTHS
PRO FORMA ENDED
YEAR ENDED DECEMBER 31, YEAR ENDED JUNE 30,
------------------------------ DECEMBER 31, -------------------
1997 1998 1999 1999 1999 2000
-------- -------- -------- ------------ -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales................................. $218,150 $234,899 $229,106 $229,106 $114,112 $120,573
Costs and expenses:
Cost of sales........................... 125,533 139,074 146,472 146,472 69,262 69,119
Selling and administrative expense...... 35,148 35,188 35,901 35,901 17,626 18,812
Recapitalization expenses............... -- -- 10,674 -- 10,674 --
Research and development................ 9,884 10,870 10,930 10,930 5,130 4,803
Restructuring expenses.................. -- -- -- -- -- 20,094
-------- -------- -------- -------- -------- --------
Operating income.......................... 47,585 49,767 25,129 35,803 11,420 7,745
Interest income........................... 566 278 883 883 496 546
Interest expense.......................... (392) (634) (23,194) (42,537) (29) (21,621)
Miscellaneous, net........................ (1,455) (1,058) (123) (123) (81) --
-------- -------- -------- -------- -------- --------
Income (loss) from continuing operations
before income taxes..................... 46,304 48,353 2,695 (5,974) 11,806 (13,330)
Income taxes.............................. 9,856 7,107 8,980 12,220 (1,985) 2,152
-------- -------- -------- -------- -------- --------
Income (loss) from continuing
operations.............................. 36,448 41,246 (6,285) $(18,194) 13,791 (15,482)
========
Income from discontinued operations less
applicable income taxes................. 6,729 6,936 2,556 2,556 --
-------- -------- -------- -------- --------
Net income (loss)......................... $ 43,177 $ 48,182 $ (3,729) $ 16,347 $(15,482)
======== ======== ======== ======== ========
OTHER FINANCIAL DATA:
Depreciation and amortization............. $ 10,348 $ 11,235 $ 12,638 $ 12,638 $ 6,226 $ 6,225
Capital expenditures...................... 12,129 16,326 14,500 14,500 7,748 7,448
Cash flows from operating activities...... 52,395 56,078 49,274 37,365 44,249 13,529
Cash flows from investing activities...... (12,129) (16,326) (14,500) (14,500) (7,748) (7,448)
Cash flows from financing activities...... (50,669) (41,733) (19,055) (19,055) (13,330) (8,858)
EBITDA.................................... 57,933 61,002 48,441 48,441 28,320 34,064
Ratio of earnings to fixed charges........ 36.1x 38.1x 1.1x 26.0x
Ratio of EBITDA to interest expense....... 1.2x 1.6x
Ratio of total debt to EBITDA............. 7.3x 10.3x
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF
------------------------------- JUNE 30,
1997 1998 1999 2000
-------- -------- --------- ---------
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 7,406 $ 5,594 $ 22,332 $ 19,447
Total assets................................................ 254,413 265,673 186,506 184,216
Long-term debt including current maturities................. 1,300 -- 350,134 350,277
Preferred stock mandatorily redeemable in 2019.............. -- -- 194,250 203,500
Total common stockholders' equity (deficit)................. 209,840 219,194 (412,860) (446,823)
</TABLE>
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RISK FACTORS
You should carefully consider all information in this prospectus, including
these risk factors, before you decide to invest in the notes. Each of these
risks could reduce the value of the exchange notes.
RISKS RELATING TO THE EXCHANGE OFFER AND THE NOTES
IF YOU DO NOT PARTICIPATE IN THE EXCHANGE OFFER, YOU WILL CONTINUE TO BE SUBJECT
TO TRANSFER RESTRICTIONS
If you do not exchange your initial notes for exchange notes pursuant to
the exchange offer, you will continue to be subject to the restrictions on
transfer of your initial notes. We do not intend to register the initial notes
under the Securities Act. To the extent initial notes are tendered and accepted
in the exchange offer, the trading market, if any, for the initial notes would
be adversely affected.
THERE IS NO PRIOR MARKET FOR THE EXCHANGE NOTES. IF ONE DEVELOPS, IT MAY NOT BE
LIQUID
The exchange notes are new securities for which there currently is no
market. Prices for non-investment grade debt have been highly volatile in the
past. It is possible that the market for the exchange notes will also be
volatile. This price volatility may affect your ability to resell your exchange
notes or the timing of the sale. We do not intend to apply for listing of the
exchange notes on any securities exchange or for quotation through any automated
quotation system. It is not certain that any market for the exchange notes will
develop or that any such market would be liquid. If you are able to resell the
exchange notes, you may not be able to resell them at or above the price you
paid for them or the initial notes.
OUR DEBT COVENANTS CAN RESTRICT OUR OPERATING FLEXIBILITY
Various financial and operating covenants in our debt agreements, including
our credit agreement and the notes indenture, and any covenants in future
financing agreements, may adversely affect our ability to finance operations or
capital needs or to engage in other business activities. These covenants limit
or restrict our ability to:
-- incur additional debt or prepay or modify any additional debt that
may be incurred;
-- make certain acquisitions or investments;
-- make capital expenditures;
-- pay dividends and make distributions;
-- repurchase our securities;
-- create liens;
-- transfer or sell assets;
-- enter into transactions with affiliates;
-- issue or sell stock of subsidiaries;
-- merge or consolidate;
-- repurchase the notes upon a change of control; or
-- materially change the nature of our business.
In addition, our credit agreement also requires us to comply with certain
financial ratios. Our ability to comply with these ratios may be affected by
events beyond our control. If we breach any of the covenants in the credit
agreement or the indenture, we will be in default under our debt agreements. A
significant portion of our indebtedness could then become immediately due and
payable. We are not certain whether we would have, or be able to obtain,
sufficient funds to make these accelerated payments, including payments on the
notes. Compliance with the covenants is also a condition to revolver borrowings
under the credit agreement on which we rely to fund our liquidity. See
"Description of the Exchange Notes" and "Description of Other Indebtedness."
These restrictions can adversely affect our ability to respond to changing
economic and business conditions and may place us at a competitive disadvantage
relative to other companies that are subject to fewer or less restrictive
limitations. Certain transactions that we may view as important opportunities,
such as acquisitions, are also subject to the consent of our credit agreement
lenders, which may be withheld or granted subject to conditions specified at the
time that may affect the attractiveness or viability of the transaction.
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IN THE EVENT OF A BANKRUPTCY, LIQUIDATION OR DISSOLUTION OF, OR A DEFAULT ON OUR
SENIOR INDEBTEDNESS BY, EITHER THE ISSUER OR ANY NOTE GUARANTOR, THE ASSETS OF
THE ISSUER OR GUARANTOR WILL NOT BE AVAILABLE TO PAY OBLIGATIONS TO YOU UNDER
THE NOTES UNTIL THE ISSUER OR GUARANTOR HAS MADE ALL PAYMENTS ON OUR SENIOR
INDEBTEDNESS AND INDEBTEDNESS OF OUR SUBSIDIARIES
The notes will be unsecured and subordinated in right of payment to all of
our indebtedness, except for trade payables and indebtedness that expressly
provides that it ranks equal or junior to the notes. The guarantees of the notes
issued by certain of our subsidiaries will be subordinated to all indebtedness
of the guarantors, except for trade payables and indebtedness that expressly
provides that it ranks equal or junior to the guarantees. There is currently no
debt outstanding that provides that it is equal or junior to the notes or the
guarantees. Our assets will not be available to pay on the notes until all of
our senior indebtedness has been paid in full if we are in a bankruptcy,
liquidation or reorganization or in default under our senior indebtedness.
Similarly, assets of our subsidiary guarantors will not be available to pay on
the notes until all their senior indebtedness has been paid in full if they are
in a bankruptcy, liquidation or reorganization or in default under their senior
indebtedness. If any of these events occur, we and our subsidiary guarantors are
unlikely to have sufficient assets remaining after discharging senior
indebtedness to pay amounts due on the notes. In addition, the notes will be
effectively subordinated to all the liabilities of our non-guarantor
subsidiaries. The assets, liabilities, revenues and income of our non-guarantor
subsidiaries are substantial.
We and our guarantor subsidiaries had $200 million of senior indebtedness
outstanding on June 30, 2000. Our non-guarantor subsidiaries had $55.7 million
of liabilities as of June 30, 2000. The notes indenture allows us and our
subsidiaries to incur substantial amounts of additional debt, all of which may
be senior indebtedness.
Our obligations under the credit agreement, in addition to being guaranteed
on a senior basis by our U.S. subsidiaries, are secured by substantially all of
our assets, including the stock of our subsidiary guarantors and other assets,
and are also secured by substantially all of the assets of our subsidiary
guarantors. If we default on any payments under our credit agreement, the
lenders could declare all amounts outstanding, together with accrued and unpaid
interest, immediately due and payable. If we are unable to repay the amounts
due, the lenders could require repayment by the guarantors or proceed against
the collateral securing the debt. In these circumstances, we and the guarantors
are unlikely to have sufficient assets left to pay holders of the notes. In the
event of a default on the notes, or a liquidation, bankruptcy or dissolution of
a non-guarantor subsidiary, we and our creditors, including holders of the
notes, would not be entitled to cash flow or assets from that subsidiary until
that subsidiary's creditors are paid in full.
In addition, certain events of default under our senior indebtedness would
prohibit us from making any payments on the notes.
WE ARE A HOLDING COMPANY AND MANY OF OUR SUBSIDIARIES HAVE NOT GUARANTEED THE
NOTES
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.
Our non-guarantor subsidiaries have a substantial portion of our
consolidated assets, liabilities, revenues and income. The noteholders will have
no claim to the assets of these subsidiaries. The notes are therefore
effectively subordinated to claims of the creditors, including trade creditors,
of these subsidiaries. At June 30, 2000, these subsidiaries had liabilities of
$55.7 million, and the notes indenture allows these subsidiaries (as well as
Knowles and the guarantor subsidiaries) to incur substantial amounts of debt. In
addition, the ability of our non-guarantor subsidiaries to make any funds
available to us will depend on their earnings, the terms of their indebtedness,
business and tax considerations and legal restrictions.
THE EXCHANGE NOTES AND GUARANTEES MAY BE UNENFORCEABLE DUE TO FRAUDULENT
CONVEYANCE STATUTES -- A COURT COULD VOID OR SUBORDINATE OUR OBLIGATIONS UNDER
THE NOTES IF IT FOUND THAT THOSE OBLIGATIONS WERE NOT PROPERLY INCURRED
United States federal and state fraudulent conveyance laws that protect
creditors may apply to the notes. Although these laws differ among various
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jurisdictions, in general, a court could find that the exchange notes
constituted a fraudulent conveyance if:
-- we issued the initial notes with actual intent to hinder, delay or
defraud creditors; or
-- we did not receive fair consideration or reasonably equivalent value
for the initial notes; and
- we were insolvent or became insolvent because we issued the initial
notes;
- we were engaged in a business or transaction for which our
remaining assets are unreasonably small; or
- we intended to incur, or believed that we would incur, debts that
we could not pay as they mature.
If a court voided the initial notes as a fraudulent conveyance, holders of
exchange notes would not have a claim against us or their claim would be
subordinate to all of our other debts. A court could also void payments we make
to noteholders and require that noteholders return the payments to us.
The test for insolvency varies depending on the law that is applied.
Generally, however, we would be considered insolvent at a particular time if:
-- the fair market value (fair saleable value) of our assets were less
than the sum of our debts and liabilities (including contingent
liabilities); or
-- we are incurring debts that we could not pay as they mature.
We issued the initial notes to refinance debt that we incurred in
connection with our recapitalization. A court could therefore also find that the
initial notes constituted a fraudulent conveyance if the above tests were met at
the time we incurred the debt that we refinanced.
Each of our guarantor subsidiaries is also subject to fraudulent conveyance
laws. A court could find that a guarantee provided by a guarantor subsidiary
constituted a fraudulent conveyance if the above tests were met with respect to
that guarantee and guarantor subsidiary either at the time of our
recapitalization or at the time we issued the initial notes.
Based upon financial and other information currently available, we believe
that the initial notes were issued, and the debt that we refinanced was
incurred, for proper purposes and that we have remained solvent since the time
of our recapitalization. We also believe that we will continue to have
sufficient capital for our business and continue to be able to pay our debts as
they mature.
We believe that our guarantor subsidiaries entered into their guarantees of
the debt we refinanced and entered into the guarantees of the initial notes for
proper purposes and that they have remained solvent since the time of our
recapitalization. We also believe that our guarantor subsidiaries will continue
to have sufficient capital for their businesses and continue to be able to pay
their debts as they mature.
We cannot provide any assurance as to the standards a court would apply in
determining whether the initial notes or the guarantees constituted a fraudulent
conveyance. We also cannot assure you that a court would agree with our
conclusions.
RISKS RELATING TO KNOWLES ELECTRONICS HOLDINGS
OUR HIGH LEVERAGE COULD ADVERSELY AFFECT OUR BUSINESS
We are highly leveraged. As of June 30, 2000, we had $350.3 million of
consolidated outstanding debt. We also had a total common stockholders' deficit
of $446.8 million. We may also need to incur additional debt in the future for
working capital or to complete capital projects or acquisitions, even though our
principal credit agreement and the notes indenture limit our ability to do so.
The high degree of our leverage can have important adverse consequences for
Knowles, such as:
-- limiting our ability to obtain additional financing to fund our
growth strategy, working capital, capital expenditures, debt service
requirements or other purposes;
-- limiting our ability to invest our operating cash flow in our
business because we must use a substantial portion of these funds to
pay principal and interest;
-- limiting our ability to compete with companies that are not as highly
leveraged and that may be better positioned to withstand economic
downturns;
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-- increasing our vulnerability to economic downturns and changing
market conditions; and
-- increasing our vulnerability to fluctuations in market interest
rates, since $200 million of our outstanding debt has floating
interest rates and only a portion of this risk is subject to hedging
arrangements.
Our ability to pay principal and interest on our debt depends partly on our
performance, which in turn can be affected by general economic or competitive
conditions beyond our control. Our financial position could also prevent us from
obtaining necessary financing at favorable rates or at all, including at times
when we must refinance maturing debt or if we are required to repurchase the
notes due to the occurrence of a change of control.
If we cannot pay principal and interest on our debt and meet our other
liquidity needs from operating cash flow, we may have to delay planned
investments, sell assets, obtain additional equity capital or restructure our
debt. Depending on the circumstances at the time, we may not be able to
accomplish any of these actions on favorable terms or at all. If we default on
any of our debt, the relevant lenders could accelerate the maturity of our debt
and take other actions that could adversely affect us. For example, in the event
of a default under our principal credit agreement, the lender could foreclose on
the security for the facility, which includes virtually all of our assets.
OUR MARKETS ARE INTENSELY COMPETITIVE AND OUR BUSINESSES ARE SUBJECT TO PRICING
PRESSURES
The markets for our products are highly competitive. We compete with a
variety of companies in various segments of the hearing aid components, high
technology infrared and acoustics and automotive components markets. Emkay is
developing several new products for markets with high growth potential,
including voice recognition, Internet-on-television, computer telephony
integration and videoconferencing, which by their nature are subject to
competition, obsolescence, changes in pricing and short replacement cycles. As
these market segments mature, we will face increased competition from consumer
electronics companies and other companies that currently manufacture and sell
communications and computer equipment. These new competitors are likely to be
larger, offer broader product lines, bundle or integrate their acoustic and
infrared products with their other products, offer products that are
incompatible with our products and have substantially greater financial,
marketing and other resources than we have.
The market for transducers has been subject to downward pressures on
pricing in recent years. This pricing pressure is attributable to Microtronic's
attempt to build its market share by reducing prices since its purchase of
Siemens's transducer manufacturing business in 1995. We believe Microtronic has
an approximate 17% share of the transducer market. Downward pressures on headset
prices have resulted from headset assemblers in China offering low priced
products to penetrate Emkay's target markets. Our Automotive Components business
unit is also subject to pricing pressures as a result of the maturity of the
market and the practice of providing customers with annual reductions in prices.
We expect that these downward pressures on pricing will continue in the future.
The pricing pressures in the markets for our products could result in a
reduction of our revenues and net income.
OUR TARGETED MARKETS ARE SUBJECT TO RAPID CHANGES IN TECHNOLOGY AND CUSTOMER
REQUIREMENTS
The markets for transducers, high technology acoustic and infrared products
and automotive components are characterized by rapidly changing technology,
changes in customer requirements and preferences, frequent new product and
service introductions based on newly developed processes and technologies, and
evolving industry standards and practices that could render our existing
products obsolete or less attractive to customers. Some of the new technologies
currently under development that we believe we will need to develop in order to
compete effectively include silicon transducers, far field microphone arrays (a
group of microphones that focus on a particular speaker while canceling other
background noise) and contactless automotive position sensors. We may not be
successful in applying new technologies efficiently and in developing new
products or enhancing existing products on a timely basis to satisfy changes in
customer requirements and preferences.
In addition, alternative technologies may reduce or even eliminate the
utility of our products. The successful development of biological regeneration
of hearing and surgical implant technology would reduce the need for hearing
aids. Emissions
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regulations for automobile diesel engines are very stringent in the United
States and Europe. In response to such regulations, automobiles sold in these
markets incorporate advanced fuel injection technology, eliminating the need for
diesel engine solenoids. The incorporation of fuel injection technology into
non-automobile diesel engines in the United States and Europe (our primary
market for solenoids) could reduce solenoid sales. Emissions regulations in
Europe and North America have also contributed to a reduction in orders for one
of our sensor products by another customer. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Overview" and
"-- Results of Operations -- Six Months Ended June 30, 2000 Compared to Six
Months Ended June 30, 1999" and "-- Year Ended December 31, 1999 Compared to
Year Ended December 31, 1998."
WE DEPEND ON OUR LARGEST CUSTOMERS FOR OUR SALES AND FOR THE INTEGRATION OF OUR
PRODUCTS
Our businesses are dependent on sales of products to a small number of
large customers. Our top ten customers accounted for approximately 55% of our
net sales in 1999. Siemens is our largest customer and accounted for
approximately 11% of our net sales in 1999. We believe that a relatively small
number of customers will continue to account for a significant portion of our
revenues for the foreseeable future. The concentration of our customers may
further increase because KE's customers GN Danavox and ReSound Corporation have
merged to become GN ReSound, and Beltone Electronics Corporation and Philips
Hearing Instruments have merged and have subsequently been acquired by GN
ReSound. Although we have pricing agreements in place with many of our
customers, these agreements generally do not require them to purchase a
specified or minimum amount of our products, and our customers are generally
able to terminate their relationships with us at any time. For example, one of
our major Automotive Components customers has recently reduced orders for one of
our sensor products. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview" and "-- Results of
Operations -- Six Months Ended June 30, 2000 Compared to Six Months Ended June
30, 1999" and "-- Year Ended December 31, 1999 Compared to Year Ended December
31, 1998." If we lose any of our key customers or if a key customer reduces its
orders of our products or requires us to reduce our prices more than we are able
to reduce costs, our results of operations could suffer.
We also rely on our key customers for the integration into their products
of our transducers, high technology acoustic products and automotive components.
Our success depends on the continuing compatibility of our products with
products sold by our key customers. If any key customer alters the components
needed to produce its products, our ability to provide easily compatible
products could become more difficult and could lead to reduced sales.
OUR NEW EMKAY BUSINESS FACES UNCERTAINTY OF SUCCESS
Our Emkay business unit began operations in 1994 to develop innovative
products for markets with high growth potential. These new opportunities may
require us to make substantial investments in new product development without
any assurance that a significant market will develop for the resulting products.
For example, although we have targeted the voice recognition market for sales of
our wired headsets, we believe that sales of complex voice recognition products
will not increase substantially until voice recognition software provides better
performance. We also believe that sales of voice recognition products have
stagnated in North America in particular as a result of consumer dissatisfaction
with product performance. In addition, although we have substantial experience
in manufacturing and marketing hearing aid and automotive components, we have
limited experience in other high technology markets. We also expect to incur
selling and administrative expenses associated with developing Emkay.
WE ARE RESTRUCTURING OUR MANUFACTURING OPERATIONS, WHICH MAY DISRUPT OUR
BUSINESSES AND MAY NOT RESULT IN GREATER EFFICIENCIES
In March 2000, we announced plans to consolidate our worldwide
manufacturing facilities and to divest our Ruf position sensor business. We plan
to outsource some of our manufacturing activities and move other manufacturing
to lower cost environments. Additionally, we intend to reduce our global
workforce by twenty percent. The restructuring resulted in a charge of $20.1
million in the first quarter of 2000, and may require future substantial capital
and other expenditures. The restructuring
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will also require substantial attention from senior management. The
restructuring efforts may disrupt our operations as well as those of our
subsidiaries as our management's attention is diverted from other tasks and as
technological, practical or personnel issues arise. In addition, the
restructuring may not result in the intended cost efficiencies.
WE DEPEND ON LIMITED SUPPLIERS FOR SOME OF OUR KEY MATERIALS AND COMPONENTS AND
THIRD PARTY ASSEMBLERS FOR SOME OF OUR PRODUCTS
We obtain some of the materials included in our products, such as certain
circuits, magnets and wire used in receivers, from single source suppliers.
Although we seek to limit our dependence on single source suppliers and maintain
high inventories as a result, any disruption or termination of these sources
could limit our ability to manufacture our products or force us to use lower
quality materials in our products. This in turn could not only reduce sales but
also cause longer-term damage to customer relationships. In addition, Emkay uses
third parties for final assembly of its products. Any failure by these third
parties to assemble our final products could also reduce sales and result in
damage to customer relationships.
OUR OPERATIONS ARE SUBJECT TO VARIOUS RISKS BECAUSE WE OPERATE IN DIFFERENT
COUNTRIES
We have international operations and facilities. Approximately 63% of our
net revenues in 1999 came from international sales, and approximately 74% of our
employees are located in Europe and Asia. International operations are generally
subject to many additional risks, including:
-- the burden of complying with multiple and possibly conflicting laws
and unexpected changes in regulatory requirements;
-- import and export restrictions and tariffs;
-- additional expenses relating to the difficulties and costs of
staffing and managing international operations;
-- potentially adverse tax consequences;
-- political instability;
-- cultural differences;
-- the impact of business cycles and economic instability; and
-- increased expenses due to inflation.
Any one of these factors could hurt our manufacturing capability or our sales
and limit our ability to expand our operations.
In addition, our revenues are primarily denominated in the U.S. dollar and
the German Deutschemark (which is now tied to the euro). Our expenses are
principally denominated in those currencies, but are also denominated in the
local currencies of Austria, the United Kingdom, Hungary, China, Japan, Malaysia
and Taiwan. We do not hedge this exposure. There could be an adverse effect on
our financial results if the U.S. dollar, the German Deutschemark and/or the
euro depreciated relative to these other currencies.
ANY EXPANSION OR ACQUISITION MAY PROVE RISKY TO US
One of our growth strategies is to take advantage of selected opportunities
to grow by acquiring other businesses whose operations or product lines fit well
with our existing businesses or whose geographic location or market position
enables us to expand into new markets. In addition, we may seek to establish
facilities in developing countries through joint ventures of which we own a
minority interest. Our ability to implement this expansion strategy will,
however, depend on whether any appropriate businesses are available at suitable
valuations, how much money we can spend and maintenance of our customer base.
Any acquisition that we make could be subject to a number of risks, including:
-- the difficulty of identifying appropriate acquisition candidates in
the countries in which we do business;
-- failing to discover liabilities of the acquired company for which we
may be responsible as a successor owner or operator;
-- the potential disruption to our ongoing business caused by senior
management's focus on the acquisition transactions;
-- our ability to assimilate the operations and personnel of the
acquired company;
-- the loss of key personnel or customers of the acquired company; and
-- an impact on our financial statements resulting from the amortization
of acquired intangible assets or the creation of reserves or
write-downs.
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WE EXPECT TO IMPLEMENT NEW MANAGEMENT INFORMATION SYSTEMS, WHICH MAY DISRUPT OUR
BUSINESSES
We currently use a variety of separate management information systems for
our several facilities. These systems do not comprehensively serve our
production, order routing, shipping and accounting operations. We expect to
replace our various management information systems with a single system that
integrates all of these functions, but we have not yet established a definitive
timetable for implementation or selected the vendor. We expect to make up to $9
million in capital and operating expenditures through 2002 for the conversion to
a new management information system. The failure to implement a new system could
constrain our future growth. In addition, the implementation of a new system may
cause disruption to our businesses and may not result in intended cost
efficiencies.
WE DEPEND ON COLLABORATIVE ARRANGEMENTS FOR SOME OF OUR NEW PRODUCT DEVELOPMENT
Our future sales growth is dependent in part on developing products, such
as a low-cost all-silicon microphone, an audio/visual module that combines
microphones with a video image sensor and an infrared keyboard, requiring
expertise or resources not readily available to us. The success of these
arrangements will depend to a substantial degree on the efforts of our
collaborators in developing these new products. Our collaborators are usually
contractually obligated to provide us with exclusive rights to manufacture and
sell new products resulting from our joint product development efforts. However,
they may not give higher priority to the development of products with us than to
the development or sales of other products.
WE MAY IN THE FUTURE FACE PRODUCT LIABILITY CLAIMS RELATING TO OUR AUTOMOTIVE
COMPONENTS
Our automotive components business exposes us to possible claims for
personal injury, death or property damage which could result from a failure or
malfunction of products we manufacture. Many factors beyond our control could
lead to liability claims, including the failure of a vehicle in which a
component we manufacture has been installed. We have obtained insurance coverage
for these types of liabilities and believe that this insurance coverage is both
adequate and similar to that obtained by our competitors. Our insurance,
however, may not fully cover us against all claims, and adequate insurance may
not be available in the future or may be available only on unacceptable terms.
In addition to their financial costs, liability claims could also damage our
reputation.
OUR INTELLECTUAL PROPERTY RIGHTS MAY NOT BE PROTECTED; OUR ACTIVITIES MAY
INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS
Our success will depend in part on our ability to protect our proprietary
technology. We rely on a combination of patents, trade secrets, copyrights and
trademarks, together with non-disclosure and license agreements, to establish
and protect our intellectual property rights. The process of seeking patent
protection can be lengthy and expensive. Patents may not be issued in response
to our applications, and patents that are issued may be invalidated,
circumvented or challenged by others. Since patent applications are secret until
patents are issued, and since publication of discoveries in the scientific or
patent literature often lags behind actual discoveries, we cannot be certain
that we were the first to file patent applications for our inventions. In
addition, the laws of foreign countries do not protect our proprietary rights to
our technologies to the same extent as the laws of the United States. Moreover,
our patents do not fully protect us from price competition.
We negotiate licenses with third parties in respect to third-party
proprietary technologies used in certain of our manufacturing processes. We have
no reason to believe that these third parties will fail to honor the
undertakings in licenses that have been entered into and anticipate that we will
be able to enter into future licenses or renew existing licenses on reasonable
terms. There is still, however, the potential for disputes and litigation, even
when a third party has undertaken to make its licenses generally available.
We may become involved in litigation to assert our patents or other
proprietary intellectual property rights. In addition, third parties, including
our competitors, may assert patent or other intellectual property rights against
us. Any intellectual property litigation could be time-consuming and expensive
and divert management's attention. In addition, if any third-party rights are
held to be infringed, we could be required to cease production of certain
products, obtain licenses or redesign our products.
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Our policy is to require each of our employees, consultants and advisors to
execute non-disclosure and invention assignment agreements upon the commencement
of employment. These agreements generally provide that all inventions conceived
by the individual during the term of the relationship with us are our exclusive
property and must be kept confidential. These agreements, however, may not
always provide full protection for our proprietary information in the event of
unauthorized use or disclosure.
WE MAY NOT BE ABLE TO RECRUIT AND RETAIN QUALIFIED PERSONNEL
Our success will depend upon our ability to identify, hire, train and
retain highly-skilled professional technicians and engineers who can provide the
technology and creative skills required by customers. In particular, research
engineers with an acoustics background are in limited supply and are likely to
remain a limited resource for the foreseeable future. We compete intensely for
qualified personnel with other companies. Competitors may in the future attempt
to recruit our employees. Failure to attract and retain qualified professionals
in sufficient numbers would severely limit our ability to complete existing
projects and expand our operations.
Our continued success also depends on the services of certain of our
executive officers. Loss of the services of any of our senior executive officers
employees could hurt our operations.
MANY OF OUR CUSTOMERS ARE SUBJECT TO COMPLIANCE WITH REGULATORY REQUIREMENTS
Our hearing aid components customers are subject to a variety of regulatory
agency requirements in the United States and in various other countries in which
they sell their hearing aids. Manufacturers of hearing aids are subject to the
United States Federal 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. The U.S. Food and Drug Administration inspects
manufacturers of hearing aids before providing them clearance to commence
manufacturing. Similar requirements are imposed on hearing aid manufacturers by
the European Union. The failure to pass a regulatory inspection or to comply
with regulatory requirements could lead to penalties, including restrictions
that delay our customers in moving ahead with the manufacture and sales of
products that incorporate our hearing aid components. In addition, FDA action
against our customers can result in negative publicity for the hearing aid
industry. In the past, negative press resulting from FDA public statements about
overstated claims by hearing aid manufacturers have resulted in lower hearing
aid sales and, in turn, reduced sales of our transducers.
OUR BUSINESS IS SUBJECT TO THE RISK OF ENVIRONMENTAL LIABILITY
Our business is subject to extensive federal, state, local and foreign
environmental laws, including those relating to chemical and other discharges in
the air, water and land, the handling and disposal of hazardous waste and the
cleanup of properties affected by hazardous materials. We are not currently
involved in any material proceedings relating to environmental matters, and,
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.
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USE OF PROCEEDS
We will not receive any cash proceeds from the issuance of the exchange
notes. In consideration for issuing the exchange notes as contemplated in this
prospectus, we will receive initial notes in like principal amount, the terms of
which are identical in all material respects to the exchange notes. The initial
notes surrendered in exchange for the exchange notes will be retired and
canceled and cannot be reissued. Accordingly, the issuance of the exchange notes
will not result in any increase in our indebtedness. The net proceeds to us from
the sale of the initial notes, together with available cash, were used to repay
the subordinated bridge notes that were issued to finance a portion of our
recapitalization. See "The Recapitalization and Ownership of Capital Stock."
THE EXCHANGE OFFER
The following is a summary of the Registration Rights Agreement dated as of
October 1, 1999 among Knowles Electronics Holdings, Inc. and the placement
agents in the offering of the initial notes, Morgan Stanley & Co. Incorporated
and Chase Securities Inc. A copy of the Registration Rights Agreement is
available as set forth under the heading "Summary -- Where You Can Find More
Information." When we refer to "Knowles Electronics Holdings" in this section,
we mean Knowles Electronics Holdings, Inc. and not its subsidiaries.
TERMS OF THE EXCHANGE OFFER
In connection with the issuance of the initial notes pursuant to the
placement agreement dated as of September 28, 1999 among Knowles Electronics
Holdings, as the issuer, Knowles Intermediate Holding, Inc., Emkay Innovative
Products, Inc., Knowles Manufacturing Ltd., Synchro-Start Products, Inc.,
Knowles Electronics, LLC, as the subsidiary guarantors, and the placement
agents, the placement agents and their respective assignees became entitled to
the benefits of the Registration Rights Agreement.
The Registration Rights Agreement requires Knowles Electronics Holdings to
file the registration statement, of which this prospectus is a part, for a
registered exchange offer relating to an issue of new exchange notes identical
in all material respects to the initial notes but containing no restrictive
legends. Under the Registration Rights Agreement, Knowles Electronics Holdings
is required to:
-- use its best efforts to file the registration statement with the
Securities and Exchange Commission and have the registration
statement remain effective until the closing of the exchange offer;
-- commence the exchange offer promptly after the registration statement
has been declared effective by the Securities and Exchange
Commission;
-- use its best efforts to cause the exchange offer to be consummated no
later than 60 days after the effective date; and
-- keep the registration statement effective for not less than 20
business days after the date on which notice of the exchange offer is
mailed to holders of the initial notes, although Knowles Electronics
Holdings may, at its discretion, accept tenders after the date that
Knowles Electronics Holdings consummates the exchange offer.
We will accept for exchange all initial notes validly tendered and not
withdrawn prior to 5:00 p.m., New York City time, on the expiration date. We
will issue exchange notes for an equal principal amount of outstanding initial
notes accepted in the exchange offer. Holders may tender initial notes only in
integral multiples of $1,000. This prospectus, together with the accompanying
letter of transmittal, is being sent to all record holders of initial notes as
of September 8, 2000. The exchange offer is not conditioned upon the tender of
any minimum principal amount of initial notes. Our obligation to accept initial
notes for exchange is, however, subject to the conditions as set forth herein
under "-- Conditions."
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Initial notes will be deemed accepted when, as and if Knowles Electronics
Holdings has given written notice of acceptance to the exchange agent. The
exchange agent will act as agent for the tendering holders of initial notes for
the purposes of receiving the exchange notes and delivering them to the holders.
Based on interpretations by the staff of the SEC, as set forth in no-action
letters issued to other issuers, we believe that the exchange notes issued in
the exchange offer may be offered for resale, resold or otherwise transferred by
each holder without compliance with the registration and prospectus delivery
provisions of the Securities Act, provided that:
-- the holder is not a broker-dealer who acquires the initial notes
directly from Knowles Electronics Holdings for resale pursuant to
Rule 144A under the Securities Act or any other available exemption
under the Securities Act;
-- the holder is not an "affiliate" of Knowles Electronics Holdings, as
that term is defined in Rule 405 under the Securities Act; and
-- the exchange notes are acquired in the ordinary course of the
holder's business and the holder is not engaged in, and does not
intend to engage in, a distribution of the exchange notes and has no
arrangement or understanding with any person to participate in a
distribution of the exchange notes.
By tendering the initial notes in exchange for exchange notes, each holder,
other than a broker-dealer, will represent to Knowles Electronics Holdings that:
-- any exchange notes to be received by it will be acquired in the
ordinary course of its business;
-- it is not engaged in, and does not intend to engage in, a
distribution of such exchange notes and has no arrangement or
understanding to participate in a distribution of the exchange notes;
and
-- it is not an affiliate, as defined in Rule 405 under the Securities
Act, of Knowles Electronics Holdings.
If a holder of initial notes is engaged in or intends to engage in a
distribution of the exchange notes or has any arrangement or understanding with
respect to the distribution of the exchange notes to be acquired pursuant to the
exchange offer, the holder may not rely on the applicable interpretations of the
staff of the SEC and must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with any secondary resale
transaction. Each broker-dealer that receives exchange notes for its own account
in the exchange offer must acknowledge that it will deliver a prospectus in
connection with any resale of such exchange notes. The accompanying letter of
transmittal states that by so acknowledging and by delivering a prospectus, a
broker-dealer will not be deemed to admit that it is an "underwriter" within the
meaning of the Securities Act.
This prospectus, as it may be amended or supplemented from time to time,
may be used by a broker-dealer in connection with resales of exchange notes
received in exchange for initial notes where such initial notes were acquired by
the broker-dealer as a result of market-making activities or other trading
activities. Knowles Electronics Holdings has agreed to make this prospectus
available to any broker-dealer for a period of time not to exceed 180 days after
the last date of acceptance for exchange. See "Plan of Distribution."
The Registration Rights Agreement requires that if:
-- because of any change in law or applicable interpretations thereof by
the SEC's staff, Knowles Electronics Holdings is not permitted to
effect the exchange offer;
-- the exchange offer is not for any other reason consummated by April
28, 2000; or
-- the exchange offer has been completed and in the opinion of counsel
for the placement agents a registration statement must be filed and a
prospectus must be delivered by the placement agents in connection
with any offering and sale of initial notes,
then, in any such case, Knowles Electronics Holdings will use its best efforts
to cause to be filed as soon as practicable a shelf registration statement with
the SEC covering resales of the initial notes by holders who satisfy the
conditions relating to the provision of information in connection with the shelf
registration statement, and to have the shelf registration statement declared
effective by the SEC.
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Because the exchange offer had not yet been consummated and a shelf
registration statement had not been declared effective, on April 28, 2000 the
interest rate on the initial notes increased by 0.5% per annum pursuant to the
Registration Rights Agreement until:
-- the exchange offer is consummated; or
-- the shelf registration statement is declared effective.
The exchange offer that this prospectus describes will satisfy the
requirements of the Registration Rights Agreement such that Knowles Electronics
Holdings will no longer be required to pay additional interest from the date the
exchange offer is consummated.
Holders who do not tender their initial notes before the expiration of the
exchange offer will not be entitled to exchange these untendered initial notes
for exchange notes. Holders of initial notes will not be able to offer or sell
their initial notes, except pursuant to an exemption from, or in a transaction
not subject to, the Securities Act and applicable state securities laws, unless
the initial notes are subsequently registered under the Securities Act. Subject
to limited exceptions, Knowles Electronics Holdings will have no obligation to
register the initial notes.
EXPIRATION DATE; EXTENSIONS; AMENDMENTS; TERMINATION
The term "expiration date" means October 19, 2000 (30 days following the
commencement of the exchange offer), unless the exchange offer is extended, in
which case the term "expiration date" shall mean the latest date to which the
exchange offer is extended.
In order to extend the expiration date, Knowles Electronics Holdings will
notify the exchange agent of any extension by written notice and may notify the
holders of the initial notes by mailing an announcement or by means of a press
release or other public announcement prior to 9:00 A.M., New York City time, on
the next business day after the previously scheduled expiration date.
In addition, Knowles Electronics Holdings reserves the right to delay
acceptance of any initial notes, to extend the exchange offer or to terminate
the exchange offer and not permit acceptance of initial notes not previously
accepted if any of the conditions set forth herein under "-- Conditions" shall
have occurred and shall not have been waived by Knowles Electronics Holdings (if
permitted to be waived), by giving written notice of such delay, extension or
termination to the exchange agent. Knowles Electronics Holdings also reserves
the right to amend the terms of the exchange offer in any manner deemed by
Knowles Electronics Holdings to be advantageous to the holders of the initial
notes. If Knowles Electronics Holdings makes any material change to terms of the
exchange offer, the exchange offer shall remain open for a minimum of an
additional five business days, if the exchange offer would otherwise expire
during such period. Any such delay in acceptance, extension, termination or
amendment will be followed as promptly as practicable by written notice of the
delay to the exchange agent. If Knowles Electronics Holdings amends the exchange
offer in a manner that constitutes a material change, Knowles Electronics
Holdings will promptly disclose the amendment in a manner reasonably calculated
to inform the holders of the initial notes of the amendment, including by
providing public announcement or giving oral or written notice to the holders of
the initial notes. A material change in the terms of the exchange offer could
include, among other things, a change in the timing of the exchange offer, a
change in the exchange agent, and other similar changes in the terms of the
exchange offer.
Without limiting the manner in which Knowles Electronics Holdings may
choose to make a public announcement of any delay, extension, amendment or
termination of the exchange offer, Knowles Electronics Holdings will have no
obligation to publish, advertise, or otherwise communicate any such public
announcement.
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INTEREST ON THE EXCHANGE NOTES
The exchange notes will accrue interest payable in cash at 13 1/8% per
annum, from the later of:
-- the last interest payment date on which interest was paid on the
initial notes surrendered in exchange therefor; and
-- if the initial notes are surrendered for exchange on a date subsequent
to the record date for an interest payment date to occur on or after
the date of such exchange and as to which interest will be paid, the
date of such interest payment.
PROCEDURES FOR TENDERING
In order to tender initial notes in the exchange offer, a holder must
complete one of the procedures described below. In addition, either:
-- The holder must cause The Depository Trust Company ("DTC") to deliver
to the exchange agent prior to 5:00 p.m., New York City time, on the
expiration date, confirmation that such holder's initial notes have
been transferred from the account of a DTC participant to the exchange
agent's account at DTC. The confirmation should include a message
stating that DTC has received express acknowledgement from such DTC
participant that it has received, and agrees to be bound by, the terms
of the accompanying letter of transmittal and that the issuers may
enforce such agreement against such DTC participant.
-- The holder must complete, sign and date the letter of transmittal or a
facsimile of it, have the signatures guaranteed if required by the
letter of transmittal and mail or otherwise deliver the letter of
transmittal or facsimile, together with certificates for the initial
notes being tendered, to the exchange agent prior to 5:00 p.m., New
York City time, on the expiration date.
-- The holder must comply with the guaranteed delivery procedures
described below under "Guaranteed Delivery Procedure".
THE METHOD OF DELIVERY OF INITIAL NOTES, LETTERS OF TRANSMITTAL AND ALL
OTHER REQUIRED DOCUMENTS IS AT THE ELECTION AND RISK OF THE HOLDERS. IN THE CASE
OF ANY TENDER OF CERTIFICATED NOTES, WE RECOMMEND THAT HOLDERS USE AN OVERNIGHT
OR HAND-DELIVERY SERVICE RATHER THAN TENDERING BY MAIL. IF A HOLDER DOES DELIVER
BY MAIL, WE RECOMMEND USING REGISTERED MAIL, PROPERLY INSURED, WITH RETURN
RECEIPT REQUESTED. IN ALL CASES, SUFFICIENT TIME SHOULD BE ALLOWED TO ASSURE
TIMELY DELIVERY. NO LETTERS OF TRANSMITTAL OR INITIAL NOTES SHOULD BE SENT TO
KNOWLES ELECTRONICS HOLDINGS.
Holders of initial notes may also request that their respective brokers,
dealers, commercial banks, trust companies or nominees tender initial notes for
them.
The tender by a holder of initial notes will constitute an agreement
between such holder and Knowles Electronics Holdings in accordance with the
terms and subject to the conditions set forth here and in the accompanying
letter of transmittal.
Only a holder of initial notes may tender the initial notes in the exchange
offer. The term "holder" for this purpose means any person in whose name initial
notes are registered on the books of Knowles Electronics Holdings or any other
person who has obtained a properly completed bond power from the registered
holder.
Any beneficial owner whose initial notes are registered in the name of a
broker, dealer, commercial bank, trust company or other nominee and who wishes
to tender should contact the registered holder promptly and instruct the
registered holder to tender on his or her behalf. If the beneficial owner wishes
to tender on his or her own behalf, such beneficial owner must, prior to
completing and executing the letter of transmittal and delivering his or her
initial notes, either make appropriate arrangements to register ownership of the
initial notes in such beneficial owner's name or obtain a properly completed
bond power from the registered holder. The transfer of registered ownership may
take considerable time.
19
<PAGE> 20
SIGNATURE REQUIREMENTS AND SIGNATURE GUARANTEES
Except in two situations described below, signatures on a letter of
transmittal or a notice of withdrawal must be guaranteed by:
-- a member firm of a registered national securities exchange or of the
National Association of Securities Dealers, Inc.;
-- a commercial bank or trust company having an office or correspondent
in the United States; or
-- an "eligible guarantor" institution within the meaning of Rule 17Ad-15
under the Securities Exchange Act of 1934.
Signature guarantees are not required if the initial notes are tendered:
-- by a registered holder of the initial notes or a DTC participant whose
name appears on a security position listing as holder, in either case,
who has not completed the box entitled "Special Issuance Instructions"
or "Special Delivery Instructions" on the letter of transmittal and
the exchange notes are being issued directly to such registered holder
or are being deposited into such participant's account at DTC, as
applicable; or
-- for the account of an eligible guarantor institution.
If the letter of transmittal is signed by the recordholder(s) of the
initial notes tendered thereby, the signature must correspond with the name(s)
written on the face of the initial notes without alteration, enlargement or any
change whatsoever. If the letter of transmittal is signed by a DTC participant,
the signature must correspond with the name as it appears on the security
position listing as the holder of the initial notes.
If the registered holder of initial notes does not sign the letter of
transmittal, but rather the letter of transmittal is signed by someone else,
those initial notes must be:
-- endorsed by the registered holder with the signature on that letter
guaranteed by an eligible guarantor institution; or
-- accompanied by bond power in a form satisfactory to the issuers,
signed by the registered holder.
If the letter of transmittal, endorsement, bond power, power of attorney or
any other documents required by the letter of transmittal are signed by
trustees, executors, administrators, guardians, attorneys-in-fact, officers of
corporations or others acting in a fiduciary or representative capacity, these
persons must:
-- indicate their status when signing; and
-- submit evidence that satisfies Knowles Electronics Holdings of their
authority to act in this capacity with respect to the letter of
transmittal.
VALIDITY, FORM, ELIGIBILITY, ACCEPTANCE OF TENDERED INITIAL NOTES
All questions as to the validity, form, eligibility, time of receipt,
acceptance and withdrawal of the tendered initial notes will be determined by
Knowles Electronics Holdings in its sole discretion, which determination will be
final and binding. Knowles Electronics Holdings reserves the absolute right to
reject any and all initial notes not properly tendered or any initial notes
which, if accepted, would, in the opinion of Knowles Electronics Holdings or its
counsel, be unlawful. Knowles Electronics Holdings also reserves the absolute
right to waive any conditions of the exchange offer or irregularities or defects
in tender as to particular initial notes. Knowles Electronics Holdings'
interpretation of the terms and conditions of the exchange offer, including the
instructions in the letter of transmittal, will be final and binding on all
parties.
Unless waived, any defects or irregularities in connection with tenders of
initial notes must be cured within such time as Knowles Electronics Holdings
shall determine. None of Knowles Electronics Holdings, the exchange agent or any
other person shall be under any duty to give notification of defects or
irregularities with respect to tenders of initial notes, nor shall any of them
incur any liability for failure to give such
20
<PAGE> 21
notification. Tenders of initial notes will not be deemed to have been made
until such irregularities have been cured or waived. Any initial notes received
by the exchange agent that are not properly tendered and as to which the defects
or irregularities have not been cured or waived will be returned without cost by
the exchange agent to the tendering holders of such initial notes, unless
otherwise provided in the letter of transmittal, as soon as practicable
following the expiration date.
In addition, Knowles Electronics Holdings reserves the right in its sole
discretion, subject to the provisions of the indenture relating to the initial
notes and the exchange notes, to:
-- purchase or make offers for any initial notes that remain outstanding
subsequent to the expiration date or, terminate the exchange offer in
accordance with the terms of the Registration Rights Agreement; and
-- to the extent permitted by applicable law, purchase initial notes in
the open market, in privately negotiated transactions or otherwise.
The terms of any such purchases or offers could differ from the terms of
the exchange offer.
GUARANTEED DELIVERY PROCEDURES
If a registered holder of initial notes desires to tender initial notes but
cannot complete the procedures for tendering described above in a timely manner,
such holder may tender initial notes by causing an "eligible guarantor"
institution, within the meaning of Rule 17Ad-15 under the Securities Exchange
Act of 1934, to mail or otherwise deliver to the exchange agent prior to 5:00
p.m., New York City time, on the expiration date, a properly completed and duly
signed notice of guaranteed delivery and letter of transmittal, substantially in
the form accompanying this prospectus. Such notice of guaranteed delivery must:
-- set forth the registered holder's name and address, the certificate
number of the initial notes being tendered, if available, and the
principal amount of the initial notes being tendered;
-- state that the tender is being made by an eligible guarantor
institution; and
-- guarantee that, within, five business days after the expiration date,
the eligible guarantor institution will deposit with the exchange
agent (1) a confirmation that the initial notes being tendered have
been transferred from the account of a DTC participant to the exchange
agent's account at DTC and any other documents required by the letter
of transmittal or (2) certificates for the initial notes being
tendered in proper form for transfer and (3) any other documents
required by the letter of transmittal.
Any such tender will be valid if, within, five business days after the
expiration date, the eligible guarantor institution makes such deposit as
guaranteed.
ACCEPTANCE OF INITIAL NOTES FOR EXCHANGE; DELIVERY OF EXCHANGE NOTES
After all of the conditions to the exchange offer have been satisfied or
waived, all initial notes properly tendered will be accepted, promptly after the
expiration date, and the exchange notes will be issued promptly after acceptance
of the initial notes. See "-- Conditions" below. For purposes of the exchange
offer, initial notes shall be deemed to have been accepted as validly tendered
for exchange when and if Knowles Electronics Holdings has given written notice
thereof to the exchange agent.
In all cases, issuance of exchange notes for initial notes that are
accepted for exchange pursuant to the exchange offer will be made only after the
exchange agent's timely receipt of:
-- certificates for such initial notes or a timely confirmation of a
book-entry transfer of such initial notes into the exchange agent's
account at DTC;
-- a properly completed and duly executed letter of transmittal; and
-- all other required documents required by the letter of transmittal.
21
<PAGE> 22
If any tendered initial notes are not accepted for any reason set forth in
the terms and conditions of the exchange offer or if initial notes are submitted
for a greater principal amount than the holder desires to exchange, such
unaccepted or non-exchanged initial notes will be returned without expense to
the tendering holder as promptly as practicable after the expiration or
termination of the exchange offer. In the case of initial notes tendered by the
book-entry transfer procedures described below, the non-exchanged initial notes
will be credited to an account maintained with DTC.
BOOK-ENTRY TRANSFER
The exchange agent will make a request to establish an account with respect
to the initial notes at DTC for purposes of the exchange offer within two
business days after the date of this prospectus. Any financial institution that
is a DTC participant may make book-entry delivery of initial notes by causing
DTC to transfer such initial notes into the exchange agent's account at DTC in
accordance with DTC's procedures for transfer. However, although delivery of
initial notes may be effected through book-entry transfer into the exchange
agent's account at DTC, a confirmation of book-entry transfer or the letter of
transmittal or facsimile thereof with any required signature guarantees and any
other required documents must, in any case, be transmitted to and received by
the exchange agent at one of the addresses set forth below under "-- Exchange
Agent" below on or prior to the expiration date or the guaranteed delivery
procedures described below must be complied with. DELIVERY OF DOCUMENTS TO DTC
DOES NOT CONSTITUTE DELIVERY TO THE EXCHANGE AGENT. All references in this
prospectus to deposit of initial notes shall be deemed to include DTC's
book-entry delivery method.
WITHDRAWAL OF TENDERS
Except as otherwise provided herein, tenders of initial notes may be
withdrawn at any time prior to 5:00 p.m., New York City time, on the expiration
date.
A holder may withdraw initial notes it has tendered in the exchange offer
by delivering a written notice of withdrawal to the exchange agent prior to 5:00
p.m., New York City time on the expiration date. Any such notice of withdrawal
must:
1. specify the name of the person that tendered the initial notes to be
withdrawn;
2. identify the initial notes to be withdrawn, including, if applicable,
the registration number or numbers and total principal amount of such
initial notes;
3. be signed by the holder in the same manner as the original signature on
the letter of transmittal by which such initial notes were tendered,
including any required signature guarantees, or be accompanied by
documents of transfer sufficient to permit the trustee with respect to
the initial notes to register the transfer of such initial notes into
the name of the person withdrawing the tender;
4. specify the name in which any such initial notes are to be registered,
if different from that of the person that deposited them initially; and
5. if the initial notes have been tendered pursuant to the book-entry
procedures, specify the name and number of the DTC participant's account
at DTC to be credited, if different than that of the person withdrawing
the tender.
Knowles Electronics Holdings will determine all questions as to the
validity, form and eligibility, time of receipt of such notices, which shall be
final and binding on all parties. Any initial notes so withdrawn will be deemed
not to have been validly tendered for exchange for purposes of the exchange
offer. Any initial notes that have been tendered for exchange and that are not
exchanged for any reason will be returned to the holder thereof without cost to
such holder (or, in the case of initial notes tendered by book-entry transfer,
such initial notes will be credited to an account maintained with the Book-Entry
Transfer Facility for the initial notes) as soon as practicable after
withdrawal, rejection of tender or termination of the exchange offer. Properly
withdrawn initial notes may be re-tendered by following one of the procedures
described under "-- Procedures for Tendering" and "-- Book-Entry Transfer" above
at any time on or prior to the expiration date.
22
<PAGE> 23
CONDITIONS
Notwithstanding any other term of the exchange offer, initial notes will
not be required to be accepted for exchange, nor will exchange notes be issued
in exchange for any initial notes, and Knowles Electronics Holdings may
terminate or amend the exchange offer as provided herein before the acceptance
of such initial notes, if:
1. because of any change in law, or applicable interpretations thereof by
the SEC, Knowles Electronics Holdings determines that it is not
permitted to effect the exchange offer;
2. an action is proceeding or threatened that would materially impair
Knowles Electronics Holdings' ability to proceed with the exchange
offer; or
3. not all government approvals that Knowles Electronics Holdings deems
necessary for the consummation of the exchange offer have been received.
Knowles Electronics Holdings has no obligation to, and will not knowingly,
permit acceptance of tenders of initial notes:
-- from affiliates of Knowles Electronics Holdings within the meaning of
Rule 405 under the Securities Act;
-- from any other holder or holders who are not eligible to participate
in the exchange offer under applicable law or interpretations by the
SEC; or
-- if the exchange notes to be received by such holder or holders of
initial notes in the exchange offer, upon receipt, will not be
tradable by such holder without restriction under the Securities Act
and the Securities Exchange Act and without material restrictions
under the 'blue sky' or securities laws of substantially all of the
states of the United States.
ACCOUNTING TREATMENT
The exchange notes will be recorded at the same carrying value as the
initial notes, as reflected in Knowles Electronics Holdings' accounting records
on the date of the exchange. Accordingly, no gain or loss for accounting
purposes will be recognized by Knowles Electronics Holdings. The costs of the
exchange offer and the unamortized expenses related to the issuance of the
initial notes will be amortized over the term of the exchange notes.
EXCHANGE AGENT
The Bank of New York has been appointed as exchange agent for the exchange
offer. Questions and requests for assistance and requests for additional copies
of this prospectus, the letter of transmittal or notice of guaranteed delivery
should be directed to the exchange agent addressed as follows:
By Mail:
The Bank of New York
101 Barclay Street
Reorganization Section 7E
New York, New York 10286
Attention: Tolutope Adeyoju
By Courier or Hand Delivery:
The Bank of New York
101 Barclay Street
Corporate Trust Services Window
Ground Level
New York, New York 10286
Attention: Tolutope Adeyoju
By Facsimile: (212) 815-6339
Confirm by Telephone: (212) 815-3738
23
<PAGE> 24
FEES AND EXPENSES
Knowles Electronics Holdings will pay the expenses of soliciting tenders
under the exchange offer. The principal solicitation for tenders pursuant to the
exchange offer is being made by mail. However, additional solicitations may be
made by telephone, telecopy or in person by officers and regular employees of
Knowles Electronics Holdings.
Knowles Electronics Holdings will not make any payments to brokers, dealers
or other persons soliciting acceptances of the exchange offer. Knowles
Electronics Holdings, however, will pay the exchange agent reasonable and
customary fees for its services and will reimburse the exchange agent for its
reasonable documented out-of-pocket expenses in connection therewith. Knowles
Electronics Holdings may also pay brokerage houses and other custodians,
nominees and fiduciaries the reasonable out-of-pocket expenses incurred by them
in forwarding copies of this prospectus, the letter of transmittal and related
documents to the beneficial owners of the initial notes, and in handling or
forwarding tenders for exchange.
The expenses to be incurred in connection with the exchange offer will be
paid by Knowles Electronics Holdings, including fees and expenses of the
exchange agent and trustee and accounting, legal, printing and related fees and
expenses.
Knowles Electronics Holdings will pay all transfer taxes, if any,
applicable to the exchange of initial notes pursuant to the exchange offer. If,
however:
-- certificates representing exchange notes or initial notes for
principal amounts not tendered or accepted for exchange are to be
delivered to, or are to be registered or issued in the name of, any
person other than the registered holder of the initial notes tendered;
-- tendered initial notes are registered in the name of any person other
than the person signing the letter of transmittal; or
-- a transfer tax is imposed for any reason other than the exchange of
initial notes pursuant to the exchange offer,
then the amount of any such transfer taxes, whether imposed on the registered
holder or any other persons, will be payable by the tendering holder. If
satisfactory evidence of payment of such taxes or exemption therefrom is not
submitted with the letter of transmittal, the amount of the transfer taxes will
be billed directly to the tendering holder.
24
<PAGE> 25
THE RECAPITALIZATION AND OWNERSHIP OF CAPITAL STOCK
On June 30, 1999, Key Acquisition, L.L.C., all of whose membership
interests are held by limited partnerships for which Doughty Hanson & Co.
Limited or its affiliates (collectively, "Doughty Hanson") acts as general
partner, acquired control of Knowles Electronics Holdings, Inc. in a
recapitalization transaction. On June 29, 1999, Knowles' equipment financing
business (The Finance 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. As part of our 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 our 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, and 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 owes 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 our recapitalization, a syndicate of lenders led by The
Chase Manhattan Bank and Morgan Stanley Senior Funding, Inc. provided us with
$250 million of senior credit facilities consisting of a $50 million revolving
credit facility, subject to certain conditions, and $200 million in term loans
pursuant to a Credit Agreement, dated as of June 28, 1999, which was amended and
restated as of July 21, 1999 (the "Credit Agreement"). We also received $150
million from the sale of subordinated bridge notes (the "Subordinated Bridge
Notes") to Morgan Stanley Senior Funding, Inc. and The Chase Manhattan Bank, all
of which were repaid with proceeds from the offering of the initial notes and
available cash. The recapitalization was financed with term loans under the
Credit Agreement and the Subordinated Bridge Notes as well as a $214.2 million
equity investment by Key Acquisition, certain senior officers of Knowles and the
Knowles family. The sources and uses of funds for the recapitalization are
summarized below:
SOURCES AND USES
(IN MILLIONS)
<TABLE>
<CAPTION>
SOURCES OF FUNDS AMOUNT
---------------- ------
<S> <C>
Revolving Facility(1)................... $ --
Term Loan A............................. 50.0
Term Loan B............................. 150.0
Subordinated Bridge Notes(2)............ 150.0
Redeemable preferred stock due 2019:
Purchased by Doughty Hanson........... 164.4
Issued in exchange for common stock of
preexisting stockholders............ 20.6
Common stock:
Purchased by Doughty Hanson........... 24.0
Issued in exchange for common stock of
preexisting stockholders............ 3.0
Purchased by senior officers.......... 2.2
------
Total sources........................... $564.2
======
</TABLE>
<TABLE>
<CAPTION>
USES OF FUNDS AMOUNT
------------- ------
<S> <C>
Cash purchase of common stock(3)........ $505.5
Acquisition of common stock of
pre-existing stockholders in exchange
for new common and preferred stock.... 23.6
Cash retained by Knowles................ 8.1
Estimated fees and expenses(3).......... 27.0
------
Total uses.............................. $564.2
======
</TABLE>
------------
(1) Total availability under the Revolving Facility is $50.0 million, subject to
certain conditions.
(2) Proceeds from the initial offering were used to repay the Subordinated
Bridge Notes.
(3) The amount payable to our preexisting stockholders for the repurchase of
their common stock in our recapitalization was subject to the post-closing
adjustment described above. We also paid our preexisting stockholders $2.8
million for certain tax deductions they lost as a result of the
recapitalization.
25
<PAGE> 26
Ownership of Knowles. Key Acquisition, which owns approximately 81.4% of
our common stock and 88.9% of our preferred stock, is controlled by Doughty
Hanson. Doughty Hanson was founded in 1986 as a private partnership dedicated to
originating and arranging private equity and venture capital transactions for
market-leading businesses in Europe. To date, the firm has invested $11.0
billion of capital on behalf of a variety of institutional investors, and it has
become Europe's largest independent private equity fund manager. Since its
formation, Doughty Hanson has made investments in a variety of industries,
including sanitary installation systems, flooring products, non-beverage metal
packaging, sports watches, aircraft parts, precision parts and athletic apparel
and equipment manufacturing. The investment in Knowles represents Doughty
Hanson's first major equity investment in the United States.
Holding Company Reorganization. Subsequent to our recapitalization, we
reorganized our predecessor 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. On September 23, 1999, Knowles
Electronics, Inc. changed its name to Knowles Electronics Holdings, Inc. As a
result of the reorganization, Knowles Electronics Holdings, Inc. is now a
holding company that does not conduct any significant operations.
26
<PAGE> 27
CAPITALIZATION
The following table sets forth Knowles' historical consolidated cash, cash
equivalents and capitalization as of June 30, 2000. This table should be read in
conjunction with the historical consolidated financial statements of Knowles and
the related notes included in the back of this prospectus.
<TABLE>
<CAPTION>
AS OF
JUNE 30,
2000
--------------
(IN THOUSANDS)
<S> <C>
Cash and cash equivalents................................... $ 19,447
=========
Long-term debt, including current maturities:
Senior Credit Facility:(1)
Revolving Facility..................................... $ --
Term Loans............................................. 200,000
Senior Subordinated Notes(2).............................. 150,277
---------
Total long-term debt................................... 350,277
Preferred stock mandatorily redeemable in 2019, including
accumulating dividends of $18,500......................... 203,500
Common stockholders' equity (deficit)....................... (446,823)
---------
Total capitalization.............................. $ 106,954
=========
</TABLE>
------------
(1) Knowles incurred $200 million of term indebtedness pursuant to its Credit
Agreement in connection with the recapitalization. The Credit Agreement
consists of (i) a $50 million seven-year term loan, (ii) a $150 million
eight-year term loan, and (iii) a $50 million seven-year revolving credit
facility, subject to certain conditions.
(2) Net of unamortized discount of $2,923.
27
<PAGE> 28
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
The following unaudited pro forma condensed consolidated statement of
operations of Knowles gives effect to the recapitalization and related
transactions and the offering of the initial notes and the application of the
proceeds as if such transactions occurred on January 1, 1999. See "The
Recapitalization."
The unaudited pro forma condensed consolidated statement of operations is
not necessarily indicative of either future results of operations or results
that might have been achieved if the foregoing transactions had been consummated
as of the indicated dates. The pro forma adjustments are based upon currently
available information and upon certain assumptions that we believe are
reasonable. The unaudited pro forma condensed consolidated statement of
operations should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the historical
consolidated financial statements of Knowles, together with the related notes,
included in the back of this prospectus.
The effects of our recapitalization and recent transactions and the
issuance of the initial notes and the application of the proceeds are reflected
in the unaudited consolidated balance sheet and statement of operations as of
and for the six months ended June 30, 2000 included in this prospectus at pages
F-22 and F-23 and, therefore, no pro forma balance sheet and statement of
operations are presented as of such date or for such period.
28
<PAGE> 29
KNOWLES ELECTRONICS HOLDINGS, INC.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999
---------------------------------------
HISTORICAL ADJUSTMENTS PRO FORMA
---------- ----------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Net sales................................................ $229,106 $229,106
Costs and expenses:
Cost of sales.......................................... 146,472 146,472
Selling and administrative expense..................... 35,901 35,901
Recapitalization expenses.............................. 10,674 $(10,674)(a) --
Research and development............................... 10,930 10,930
-------- -------- --------
Operating income......................................... 25,129 10,674 35,803
Other income(expense):
Interest income........................................ 883 883
Interest expense....................................... (23,194) (718)(b)
(18,625)(c) (42,537)
Miscellaneous, net....................................... (123) (123)
-------- -------- --------
Income (loss) before income taxes........................ 2,695 (8,669) (5,974)
Income tax expense....................................... 8,980 3,240(d) 12,220
-------- -------- --------
Income (loss) from continuing operations................. $ (6,285) $(11,909) $(18,194)
======== ======== ========
</TABLE>
See accompanying notes.
29
<PAGE> 30
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
(a) Reflects the elimination of expenses related to our recapitalization
consisting 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.
(b) Reflects the amortization, using the effective interest method, of deferred
financing costs over the terms of the Subordinated Bridge Notes, the Notes
and Term Loans A and B of the Credit Agreement.
(c) Pro forma interest expense has been calculated based upon pro forma debt
levels and applicable interest rates. The Subordinated Bridge Notes were
outstanding for three months and one day after the consummation of the
recapitalization. Three months and one day after the consummation of the
recapitalization, the Subordinated Bridge Notes were refinanced with
available cash and the proceeds from the offering of the initial notes,
which have a fixed interest rate of 13 1/8% and were sold at a price of
97.954%. Pro forma interest expense on Term Loans A and B of the Credit
Facility was calculated on an annual basis using an interest rate of 5.5%
(LIBOR) plus 2.50% for Term Loan A and 3.00% for Term Loan B. Each 1/2 of 1%
change in the base interest rate for the Term Loans would have a $1,000
effect on pro forma interest expense for the year ended December 31, 1999.
(d) Knowles was an S corporation during the period from January 1, 1999 through
June 29, 1999. In connection with the closing of the recapitalization on
June 30, 1999, Knowles became a C corporation. The adjustment reflects the
income taxes of Knowles as if it were a C corporation for the entire year
ended December 31, 1999 as well as the impact of the decrease in pro forma
pre-tax income as a result of the pro forma adjustments described above.
30
<PAGE> 31
SELECTED CONSOLIDATED FINANCIAL DATA
The table below provides selected historical consolidated financial data of
Knowles as of and for each of the periods indicated. The selected financial data
for each of the three years in the period ended December 31, 1999 is derived
from historical consolidated financial statements of Knowles Electronics
Holdings, Inc. that have been audited by Ernst & Young LLP and are included in
this prospectus. Effective for the calender year 1997 reporting period, we
changed our fiscal year from one ending on June 30 to one ending on December 31.
The selected financial data for the six month period ended December 31, 1996 and
for each of the fiscal years in the two year period ended June 30, 1996 is
derived from historical consolidated financial statements of Knowles Electronics
Holdings, Inc. that have been audited by Ernst & Young LLP but are not included
in this prospectus. The selected financial data for the six month periods ended
June 30, 1999 and 2000 is derived from unaudited historical consolidated
financial statements of Knowles Electronics Holdings, Inc. that are included in
the prospectus and include all adjustments, consisting of an accrual for
restructuring expenses and normal recurring accruals, necessary to fairly
present the data for these periods. The operating results for the six months
ended June 30, 2000 are not necessarily indicative of the results that may be
expected for the entire fiscal year. The data presented below should be read in
conjunction with the historical consolidated financial statements and the
related notes included elsewhere in this prospectus and "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
SIX MONTHS
FISCAL YEAR ENDED ENDED SIX MONTHS
JUNE 30, DECEMBER 31, YEAR ENDED DECEMBER 31, ENDED JUNE 30,
------------------- ------------ ------------------------------ -------------------
1995 1996 1996 1997 1998 1999 1999 2000
-------- -------- ------------ -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales........................ $135,231 $144,935 $92,782 $218,150 $234,899 $229,106 $114,112 $120,573
Costs and expenses:
Cost of sales.................. 73,712 79,057 52,317 125,533 139,074 146,472 69,262 69,119
Selling and administrative
expense...................... 19,593 22,191 14,067 35,148 35,188 35,901 17,626 18,812
Research and development....... 3,336 4,271 3,189 9,884 10,870 10,930 5,130 4,803
Recapitalization expense(1).... -- -- -- -- -- 10,674 10,674 --
Restructuring expenses......... -- -- -- -- -- -- -- 20,094
-------- -------- ------- -------- -------- -------- -------- --------
Operating income................. 38,590 39,416 23,209 47,585 49,767 25,129 11,420 7,745
Interest income.................. 717 828 154 566 278 883 496 546
Interest expense................. -- -- (257) (392) (634) (23,194) (29) (21,621)
Miscellaneous, net............... 1,769 1,834 680 (1,455) (1,058) (123) (81) --
-------- -------- ------- -------- -------- -------- -------- --------
Income (loss) from continuing
operations before income
taxes.......................... 41,076 42,078 23,786 46,304 48,353 2,695 11,806 (13,330)
Income taxes..................... 17,806 18,741 10,028 9,856 7,107 8,980 (1,985) 2,152
-------- -------- ------- -------- -------- -------- -------- --------
Income (loss) from continuing
operations..................... 23,270 23,337 13,758 36,448 41,246 (6,285) 13,791 (15,482)
Income from discontinued
operations less applicable
income taxes(2)................ 7,401 7,581 3,910 6,729 6,936 2,556 2,556 --
-------- -------- ------- -------- -------- -------- -------- --------
Net income (loss)................ $ 30,671 $ 30,918 $17,668 $ 43,177 $ 48,182 $ (3,729) $ 16,347 $(15,482)
======== ======== ======= ======== ======== ======== ======== ========
C Corporation Pro Forma Data(3)--
unaudited:
C corporation pro forma income
taxes........................ $ -- $ -- $ -- $ 11,600 $ 18,500 $ 19,125 $ -- $ --
C corporation pro forma income
(loss) from continuing
operations adjusted for
income taxes................. $ -- $ -- $ -- $ 34,704 $ 29,853 $(16,430) $ -- $ --
======== ======== ======= ======== ======== ======== ======== ========
OTHER FINANCIAL DATA:
Depreciation and
amortization................. $ 4,399 $ 5,808 $ 4,614 $ 10,348 $ 11,235 $ 12,638 $ 6,226 $ 6,225
Capital expenditures........... 8,449 8,954 6,941 12,129 16,326 14,500 7,748 7,448
Cash flows from operating
activities................... 27,467 27,204 19,865 52,395 56,078 49,274 44,249 13,529
Cash flows from investing
activities................... (7,185) (8,196) (18,289) (12,129) (16,326) (14,500) (7,748) (7,448)
Cash flows from financing
activities................... (27,164) (34,455) 1,565 (50,669) (41,733) (19,055) (13,330) (8,858)
EBITDA(4)(5)................... 42,989 45,224 27,823 57,933 61,002 48,441 28,320 34,064
Ratio of earnings to fixed
charges(6)................... 115.1x 125.1x 50.0x 36.1x 38.1x 1.1x 26.0x
</TABLE>
31
<PAGE> 32
<TABLE>
<CAPTION>
AS OF
AS OF JUNE 30, AS OF DECEMBER 31, JUNE 30,
------------------- ------------------------------------------ ---------
1995 1996 1996 1997 1998 1999 2000
-------- -------- -------- -------- -------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents........................ $ 5,553 $ 5,477 $ 18,377 $ 7,406 $ 5,594 $ 22,332 $ 19,447
Total assets..................................... 225,710 225,664 272,045 254,413 265,673 186,506 184,216
Long term debt including current maturities...... -- 800 13,000 1,300 -- 350,134 350,277
Preferred stock mandatorily redeemable in 2019... -- -- -- -- -- 194,250 203,500
Total common stockholders' equity (deficit)...... 202,898 198,561 196,128 209,840 219,194 (412,860) (446,823)
</TABLE>
---------------
(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) 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.
(3) 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 our
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.
(4) "EBITDA" has been calculated as earnings before interest, taxes,
depreciation, amortization, miscellaneous income/expense, and, for the six
months ended June 30, 2000, expenses relating to our restructuring announced
in March 2000 and, for the six months ended June 30, 1999 and twelve months
ended December 31, 1999, our recapitalization expenses. 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.
(5) We announced a major restructuring in March 2000, resulting in a first
quarter charge of $20.1 million. We are consolidating 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, and we expect to reduce
our global workforce by about 20%.
(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 six months ended June 30, 2000 by approximately $13.3 million.
32
<PAGE> 33
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 prospectus.
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 high growth
potential. Since we were founded in 1946, we have leveraged our core competency
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, Germany, Austria, Malaysia and China. Our 1999 revenue, operating
income and EBITDA, as reported, were $229.1 million, $25.1 million and $37.8
million, respectively. Our 1999 revenue, operating income and EBITDA, adjusted
for our recapitalization expenses of $10.7 million and special charges of $8.9
million taken to increase our reserves for slow moving and obsolete inventory
and product warranty claims, were $229.1 million, $44.7 million and $57.4
million, respectively.
Our three segments are:
-- 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 core
competencies in infrared technology and electronics to provide high
technology solutions for markets with high growth potential,
including computer telephony integration, automotive communications
and entertainment systems, and devices other than PCs accessing the
web.
-- AUTOMOTIVE COMPONENTS. Our Automotive Components business unit is
comprised of two businesses, Synchro-Start Products, Inc. ("SSPI"),
which produces diesel engine solenoids and electronic governors, and
Ruf electronics GmbH ("Ruf"), a leading producer of automotive
position sensors. Within six to twelve months from June 2000, we
expect to divest the Ruf position sensor business, which accounts for
approximately 45% of the sales and a negligible portion of the
operating income of Automotive Components. We do not yet know when
the business will be sold, or for how much, but the effect on our
financial condition is not expected to be material.
The following table sets forth the approximate percentage of our net sales
from each segment.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------- -----------------
SEGMENT 1997 1998 1999 1999 2000
------- ----- ----- ----- ------ ------
<S> <C> <C> <C> <C> <C>
KE....................................... 55.9% 57.1% 59.1% 58.6% 59.6%
Emkay.................................... 11.4 13.4 14.1 12.9 13.0
Automotive Components.................... 32.7 29.5 26.8 28.5 27.4
----- ----- ----- ----- -----
Total.......................... 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== =====
</TABLE>
33
<PAGE> 34
The following table sets forth the percentage of our operating income from
each segment. The percentages for the year ended December 31, 1999 and six
months ended June 30, 1999 exclude one-time recapitalization expenses of $10.7
million, and the percentages for all periods exclude the unallocated corporate
overhead expenses described below.
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------- -----------------
SEGMENT 1997 1998 1999 1999 2000
------- ----- ----- ----- ------ ------
<S> <C> <C> <C> <C> <C>
KE...................................... 77.9% 75.9% 101.1% 94.0% 119.2%
Emkay................................... 8.5 10.1 3.4 2.4 6.8
Automotive Components................... 13.6 14.0 (4.5) 3.6 (26.0)
----- ----- ----- ------ ------
Total......................... 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ====== ======
</TABLE>
Note that the percentages for the six months ended June 30, 2000 excluding
restructuring expenses would be 86.6% for KE, 3.4% for Emkay, and 10.0% for
Automotive Components.
Net sales. We recognize net sales upon the shipment of products to the
buyer, which is typically when title transfers to the buyer.
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 the
market for hearing aids can be expanded to more than offset this decline in
transducer prices.
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 voice recognition and computer
telephony integration products. However, we believe that sales of complex voice
recognition products will not increase substantially until voice recognition
software provides better performance. We also believe that sales of voice
recognition products have stagnated in North America in particular as a result
of consumer dissatisfaction with product performance. There has been price
competition in these markets.
Net sales from Automotive Components are generally driven by the sale of
diesel engine solenoids and position sensors. Sales of diesel engine solenoid
products for use as 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. Net sales of position sensors products are driven by sales of new
automobiles and trucks, which are expected to remain relatively flat. However,
we expect advanced "drive-by wire" control systems to be included in more new
luxury vehicles, and later across other product lines of the automotive
manufacturers, which would result in more position sensors being installed per
vehicle. In "drive-by-wire" control systems there is no direct mechanical
connection between the actions taken by the driver and the vehicle's response,
i.e., the steering wheel is not connected by a steering column to the front
tires, but is instead connected to an electronic control system that signals the
tires to be turned by a separate mechanical process.
Automotive Components' net sales of sensors have recently decreased for two
reasons. First, currency changes between the German Deutschemark and the U.S.
dollar caused a reduction of approximately $1.8 million in position sensor sales
in 1999 compared to 1998. Second, the current diesel fuel injection pump of our
largest position sensor customer is being replaced by a new technology on some
diesel engines, due in part to environmental regulations in Europe and North
America. Consequently, this customer reduced orders of this sensor for use on
both larger and smaller diesel engines from approximately $10 million in 1998 to
$6 million in 1999, and has continued to reduce orders of this sensor this year.
Automotive Components' net sales to another original equipment manufacturer have
also recently decreased as that manufacturer has begun to dual source components
that we had previously supplied on a sole source basis. Our sales to this
manufacturer were over $4 million in 1998 compared to less than $3 million in
1999. We are seeking to address these declines in sales by developing new
products and establishing new customer relationships. For
34
<PAGE> 35
example, we have recently entered into a single source contract with a major
North American automobile parts manufacturer from whom we have not previously
had significant revenues. There is substantial price competition in the
Automotive Components' market. Original equipment manufacturers generally
require scheduled price decreases.
Cost of sales. Our cost of sales consists mainly of materials, direct and
indirect labor costs and other overhead. Other overhead includes depreciation,
equipment maintenance, shipping and manufacturing supplies. Direct and indirect
labor payroll expense is the largest 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 selling and administrative expense).
The majority of our depreciation expense 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, Malaysia and Hungary. We have recently expanded our facilities
in China and Hungary. In March 2000, we announced plans to consolidate our
worldwide manufacturing operations. We will outsource some activities currently
performed in Itasca and Rolling Meadows, Illinois. In addition, we will cease
production at our United Kingdom, Taiwanese and German manufacturing facilities.
Production from those operations will be moved to China, Malaysia and Hungary.
Over the next twelve to eighteen months, the Company expects to reduce its
global workforce by approximately 20 percent.
KE's material costs primarily relate to unprocessed materials or
commodities, including steel, copper wire, and magnet bar stock. KE purchases
certain integrated circuits and magnets customized specifically for its products
from single source suppliers. 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. However, it also purchases parts and sub-assemblies customized
specifically for its products and depends, therefore, to a greater extent on
suppliers.
Selling and administrative expense. Our selling and administrative
expenses consist of personnel costs, legal, accounting and other professional
costs, management information systems and rent. Our selling expenses have not
been a significant portion of this line item, but are increasing due to Emkay,
which is building a sales 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.
We expect to replace certain management information systems over the next
three years, requiring expenditures of approximately $9 million through 2002. A
portion of the associated costs will be expensed and the remainder will be
capitalized.
Research and development. Research and development costs consist mainly of
labor, 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.
Other income (expense). Other income (expense) consists of interest
income, interest expense and miscellaneous expenses. Neither interest income nor
interest expense was significant in 1997 and 1998. However, due to our
recapitalization, net interest expense increased to $22.3 million in 1999 and it
will increase to approximately $42 million in 2000.
Income taxes. For 1997, 1998 and the first half of 1999 (prior to our
recapitalization), Knowles was an S corporation and was generally not subject to
federal income taxes. Income taxes paid during that time period relate to
Knowles' non-U.S. subsidiaries that did not have the benefit of S corporation
treatment and state and local taxes applicable to Knowles and its subsidiaries.
Effective June 30, 1999, Knowles became a C corporation and will therefore be
subject to federal income taxes. Income taxes are expected to be approximately
25% of pretax income in 2000.
Income from discontinued operations. Knowles discontinued its equipment
financing business and distributed it on June 29, 1999, the day prior to the
recapitalization, to its preexisting stockholders. Net sales and costs and
expenses directly attributable to these operations are not included in recurring
operations on our income statements in the periods presented.
35
<PAGE> 36
Foreign exchange exposure. Our revenues are primarily denominated in the
U.S. dollar and the German Deutschemark (which is now tied to the euro). Our
expenses are principally denominated in those currencies, but are also
denominated in the local currencies of Austria, the United Kingdom, Hungary,
China, Japan, Malaysia and Taiwan. We do not hedge this exposure, since we
generally incur significant costs in the same currencies in which we have sales.
As we move more production out of Europe to Asia, we could become more exposed
to relative changes in value among the euro, the U.S. dollar and major Asian
currencies.
SPECIAL CHARGES IN 1999
During the second quarter of 1999, we recognized non-recurring expenses
related to our recapitalization of $10.7 million. These 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. In addition,
during the second and fourth quarters of 1999, we recognized special charges of
$8.9 million to increase our reserves for slow moving and obsolete inventory and
our product warranty claims. The increase in slow moving and obsolete inventory
was due to the introduction of new products in 1998 that did not sell in 1999,
and management's new emphasis on managing inventory levels, which is intended to
reduce the amount of inventory on hand by more quickly disposing of slow moving
and obsolete inventory. Previously, we were more reluctant to write off slow
moving or obsolete inventory as our approach was to try to utilize the inventory
if at all possible. Our current approach is to not carry slow moving or obsolete
inventory for such lengthy periods but instead to dispose of this inventory to
reduce carrying costs and free up warehouse capacity. The increase in warranty
claim reserves was due to an increase in warranty claim experience due to
extended warranty periods. Also, during the third quarter of 1999, we recognized
a non-recurring expense of $3.9 million related to the amortization of deferred
financing charges associated with our subordinated bridge notes.
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.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------- ----------------
1997 1998 1999 1999 2000
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Net sales................................ 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales.......................... 57.5 59.2 63.9 60.7 57.3
Selling and administrative expense..... 16.1 15.0 15.7 15.4 15.6
Recapitalization expense............... 0.0 0.0 4.7 9.4 0.0
Restructuring expense.................. 0.0 0.0 0.0 0.0 16.7
Research and development............... 4.5 4.6 4.8 4.5 4.0
----- ----- ----- ----- -----
Operating income......................... 21.9 21.2 10.9 10.0 6.4
EBITDA................................... 26.6 26.0 16.5 15.5 11.6
</TABLE>
Operating income and EBITDA, as a percentage of net sales, as reported, were
10.9% and 16.5%, respectively, for the year ended December 31, 1999. Operating
income and EBITDA, as a percentage of net sales, excluding the recapitalization
expenses and special charges discussed above, were 19.5% and 25.1%,
respectively, for the year ended December 31, 1999. Operating income and EBITDA,
as a percentage of net sales, as reported, were 6.4% and 11.6%, respectively,
for the six months ended June 30, 2000. Operating income and EBITDA, as a
percentage of net sales, excluding expenses relating to our restructuring
announced in March 2000, were 23.1% and 28.3%, respectively, for the six months
ended June 30, 2000.
36
<PAGE> 37
SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS ENDED JUNE 30, 1999
The following table sets forth net sales by segment, and segment net sales
as a percent of total net sales.
<TABLE>
<CAPTION>
NET SALES PERCENT OF TOTAL SALES
---------------- -----------------------
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------- -----------------------
SEGMENT 1999 2000 1999 2000
------- ------ ------ -------- --------
(IN MILLIONS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
KE........................................... $ 66.8 $ 71.9 58.5% 59.7%
Emkay........................................ 14.7 15.6 12.9 12.9
Automotive Components........................ 32.6 33.0 28.6 27.4
------ ------ -----
Total................................... $114.1 $120.5 100.0% 100.0%
------ ------ ----- -----
</TABLE>
Overall, net sales increased 6% in the first half of 2000 compared to the
first half of 1999. KE's net sales increased 8% in the first half of this year
as compared to the same period last year. The first quarter was much stronger
than the second quarter, as a result of what we believe were normal variations
and not a change in overall market trends. Within KE, sales of Deltek
non-transducer products increased at a higher rate than the division, but on a
much smaller sales base. Transducer unit volume increased more than 10% in the
first half of this year, but approximately half the unit volume increase was
offset by reduced pricing. Emkay's net sales increased 6% in the first half of
2000 as compared to the same period last year. Finished goods product sales
accounted for the entire Emkay increase, as component and infrared product sales
were flat as compared with last year. Infrared product sales were flat due to
unfavorable U.S. dollar to German Deutschemark exchange rate changes
year-over-year, but increased 13% on a constant currency basis. Automotive
Components' net sales increased 1% in the first half of 2000 as compared to the
first half of 1999. SSPI diesel solenoid net sales increased 18%, primarily due
to large replacement parts orders from SSPI's largest customer. Ruf net sales
decreased 16%, primarily due to unfavorable U.S. dollar to German Deutschemark
exchange rate changes. However, Ruf's net sales declined only 5% on a constant
currency basis, due to lower sales of a specific diesel throttle position sensor
to Ruf's largest customer.
The following table sets forth cost of sales by segment, and segment cost
of sales as a percentage of segment net sales.
<TABLE>
<CAPTION>
PERCENT OF
COST OF SALES SEGMENT SALES
---------------- ----------------
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
---------------- ----------------
SEGMENT 1999 2000 1999 2000
------- ------ ------ ------ ------
(IN MILLIONS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
KE.................................................. $36.3 $36.4 54.3% 50.6%
Emkay............................................... 9.6 9.6 65.3 61.5
Automotive Components............................... 23.4 23.1 71.8 70.0
----- -----
Total.......................................... $69.3 $69.1 60.7% 57.3%
===== =====
</TABLE>
Consolidated cost of sales decreased by 3.4 percentage points as a percent
of sales in the first half of 2000 as compared to the same period in the prior
year. KE's cost of sales declined by 3.7 percentage points, partly due to higher
sales volume, but primarily due to savings associated with product transfers
initiated in the first half of last year. Emkay's cost of sales declined by 3.8
percentage points, primarily due to a smaller increase in the slow moving and
obsolete reserve this year as compared to last year. Automotive Components' cost
of sales declined by 1.8 percentage points, primarily due to lower Ruf costs as
a result of the start of a shift in production from Germany to Hungary.
General and administrative expenses were higher in the first half of 2000
compared to the same period in the prior year, primarily due to increased
professional fees related to patent and other legal activities, but also due to
increased pension costs realized as part of our analysis of the closing of
production operations in Taiwan. Selling and research and development expenses
were little changed in the first half of 2000 as compared to the first half of
1999.
37
<PAGE> 38
The following table sets forth operating income by segment, and operating
income as a percentage of net sales.
(Numbers may not total, due to rounding).
<TABLE>
<CAPTION>
OPERATING INCOME PERCENT OF SALES
----------------- -----------------
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------- -----------------
SEGMENT 1999 2000 1999 2000
------- ------- ------ ----- ------
(IN MILLIONS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
KE............................................. $ 22.2 $16.2 33.2% 22.5%
Emkay.......................................... 0.6 0.9 4.1 5.8
Automotive Components.......................... 0.8 (3.6) 2.5 (10.9)
Recapitalization Expenses...................... (10.7) --
Unallocated amount--corporate overhead......... (1.5) (5.8)
------ -----
Total..................................... $ 11.4 $ 7.7 10.0% 6.4%
====== =====
</TABLE>
The following table sets forth operating income by segment, and operating
income as a percentage of net sales, excluding recapitalization expenses for the
six months ended June 30, 1999 and restructuring expenses for the six months
ended June 30, 2000.
<TABLE>
<CAPTION>
OPERATING INCOME PERCENT OF SALES
----------------- -----------------
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------- -----------------
SEGMENT 1999 2000 1999 2000
------- ------- ------ ----- ------
(IN MILLIONS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
KE............................................. $ 22.2 $26.2 33.2% 36.4%
Emkay.......................................... 0.6 1.0 4.1 6.4
Automotive Components.......................... 0.8 3.0 2.5 9.1
Unallocated amount--corporate overhead......... (1.5) (2.4)
------ -----
Total (excluding 1999 recapitalization
expenses and 2000 restructuring
expenses)............................... $ 22.1 $27.8 19.4% 23.1%
====== =====
</TABLE>
During the second quarter of 1999, we recognized non-recurring expenses
related to our recapitalization of $10.7 million. These 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.
We announced a major restructuring in March 2000, resulting in a first
quarter charge of $20.1 million. Under the restructuring plan, we are
consolidating our 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.
The restructuring charge consists almost entirely of severance payments to
terminated employees and outplacements expenses. Through June 30, 2000, 325
positions have been eliminated of the 1,047 total positions that will be
eliminated in the restructuring and $1.8 million has been spent on severance and
outplacement costs of the $20.1 million that was accrued. We expect that a total
of approximately 700 positions will be eliminated and approximately $11 million
of the restructuring charge will be spent by December 31, 2000. We expect that
the remaining 350 positions will be eliminated and approximately $8 million of
the remaining $9 million of the restructuring charge will be spent by December
31, 2001, approximately seventy five percent during the first half of 2001.
At the five facilities where production is being eliminated, the number of
positions being eliminated at each facility and the final production dates at
each facility are as follows: (1) Burgess Hill, United Kingdom; 148 positions;
June 2000, (2) Itasca, Illinois; 248 positions; September 2000, (3) Taipai,
Taiwan; 216 positions; March, 2001, (4) Rolling Meadows, Illinois; 26 positions;
March 2001, and (5) Hoenkirchen, Germany; 270 positions; September 2001. Over
the next 12 to 18 months these actions will reduce our global workforce by about
20%.
We expect that the savings from the restructuring will be $15 to $20
million annually. Although some benefits will begin to accrue as early as the
third and fourth quarters of this year, the full impact of the benefits will not
be experienced until 2002. These benefits will be reduced in part by increases
in payments to our
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<PAGE> 39
remaining employees. In addition, over the next six to twelve months, we expect
to divest the Ruf position sensor business.
Including the restructuring charge in the first half of this year and the
recapitalization charge in the first half of last year, we reported operating
income of $7.7 million in the first half of 2000 as compared to operating income
of $11.4 million in the first half of 1999. Excluding the restructuring charge
this year and the recapitalization charge last year, we had adjusted operating
income of $27.8 million in the first half of this year as compared to $22.1
million in the first half of last year. On an adjusted basis our operating
income increased by $5.7 million, or 26%, in the first half of this year as
compared to the same period last 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 substantial during the first half of this year compared to a negligible
amount in the same period last year.
Income tax expense was significantly higher in the first half of this year,
at $2.2 million, as compared to a $2.0 million benefit in the first half of last
year. The difference is due to the higher foreign source taxable income this
year as compared to last year.
As a result of the interest expense and taxes (and restructuring charge) we
reported a loss from continuing operations of $15.5 million in the first half of
this year as compared to income from continuing operations of $13.8 million in
the same period last year.
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
The following table sets forth net sales by segment, and segment net sales
as a percentage of total net sales. (Numbers may not total due to rounding.)
<TABLE>
<CAPTION>
NET SALES PERCENT OF TOTAL SALES
---------------- -----------------------
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
---------------- -----------------------
SEGMENT 1998 1999 1998 1999
------- ------ ------ --------- --------
(IN MILLIONS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
KE........................................... $134.1 $135.4 57.1% 59.1%
Emkay........................................ 31.6 32.3 13.4 14.1
Automotive Components........................ 69.2 61.4 29.5 26.8
------ ------ ------ -----
Total.............................. $234.9 $229.1 100.0% 100.0%
====== ====== ====== =====
</TABLE>
Overall, net sales decreased 2% in 1999 compared to 1998. KE's net sales
increased 1% in 1999 as compared to 1998. The small increase in net sales was
attributable to increased unit volumes of approximately 3%, substantially offset
by price decreases. Many of KE's contracts offering significant price decreases
to customers expire in 2001 and we intend to work to reduce the number of such
contracts in future years. Emkay's net sales increased 2% due to further
penetration of wired headsets in Europe and microphone sales in Asia, offset in
large part by a decrease in wired headset sales in North America and, to a
lesser extent, by lower sales of wireless headsets. We believe the decrease in
wired headset sales resulted from stagnant sales of complex voice recognition
software, particularly in North America, due to a lower level of performance
than had been anticipated. We also believe that sales of complex voice
recognition software and products will not increase substantially until the
technology provides better performance. Emkay's net sales increase of infrared
product was substantially offset by unfavorable foreign currency fluctuations.
Automotive Components' net sales decreased 11%. Negative foreign currency
movement reduced sales by approximately 3% and a significant reduction in orders
for a diesel fuel sensor as a result of one customer's diesel fuel pump being
replaced by new technology, partly in response to environmental regulations,
reduced sales by approximately 6%. Net sales of this sensor to this manufacturer
were $10 million in 1998 compared to $6 million in 1999. Automotive Components'
net sales to another original equipment manufacturer also decreased as that
manufacturer has begun to dual source components that we had previously supplied
on a sole source basis. Our net sales to this manufacturer were in excess of $4
million in 1998 compared to less than $3 million in 1999. We are seeking to
address these declines in sales by developing new products and establishing new
customer relationships.
39
<PAGE> 40
The following table sets forth cost of sales by segment, and cost of sales
as a percentage of net sales.
<TABLE>
<CAPTION>
PERCENT OF
SEGMENT SALES
COST OF SALES --------------
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
---------------- --------------
SEGMENT 1998 1999 1998 1999
------- ------ ------ ----- -----
(IN MILLIONS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
KE.................................................. $ 75.2 $ 78.9 56.1% 58.3%
Emkay............................................... 18.7 21.1 59.2 65.3
Automotive Components............................... 45.2 46.5 65.3 75.7
------ ------
Total..................................... $139.1 $146.5 59.2% 63.9%
====== ======
</TABLE>
Consolidated cost of sales increased by 4.7 percentage points as a
percentage of sales. However, when the $8.9 million of special charges for the
increases in the inventory reserve and warranty accrual are removed,
consolidated cost of sales actually decreased by $1.5 million, or 0.7 percentage
points as a percentage of sales. KE's 2.2 percentage point increase in cost of
sales as a percentage of segment sales reflects increased warranty accrual and
increased slow-moving inventory reserves, partially offset by the shift of
production to lower wage locations. Emkay's 6.1 percentage point increase
resulted largely from a one-time adjustment of inventory (particularly headsets)
to a lower net realizable value, reflecting the stagnant conditions in the voice
recognition software market as discussed above. As a percent of net sales,
Automotive Components' cost of sales increased 10.4 percentage points due to
fixed costs being spread over lower net sales, an increase in slow-moving
inventory reserves, and higher rent in Germany.
The selling and administrative expense increase is attributable to
increased bad debt provisions, partly as a result of financial conditions at
some smaller customers of KE, higher investment in sales personnel by Emkay,
primarily to penetrate the North American market, and the cost of a business
development study for Automotive Components. These additional selling and
administrative increases were partially offset by the absence of stock
appreciation rights expense in 1999 as a result of our recapitalization.
Research and development expenses were slightly higher in 1999 due to
increased investment in product development personnel by Emkay, partially offset
by a lower level of circuit prototype development at KE.
The following table sets forth operating income by segment, and operating
income as a percentage of net sales.
<TABLE>
<CAPTION>
OPERATING INCOME PERCENT OF SALES
----------------- ----------------
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
----------------- ----------------
SEGMENT 1998 1999 1998 1999
------- ------ ------- ----- -----
(IN MILLIONS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
KE....................................................... $40.4 $ 38.7 30.1% 28.6%
Emkay.................................................... 5.4 1.3 17.1 4.0
Automotive Components.................................... 7.5 (1.7) 10.8 (2.8)
Recapitalization expenses................................ -- (10.7)
Unallocated amount -- corporate overhead................. (3.5) (2.4)
----- ------
Total.......................................... $49.8 $ 25.2 21.2% 11.0%
===== ======
</TABLE>
Operating income as a percent of sales declined 10.2 percentage points in
1999 primarily due to recapitalization expenses of $10.7 million, special
charges of $8.9 million for increases to our reserves for slow moving and
obsolete inventory and our product warranty claims and higher costs at
Automotive Components as discussed above.
Interest expense was significantly higher in 1999 than 1998 as a result of
the debt that we incurred to finance our recapitalization.
Income tax expense increased in 1999 because we established a valuation
allowance of $6.3 million for certain foreign net operating loss carryforwards,
which are more likely not to be realized, and we provided
40
<PAGE> 41
$3.1 million for the anticipated tax liability on unremitted foreign earnings,
which are not considered permanently reinvested. Knowles Electronics Holdings
was an S Corporation and generally not subject to federal income taxes during
1998, and in 1999 through June 29, when our S Corporation status was terminated.
Income from continuing operations was a $6.3 million loss in 1999 as
compared to income of $41.2 million in 1998, primarily due to the
recapitalization charges and interest expense incurred in 1999 and not in 1998.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
The following table sets forth net sales by segment, and segment net sales
as a percentage of total sales.
<TABLE>
<CAPTION>
PERCENT OF TOTAL
NET SALES SALES
---------------- ----------------
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
---------------- ----------------
SEGMENT 1997 1998 1997 1998
------- ------ ------ ------ ------
(IN MILLIONS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
KE........................................................ $121.9 $134.1 55.9% 57.1%
Emkay..................................................... 24.9 31.6 11.4 13.4
Automotive Components..................................... 71.4 69.2 32.7 29.5
------ ------ ----- -----
Total........................................... $218.2 $234.9 100.0% 100.0%
====== ====== ===== =====
</TABLE>
Overall, net sales increased 8% in 1998 compared to 1997. KE's net sales
increased 10% in 1998 as compared to 1997. KE's net sales increase reflects an
increase in unit sales of approximately 10% and the introduction of a new
high-end product, partially offset by pricing pressures from major customers and
the competitive response of protecting market share by maintaining and, in some
cases, reducing prices. Emkay's net sales increased 27% in 1998 as compared to
1997. Emkay's net sales increase resulted from the introduction of new products
and increased penetration of voice recognition products. Automotive Components'
net sales declined 3% in 1998 as compared to 1997. Automotive Components'
revenue decline was due to the Asian economic crisis and the receipt in 1997 of
a large one-time order from a major customer that was not repeated in 1998. Net
sales were also negatively affected by scheduled price decreases and negotiated
price decreases associated with shifting production to Hungary.
The following table sets forth cost of sales by segment, and cost of sales
as a percentage of net sales.
<TABLE>
<CAPTION>
PERCENT OF
COST OF SALES SEGMENT SALES
-------------------- -----------------
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
-------------------- -----------------
SEGMENT 1997 1998 1997 1998
------- -------- -------- -------- -----
(IN MILLIONS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
KE........................................................ $ 64.4 $ 75.2 52.8% 56.1%
Emkay..................................................... 14.0 18.7 56.2 59.2
Automotive Components..................................... 47.1 45.2 66.0 65.3
------ ------
Total........................................... $125.5 $139.1 57.5% 59.2%
====== ======
</TABLE>
Consolidated cost of sales increased as a percentage of net sales by 1.7
percentage points as a result of pricing pressures at KE and Emkay (particularly
on wired headsets) and lower sales at Automotive Components. KE's 3.3 percentage
point increase reflects non-recurring costs associated with shifting production
to low cost facilities. Emkay's 3.0 percentage point increase resulted from
significant sales growth in lower margin products. Automotive Components' cost
of sales declined 0.7 percentage points due to lower sales, partially offset by
the realization of the economies associated with the movement of production to
our lower cost Hungarian plant.
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<PAGE> 42
Selling and administrative expense was flat in 1998 as compared to 1997 and
decreased as a percentage of net sales. KE marketing expenses actually decreased
as a result of one-time marketing surveys and other projects in 1997 that were
not repeated in 1998 while Emkay's expenses increased by an amount similar to
the KE decrease.
Research and development expenses increased as a percentage of net sales
due in large part to the development costs associated with the silicon
microphone, which is intended not only for hearing aid applications but also to
meet the needs of automotive and computer (Emkay) customers.
The following table sets forth operating income by segment, and operating
income as a percentage of net sales.
<TABLE>
<CAPTION>
OPERATING INCOME PERCENT OF SALES
-------------------- -----------------
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
-------------------- -----------------
SEGMENT 1997 1998 1997 1998
------- -------- -------- -------- -----
(IN MILLIONS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
KE........................................................ $ 40.3 $ 40.4 33.1% 30.1%
Emkay..................................................... 4.4 5.4 17.7 17.1
Automotive Components..................................... 7.0 7.5 9.8 10.8
Unallocated amount -- corporate overhead.................. (4.1) (3.5)
------ ------
Total........................................... $ 47.6 $ 49.8 21.8% 21.2%
====== ======
</TABLE>
Operating income as a percentage of sales declined by 0.6 percentage points
due to non-recurring costs of shifting KE's production to lower cost facilities,
and greater sales of lower margin products at Emkay, partially offset by the
favorable impact at Automotive Components in 1998 of a large one-time order from
a major customer.
The slightly higher interest expense in 1998 was due to the timing and
increased size of capital expenditures and dividends in 1998, which caused a
greater use of lines of credit compared to 1997.
Income tax expense was higher in 1997 due to the write-off of the net
deferred tax asset and LIFO recapture tax that resulted from the election of S
Corporation status by the stockholders of Knowles Electronics Holdings under the
Internal Revenue Code effective January 1, 1997.
Income from continuing operations was $41.2 million in 1998 as compared to
$36.4 million in 1997, primarily due to significantly higher sales in 1998 as
compared to 1997 and the change in income tax expense discussed above.
LIQUIDITY AND CAPITAL RESOURCES
We have historically used available funds for dividend payments, capital
expenditures, inventory, accounts receivable and acquisitions. Prior to June 30,
1999 we also used available funds to finance our equipment lease lending
operation which was discontinued. These funds have been obtained from operating
activities and from lines of credit. In the future, we will continue to have
these funding needs (other than dividends and lending operation receivables),
and we will also need to fund repayments of principal under our term loans ($3.3
million in 2000, $7.8 million in 2001, $9.0 million in 2002, and additional
amounts thereafter). We also will have substantial interest expense of
approximately $42 million each year. We expect to satisfy these needs with cash
from operating activities. We also have available under our Revolving Facility
borrowings of up to $50 million, subject to certain conditions. 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.
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 as arbitrators
under our recapitalization agreement determined that Knowles owes the
preexisting stockholders approximately $8.3 million of the $13.3 million
purchase price adjustment originally proposed by
42
<PAGE> 43
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.
Net cash provided by operating activities was $49.3 million for 1999, as
compared to $56.1 million in 1998. These amounts include $30.0 million and $19.2
million, respectively, of net cash provided by discontinued operating activities
in 1999 and 1998. Net cash provided by continuing operations was $19.2 million
and $36.9 million, respectively, in 1999 and 1998. Income from continuing
operations was a loss of $6.3 million in 1999 compared to income of $41.2
million in 1998. The 1999 results reflect charges for interest expense and
recapitalization expenses of $23.2 million and $10.7 million, respectively.
Accounts receivable increased by $3.8 million, we believe due to normal business
fluctuations. Inventory increased by $2.4 million, excluding the provision for
obsolescence, due to normal business fluctuations and a buildup to cover planned
production moves. Accounts payable and other current liabilities increased $13.2
million due to accrued interest expense and higher accrual for warranty costs
and customer rebates. Deferred income tax liability increased by $4.7 million
due primarily to a provision for tax liability on unremitted foreign earnings.
Net cash used in investing activities was $14.5 million in 1999, as
compared to $16.3 million in 1998. This decline is due to reduced purchases of
property, plant and equipment.
Net cash used in financing activities was $19.1 million in 1999 as compared
to $41.7 million in 1998. The issuance of preferred and common stock of $190.6
million and the debt proceeds of $350.1 million funded the purchase of common
stock and the related recapitalization costs in 1999. Dividends paid were $24.8
million and $40.4 million in 1999 and 1998, respectively. In the future, cash
used in financing activities will consist mostly repayments of principal
beginning in September 2000 of our credit facilities and the Notes.
We expect capital expenditures of $15.0 million in 2000. Approximately $3.5
million of our capital expenditures during 2000 were used to build a new
facility for the expansion of our manufacturing operations in Hungary. We may
also pursue acquisitions or joint ventures in lower wage locations, which would
require additional capital resources. The amount and timing of actual capital
expenditures may be different than our current expectations.
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 German Deutschemark (which is now tied to
the euro). During 1999, approximately 70% of our revenue was denominated in U.S.
dollars, approximately 20% of our revenue was denominated in German
Deutschemarks, and the balance was denominated in other foreign currencies.
During the first half of 2000, the German Deutschemark lost slightly more than
10% of its value relative to the U.S. dollar, and as a result our reported
revenue for the first six months of 2000 is approximately $2.6 million less than
it would have been at last year's exchange rate. 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 the first six months of 2000, our operating income and margins were not
significantly affected by the change in the German Deutschemark exchange rate.
Some of our expenses are denominated in the local currencies of Austria, the
United Kingdom, Hungary, China, Japan, Malaysia and Taiwan, a number of which
are closely tied to the U.S. dollar and German Deutschemark. As we move more
production out of Europe to Asia, we could become more exposed to changes in the
value of the euro in relation to the U.S. dollar and major Asian currencies.
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 $2 million. The amount
outstanding under the existing notes accrues interest at a fixed rate of
13.125%, plus an additional 0.5% from April 28, 2000 until the completion of the
exchange offer. We have estimated the fair value of the notes as of June 30,
2000 to be $130.2 million based on current market prices, and as of August 11,
2000 we estimate the fair value of the notes to be $140.2 million.
43
<PAGE> 44
INDUSTRY
Data on general economic conditions and the markets and industries in which
we participate presented in this prospectus are based upon industry studies,
including an industry study prepared for us by Frost & Sullivan, an
international market research firm, and publicly available information. We have
not verified any of this information. We cannot assure you that the assumptions
used in making any estimates contained in any industry studies will prove to
have been correct, particularly assumptions with respect to general economic
growth rates.
We apply our acoustic technology capabilities in several markets, including
hearing aids and acoustic and infrared technology. In addition, we manufacture
diesel engine solenoids, electronic governors and position sensors 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. Audiologists are responsible
for fitting approximately 56.3% of the hearing aids sold in the United States.
In 1998, the world transducer market grew 6.0% to $161.6 million. Frost &
Sullivan forecasts that from 1999 to 2005 the market will increase to over $280
million, representing an annual growth rate of 8.3%. It is expected that the
rate of growth for the transducer market will be somewhat higher than the rate
of growth for the hearing aid market, principally as a result of repairs and an
expected increase in the use of multiple microphone hearing aids.
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 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 was a 22% increase from 1994 to 1997 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 last U.S. Census
indicated that 13% of the population was over the age of 65 and
projected that 25% of the U.S. population will be over 65 by 2025.
The World Health Organization estimates that there will be more than
800 million people over 65 by 2025.
44
<PAGE> 45
-- 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 $1,218 in 1999 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. In the
last year, 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, telecom and broadcasting
industries. Critical to the successful evolution of specific markets within
these industries will be the speed and quality of the voice and data input
technology.
COMPUTER TELEPHONY INTEGRATION
Computer telephony integration embraces many examples of ways in which the
computer and telephone (fixed line and cellular) can be integrated to provide
value-added telephony and has for a long time been synonymous with large call
centers. As a result of recent technological advancements, however, computer
telephony integration is now being used in both large and small corporate
environments.
Existing platforms are currently being reinforced with high growth,
acoustically driven applications, such as voice mail, access to speech enabled
web browsers, internet telephony (Frost & Sullivan forecast the global market at
$1.89 billion by 2001), text to speech conversion, voice identification, video
conferencing (Frost & Sullivan estimate the business video conferencing market
will be around $24.6 billion by 2004) and voice recognition (Lemout & Hauspie
estimate the global market will approach $3.5 billion by 2002).
Emkay has developed a focused range of ultra noise canceling wired and
wireless (based on the global short range 2.4Ghz wireless connection
standard -- Bluetooth) computer telephony integration headsets and a patented
desktop computer-telephony interface to address the needs of users within this
segment. Merrill Lynch forecasts that the penetration of Bluetooth chipsets
within the personal computer sector will be approximately 40% by 2003.
AUTOMOTIVE COMMUNICATIONS
Industry officials expect that half of the cars manufactured in the US,
Japan and Western Europe will have in-vehicle communications and entertainment
systems by 2005. Further, Matsushita Industrial Communications estimates that
40% of all cars sold in Japan by 2003 will have onboard computers with Internet
access, up from less than 1% in 1999.
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<PAGE> 46
Using natural voice commands, users will be able to check e-mail, receive
navigational information, dial cellular phone numbers, change radio stations,
play compact disks and run third party software applications. The 1999 Hanson
report estimates that the in-vehicle computing market will exceed $1 billion by
2005.
Emkay has been aggressively promoting its range of acoustic components and
sub-assemblies for such hostile environments to automotive computing suppliers.
MULTI-MEDIA
According to Frost & Sullivan, the percentage of individuals accessing the
Internet through devices other than the personal computer is expected to
increase from 4% in 1998 to 43% by 2002. Television penetration is about 98% in
the United States and western Europe compared with less than 50% for the
personal computer, and individuals can now connect to the Internet with the
addition of a digital television accessory product. As a result, a large number
of consumers can now access on-line banking, on-line gaming, home shopping,
e-mail, chat and other integrated home entertainment without ever needing to
purchase a personal computer.
Emkay has developed a complete infrared input transmission portfolio of
game pad, keyboard, pre-programmed and voice driven remote control for this type
of on-line access. Emkay has also developed a unique infrared transmission
system for original equipment manufacturer customers that allows bi-directional
communication for 4 individual game pads and an increase in battery life of more
than 40%.
AUTOMOTIVE COMPONENTS
DIESEL ENGINE SOLENOIDS
Solenoids are two position linear actuators that are used mainly to start
and stop diesel engines by converting electrical energy into mechanical work.
The North American diesel engine solenoid market grew more than 2% to $28.8
million in 1998. This growth was fueled by a strong North American economy,
which increased demand for products that require diesel engine solenoids, such
as mobile industrial and construction equipment. Revenue growth in the North
American market is projected to decline after 2000, as the market for
solenoid-equipped diesel engines is approaching saturation. Longer-lasting
engines and alternative technologies, developed principally in response to
stringent vehicle emissions regulations in the United States and Europe, are
expected to constrain unit demand in both the original equipment manufacturer
and the aftermarket (replacement) segments of the solenoid market. The western
European diesel engine solenoid market declined 0.7% to $10.9 million in 1998.
This decline was related to a decrease in diesel engine production resulting
from higher fuel prices. The market for diesel engine solenoids in the rest of
the world grew 7.5% to $17.8 million in 1998, driven by the desire to
incorporate the key start/stop function into commercial and industrial diesel
engines.
ELECTRONIC GOVERNORS
Electronic governors control engine speed and power by adjusting the engine
throttle. The North American electronic governor market grew 3% to $47.1 million
in 1998, as a result of increased industrial use as well as advanced
"drive-by-wire" control systems for vehicles. Increased future demand is
projected based on the increased need for precision speed control of small
governors and the increased use of advanced control drive-by-wire systems in
small mobile industrial equipment. The western European electronic governor
market declined 0.7% to $15.1 million in 1998. The market for electronic
governors in the rest of the world grew 7.5% to $45.0 million in 1998 as a
result of the introduction of technologies that are commonplace in North America
and western Europe.
POSITION SENSORS
Automotive position sensors are commonly used to measure the position of
the throttle, headlights, exhaust gas recirculation valve, the level of
suspension with respect to the road and the level of fuel in the tank. Vehicle
production is the major determinant of demand for position sensors. According to
industry sources, worldwide vehicle production is projected to remain relatively
flat over the near term. However, new and expanded applications, including pedal
and throttle position sensors for advanced control "drive-by-wire"
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systems and suspension height and steering position sensors for suspension
control systems for luxury vehicles, are expected to increase the number of
position sensors used in each vehicle. These new applications are already being
widely used in Europe and are now being incorporated in the United States. A
transition to contactless sensors is expected in the next five years.
Contactless sensors are being designed by us and others to increase the life and
reliability of position sensors by reducing wear. Although contactless sensors
are more expensive than contact sensors, we expect contactless technologies to
offer greater functionality and longevity than the existing contact sensor
technology. In addition, there is an ongoing shift in diesel fuel injection
technology, partially in response to more stringent emissions regulations. This
new technology, unlike existing technology, uses sensors of a type that we do
not manufacture. The North American automotive position sensor market declined
2.3% in 1998 to $147.4 million. The western European market grew 1.2% to $126.8
million in 1998, and the market for the rest of the world declined 11.8% to
$120.8 million during the same period.
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 that have high growth
potential. 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 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 operations around the world with our
largest facilities in the United States, Germany, Austria and Malaysia. Our 1999
revenue, operating income and EBITDA were $229.1 million, $25.1 million and
$37.8 million, respectively. Excluding recapitalization expenses of $10.7
million and special expenses of $8.9 million, our 1999 operating income and
EBITDA were $44.7 million and $57.4 million, respectively. Through our three
core business units, KE, Emkay and Automotive Components, we manufacture and
market products that maintain 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 THREE BUSINESS UNITS
KE -- HEARING AID COMPONENTS
KE, which accounted for approximately 59% of our 1999 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
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
22 scientists and engineers 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 14% of our 1999 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
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high growth potential, including computer telephony integration, automotive
communications and entertainment systems, and multi-media technology for
accessing the Internet through devices other than a computer. Computer telephony
applications include speech enabled web browsers, Internet telephony,
videoconferencing, voice identification and voice recognition. Emkay produces
and is developing a range of microphones, speakers, headsets and infrared remote
controls primarily for sale to original equipment manufacturers in these
markets. Emkay has significant in-house research and development capabilities,
with 21 engineers operating worldwide.
AUTOMOTIVE COMPONENTS
Our Automotive Components business unit is comprised of two businesses,
SSPI, which produces diesel engine solenoids and electronic governors, and Ruf,
a leading producer of automotive position sensors. Automotive Components
accounted for approximately 27% (52% from SSPI and 48% from Ruf) of our 1999
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 and acquired
by Knowles in 1996. Approximately 85% of Ruf's business is based on sales of
position sensors for automotive applications, including passenger vehicles and
light trucks. Automotive position sensors are commonly used to measure the
position of the throttle, headlights, exhaust gas recirculation valve, the level
of suspension with respect to the road and the level of fuel in the tank. Other
developing applications for position sensors include pedal and throttle position
sensors for drive-by-wire systems and suspension height and steering position
sensors for suspension control systems for luxury vehicles. Ruf supplies sensors
to most major European automobile manufacturers. Ruf is also attempting to break
into the North American market and has recently become a primary supplier to a
major North American automobile manufacturer of microphones used in cellular
phones on several vehicle platforms. Ruf also has recently entered into a
contract to supply steering angle sensors to a major North American automobile
parts manufacturer. Over the next six to twelve months, we expect to divest the
Ruf position sensor business.
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 70%. Customers of our Automotive Components group
include every major industrial diesel engine manufacturer and most
industrial 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 voice technology market as a result of our superior
microphones and headsets and our 50 years of experience in acoustics.
We believe that we are the only headset manufacturer that also
manufactures its own line of low cost high
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quality microphones. With our Automotive Components unit, we have
leveraged our technological expertise to create innovative designs of
solenoids, electronic governors and position sensors for our
Automotive Components customers.
-- To enhance our technological expertise, we emphasize research and
development investment. Our 1999 research and development
expenditures were $10.9 million, or 4.8% 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 12 manufacturing facilities in the United States, the United
Kingdom, Germany, Austria, Hungary, Taiwan, Malaysia and China. We
have a proven capability of moving manufacturing to lower cost
environments and are increasing our capacity at our facility in
Hungary to reduce labor costs. Our manufacturing facilities are not
unionized, with the exception of our facilities in China, Germany and
Austria, which are required to be unionized under local law. In March
2000, we announced plans to consolidate our worldwide manufacturing
operations. We will outsource some activities currently performed in
Itasca and Rolling Meadows, Illinois. In addition, we will cease
production at our United Kingdom, Taiwanese and German manufacturing
facilities. Production from those operations will be moved to China,
Malaysia and Hungary. Over the next twelve to eighteen months,
Knowles expects to reduce its global workforce by about 20 percent.
-- 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. Emkay's
operations are subcontracted in part, providing us with cost
structure flexibility and allowing us to change capacity quickly
based on product demand.
STRONG MANAGEMENT TEAM WITH SIGNIFICANT EQUITY OWNERSHIP
-- Our senior management team has significant experience in the hearing
aid industry and we believe their knowledge and relationships within
the industry provide us with a significant competitive advantage. Our
chairman, Reg Garratt, has worked with Knowles for 22 years. Our
president and chief executive officer, John Zei, has 24 years of
experience in the hearing aid industry.
-- Members of our senior management team own approximately 6.8% of our
common stock. Management participation in our equity represents a
significant portion of their net worth and demonstrates their
commitment to Knowles.
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. The world hearing aid market was $1.6 billion at manufacturers'
wholesale prices in 1998 and is expected to grow to $2.6 billion in 2005, an
estimated 7% compounded annual growth rate, according to Frost & Sullivan.
Hearing aid penetration into the market of potential users has historically
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been low, ranging from approximately 20% 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, 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, digital signal
processing and video image sensing to provide high technology solutions for high
growth markets, including voice recognition and Internet-on-television. We are
also developing high technology solutions for other markets with high growth
potential, such as computer telephony integration and videoconferencing. Some of
the new products for markets with high growth potential include the following.
-- Emkay has developed several infrared remote control products,
including remote controls for Internet-on-television that in some
cases also provide controls for a variety of home entertainment
equipment. Emkay has also developed several products for the
telephony market, including a single earset, a two-in-one headset and
a computer-telephone headset interface system. Emkay is currently
developing various devices to enable a headset to be connected to any
stationary telephone instrument.
-- Our Automotive Components unit is exploring potential applications
for our silicon microphone under development, including hands-free
cellular telephones, voice command and control systems, parking-aid
systems and fuel volume measurement systems.
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.
-- Automotive Components has a strong position in the international
solenoid marketplace and supplies over 250 customers. We anticipate
that future growth of the Automotive Components unit will come from
leveraging our existing relationships internationally. For example,
SSPI's longstanding relationship with Cummins Engine Company provides
a foundation for growth in diesel engine solenoid and electronic
governor sales in the North American market. Cummins also has a
strong international
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presence, presenting a significant opportunity for SSPI to contract
with Cummins' international divisions and joint ventures.
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, it
has developed manufacturing and management systems that allow it to operate low
cost offshore facilities without compromising either quality or level of
service. To further enhance its competitive position, KE is expanding
manufacturing in low cost labor markets near its current and emerging markets in
anticipation of future needs. In March 2000, we announced plans to consolidate
our worldwide manufacturing operations. We will outsource some activities
currently performed in Itasca and Rolling Meadows, Illinois. In addition, we
will cease production at our United Kingdom and Taiwanese manufacturing
facilities. Production from those operations will be moved to China, Malaysia
and Hungary.
DEVELOP AUTOMOTIVE MICROPHONE BUSINESS
The introduction of hands-free cellular telephones and voice command
navigation systems in automobiles will result in increased demand for
microphones. We believe that these developments present a significant
opportunity for us to expand. We have begun supplying microphones for hands-free
cellular phones and navigation systems to a major North American automobile
manufacturer.
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 under the brand name Deltek other hearing aid
components, including trimmers, volume controls and connectors for hearing aid
manufacturers. These other products represented a very small percentage of our
sales in 1999.
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 range of microphones, speakers, headsets
and infrared remote controls primarily for sale to original equipment
manufacturers. Major products are discussed below.
Wired Headsets. Emkay manufactures a variety of wired, noise canceling
headsets used for computer telephony integration applications, including voice
recognition and videoconferencing.
Wireless Headsets. Emkay has developed an ultra-lightweight, wireless,
single channel headset with a Knowles noise canceling microphone for computer
telephony integration applications that provides Emkay with a competitive edge
over other wireless headsets. The microphone and receiver use radio frequency
technology. This next generation wireless headset also incorporates a cordless
phone function which allows the headset to be used as a computer voice input
device and as a handset for cordless phones.
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Infrared Remote Controls. Emkay has developed several infrared remote
control products, including remote controls for televisions that provide
Internet access. Some of these remote controls, such as our Cyberclick product,
also control all multimedia applications for personal computers as well as a
variety of home entertainment equipment, using integrated cursor control and
media control center software. Emkay's Internet-on-television 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.
Microphones. Emkay has leveraged its microphone technology to create
devices for diverse applications, including 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. In
partnership with a government-sponsored research laboratory in Singapore, we are
developing a low-cost silicon microphone. The microphone will have the ability
to incorporate custom circuits for specific applications and will be used for a
range of applications including computers, cellular phones and
telecommunications. Working samples have been manufactured, but further
development is required.
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 applications. These products serve various functions including
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 generators,
compressors, tractors, pumps and man lifts. SSPI's recently introduced 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. Ruf has fifty years of experience producing position
sensors and associated components. These components are sold in the automotive,
industrial, telecommunications, computer and appliance markets. The majority of
Ruf's sensors are custom designed for specific customer applications such as
throttle position sensors, headlight range control sensors, fuel level sensors,
steering sensors and pedal position sensors. Ruf is investing in efforts to
produce contactless sensors designed to increase the life and reliability of
position sensors by reducing wear. As part of these efforts, Ruf has both
developed its own contactless technology and purchased a license for an
alternative type of contactless technology.
RESEARCH AND DEVELOPMENT
Our 1999 research and development expenditures were $10.9 million, or 4.8%
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 now have a leading position in this application of micro-electro
mechanical systems and are continuing development along two paths, one for KE to
meet the exacting standards of the hearing aid industry and the other for Emkay
and Automotive Components. There are approximately 40 people at our integrated
circuit processing and micro-machining research facility in Rolling Meadows,
Illinois, including a team of four engineers within Emkay that is developing a
low-cost silicon microphone in conjunction with a government sponsored
laboratory in Singapore.
KE
KE's research and development group consists of 22 scientists and engineers
located in Itasca, Illinois and focuses on product and process development. KE
believes that its ability to develop transducers with improved features is
critical to sustaining its market share and margins. In 1997, KE launched a
cylindrical microphone,
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which is the smallest microphone available to hearing aid manufacturers, and in
1998, KE launched a small receiver. Continued transducer miniaturization gives
KE a competitive advantage as manufacturers demand smaller systems in order to
produce the popular completely in the canal (CIC) hearing aid. Planned new
products and improvements include a smaller receiver, an analog/digital (A/D)
signal converter, a directional microphone, automatic volume control and
microphone improvements with respect to noise reduction, electrostatic discharge
thresholds and cellular telephone interference.
EMKAY
Emkay has developed a significant in-house research and development effort,
with 21 engineers. Over the next five years, Emkay will continue to focus its
research and development efforts on acoustics, radio frequency, infrared,
micro-electro mechanical systems and digital signal processing products for the
computer telephony integration, automotive communications and multi-media
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 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, Germany 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 Germany and radio frequency development is
conducted in Taiwan.
AUTOMOTIVE COMPONENTS
SSPI. In 1993, SSPI acquired DAI Technologies in Lisle, Illinois to
strengthen its position in microprocessor-based engine controls and engine
management software. This subsidiary functions as an advanced development group
for SSPI products. SSPI currently employs 12 engineers for the development of
advanced products and design and development of actuators and solenoids.
Ruf. Ruf products are developed using high performance work stations that
allow products to be transferred to production in a short period of time. Final
designs are tested in a complete product verification laboratory to determine
product reliability. Ruf employs 25 engineers at its facility near Munich in the
design, development and testing of sensors. Ruf formed a new advanced technology
group to design, develop, and test contactless sensor technology and hands-free
microphones for automobiles. New designs are being tested on applications at
tier-one automotive parts manufacturers. In addition, Ruf is one of the few
sensor suppliers that maintains its own chemists to formulate proprietary
resistance inks which determine the performance of the product. This allows
flexibility and quick response to customer requirements.
MANUFACTURING
We operate from twelve manufacturing facilities in the United States, the
United Kingdom, Germany, Austria, Hungary, Taiwan, 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. To ensure that we have sufficient manufacturing
capacity, we have recently expanded our facility in China and our factory in
Hungary. We periodically evaluate the composition of our various manufacturing
facilities in light of current and expected market conditions and demand.
In March 2000, we announced plans to consolidate our worldwide
manufacturing operations. We will outsource some activities currently performed
in Itasca and Rolling Meadows, Illinois. In addition, we will cease production
at our United Kingdom, Taiwanese and German manufacturing facilities. Production
from those operations will be moved to China, Malaysia and Hungary. Over the
next twelve months to eighteen months, the Company expects to reduce its global
workforce by about 20 percent.
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KE
KE operates manufacturing facilities in Illinois, England, Taiwan, 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. A description of KE's operation and production facilities is provided
in the table below under "Properties."
In addition, KE uses a small amount of space at the Emkay facility in
Austria and the Automotive Components facility in Hungary. The total space
available to KE is approximately 85% utilized. Our transducer manufacturing
facilities are ISO 9000 certified, with the exception of the Rolling Meadows
facility.
EMKAY
Several of Emkay's assembly processes are automated, although the assembly
operations are largely manual and performed by subcontractors in China and
Taiwan. Capacity can be increased as demand increases. A description of Emkay's
operation and production facilities is provided in the table below under
"Properties."
AUTOMOTIVE COMPONENTS
SSPI. Most of SSPI's finished products for the North American and European
markets are manufactured in Niles, Illinois. Finished products for the Asian
markets are manufactured in Suzhou, China. Components such as coils and stamping
are primarily manufactured in Suzhou. All of SSPI's manufacturing facilities are
ISO 9000 certified and the Niles facility was QS 9000 certified (the highest
quality standard for automotive manufacturing facilities) in December 1998.
Ruf. Ruf manufactures finished products in Hoehenkirchen, Germany, Ajka,
Hungary and Neumarkt, Austria. The Hungarian facility was opened in July 1997 to
support European automotive customers and employs more than 80 people. Sensitive
sub-assembly manufacturing, such as screen printing of the resistance lacquers,
is performed in Germany in "Class 10K" clean rooms to insure high quality. A new
larger facility is under construction in Hungary to provide manufacturing space
for all of the manufacturing operations currently conducted in Germany. The Ruf
facilities in Austria, Hungary and Germany are ISO 9000 certified and the
facilities in Germany and Austria are QS 9000 certified.
A description of the Automotive Components business unit's operation and
production facilities are provided in the table below under "Properties."
SALES AND MARKETING
KE
KE sells directly to hearing aid manufacturers through its 23-member sales
force which operates from offices in Illinois, England, Taiwan and Tokyo. Italy
and Australia are covered by independent sales representatives. 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 "Risk Factors" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
EMKAY
Emkay sells most of its products through a 17-member direct sales force to
original equipment manufacturers including computer hardware and software
vendors, headset suppliers and consumer electronics manufacturers. Emkay's sales
force and independent sales representatives are located in the United States,
the United Kingdom, Germany, France, Austria, Japan, Taiwan, China and
Australia. Agreements have been reached with several retail distributors to sell
Emkay's infrared products in Europe.
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AUTOMOTIVE COMPONENTS
SSPI. Solenoids and electronic governors are generally sold directly to
manufacturers of diesel engines and mobile industrial equipment. SSPI's sales
force and independent sales representatives are located in the United States,
the United Kingdom, China and Taiwan. SSPI also maintains independent
distributors in Japan and Australia. This direct distribution system is expected
to continue due to the specialized design of products for particular customers.
SSPI often works in conjunction with its major customers to design and
manufacture customized products.
Ruf. Ruf's products are sold primarily in Europe to tier one automotive
suppliers and, in some cases, directly to auto manufacturers. Ruf's sales force
and independent sales representatives are located in the United States, Germany,
China and Taiwan. Most products are custom designed for specific application
requirements. Ruf has a strong project management system that helps ensure that
demanding automotive development and delivery timetables are met. In addition,
Ruf has developed an experienced North American sales team based in Monroe,
Michigan.
CUSTOMERS
KE
KE is the principal supplier of transducers to all of the major hearing aid
manufacturers, including Dahlberg (marketed under the Miracle Ear brand name),
GN ReSound, Oticon, Phonak, Siemens, Starkey Laboratories and Topholm and
Westermann. In 1999, KE's top ten customers represented approximately 78% of
sales, with the largest customer, Siemens, accounting for approximately 19% of
sales.
EMKAY
Emkay's top customers for voice recognition products are based in Europe
and Asia, and include Lotus Development and IBM. Generally, customers for voice
command and control products include modem manufacturers, computer and
communications original equipment manufacturers and computer peripheral
manufacturers. Top customers for Emkay's monitor microphone cable assembly
products are ADI, Daewoo and Philips Electronics. Modem manufacturers include
Askey Computer and GVC, both based in Taiwan. Customers for Emkay's acoustic
transducers include Plantronics. Emkay's major infrared remote control customers
are NTL and TW Electronic. In 1999, Emkay's top ten customers represented
approximately 34% of sales, with the largest customer accounting for
approximately 6% of sales.
AUTOMOTIVE COMPONENTS
SSPI. SSPI provides engine control solenoids to every major diesel engine
manufacturer. Its top customers are Carrier, Cummins, John Deere, Kubota,
Melroe, Navistar and Yanmar. SSPI's top five customers comprised 60% of its
worldwide sales in 1999. SSPI has been a primary supplier of solenoids to
Cummins for over five years.
Ruf. Ruf manufactures sensors and components for many of Europe's largest
tier one automotive suppliers, including Eaton, Hella, Italtel, Meneti Marelli,
Robert Bosch Group, Sarkinnen and VDO. Ruf's products can be found in
automobiles produced by Ford, Opel, Mercedes, Volkswagen, BMW, Ferrari, Volvo,
Nissan, Honda, Audi, Peugeot, Renault, Rolls Royce, Jaguar and Fiat. Ruf's top
ten customers accounted for approximately 81% of 1999 sales. Its largest
customer accounted for approximately 44% of 1999 sales.
Through a joint development effort of Knowles, Ruf and Etymotic Research, a
design engineering firm based in Elk Grove, Illinois, Ruf has entered into an
agreement to develop and sell hands-free microphones to a major North American
automobile manufacturer. Using the Knowles cartridge microphone, Ruf has become
a primary supplier to a major North American auto manufacturer of microphones
for hands-free cellular communications and other voice recognition applications
on several vehicle platforms. It also has recently entered into a contract to
supply steering angle sensors to a major North American automobile parts
manufacturer.
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<PAGE> 56
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 1999. KE's principal
competitor is Microtronic, which we believe had a significant portion of the
remaining market share in 1999. After purchasing the Dutch transducer
manufacturing business (Microtel) from Siemens in 1995, Microtronic has tried to
build its market share by reducing prices. As a result, the market for
transducers has been subject to downward pressures on pricing in recent years.
See "Risk Factors" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
EMKAY
The voice recognition, Internet-on-television, computer telephony
integration and videoconferencing 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 computer peripheral equipment
companies as well as a number of smaller specialized companies.
AUTOMOTIVE COMPONENTS
SSPI. As the leading producer of key start/stop diesel engine solenoids,
SSPI had worldwide market share of approximately 70% in 1999. SSPI also held an
estimated 1% share of the worldwide electronic governor market in 1999. SSPI
competes with a variety of U.S. and non-U.S. companies in these two markets.
Ruf. Ruf had an estimated 24% share of the western European automotive
position sensor market and less than 1% of the North American market in 1999.
Ruf competes with a variety of U.S. and non-U.S. companies including CTS,
Bournes, Stoneridge, Novatechnik and Pierberg.
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
application 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.
EMPLOYEES
We had 3,025 employees as of June 30, 2000. Of these, approximately 66%
were production employees and approximately 34% were staff. At that date, 17
employees were employed at our corporate headquarters and our KE, Emkay and
Automotive Components business units had 2,056, 208 and 744 employees,
respectively. Geographically, 755 of our employees are based in North America,
720 employees are based in Asia and 1,550 employees are based in Europe. With
the exception of employees in China, Germany 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. As
part of our restructuring announced in March 2000, we expect to reduce our
global workforce by about 20% over the next twelve to eighteen months.
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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<PAGE> 57
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.
LEGAL MATTERS
The Company has no material pending or threatened litigation.
PROPERTIES
A description of Knowles Electronics Holdings' operations and production
facilities is provided in the table below.
<TABLE>
<CAPTION>
SQUARE FEET
--------------------------------------
OWNED/ LEASE AUTOMOTIVE
LOCATION USAGE LEASED EXPIRATION KE EMKAY COMPONENTS TOTAL
-------- ------- ------ ---------- ------- ------ ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
US
Elgin, IL............................. Mfg. Owned 71,800 71,800
Itasca, IL............................ Hdqtrs. Owned 60,900 60,900
Lisle, IL............................. Mfg. Leased 02/28/2003 21,000 21,000
Niles, IL............................. Eng. Owned 70,900 70,900
Rolling Meadows, IL................... Mfg. Leased 02/28/2001 24,800 4,000 28,800
Monroe, MI............................ Sales Leased 06/15/2001 300 300
Lansdale, PA.......................... Sales Leased 12/31/2001 300 300
------- ------ ------- -------
157,500 4,000 92,500 254,000
EUROPE
Neumarkt, Austria..................... Mfg. Owned 4,000 54,400 58,400
Hohenkirchen, Germany................. Mfg. Leased 09/30/2001 203,800 203,800
Ajka, Hungary......................... Mfg. Owned 1,500 21,400 22,900
*Ajka, Hungary........................ Mfg. Owned 70,000 70,000
Burgess Hill, UK (No. 73)............. Mfg. Owned 42,300 42,300
Burgess Hill, UK (No. 71)............. Sales Owned 12,000 12,000
------- ------ ------- -------
47,800 54,400 307,200 409,400
ASIA
Pudong, China......................... Sales Leased 06/30/2000 100 100 200
Suzhou, China (No. 20)................ Mfg. Leased 11/30/2004 21,000 21,000
Suzhou, China (Block B)............... Mfg. Leased 10/31/2000 12,400 500 12,900
Suzhou, China (No. 16)................ Mfg. Leased 11/30/2004 15,100 15,100
Tokyo, Japan.......................... Sales Leased 03/31/2001 300 300 600
**Penang, Malaysia.................... Mfg. Owned 57,500 57,500
Taipei, Taiwan........................ Mfg. Owned 43,500 21,600 20,900 86,000
------- ------ ------- -------
134,800 22,500 36,000 193,300
------- ------ ------- -------
Grand Total........................... 340,100 80,900 435,700 856,700
======= ====== ======= =======
</TABLE>
---------------
* Currently under construction
** Land lease expires 09/18/2049
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<PAGE> 58
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Pursuant to Knowles' by-laws, each of its directors is designated as a
"Class A director" or a "Class B director." Each Class A director is entitled to
four votes and each Class B director is entitled to one vote. Knowles currently
has five directors, two of whom are with Doughty Hanson (Kenneth Terry and Kevin
Luzak). Set forth below is certain information with respect to our directors and
senior officers.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Reg G. Garratt................. 70 Chairman; Class B Director
James E. Knowles............... 69 Class B Director
Kenneth John Terry............. 35 Class A Director
Kevin Luzak.................... 37 Class A Director
John J. Zei.................... 55 President and Chief Executive Officer; Class B Director
James F. Brace................. 54 Executive Vice President and Chief Financial Officer
Patrick W. Cavanagh............ 47 Vice President and General Manager Automotive Components
David Yang..................... 41 Vice President and General Manager Emkay
Stephen D. Petersen............ 42 Vice President of Finance and Secretary
</TABLE>
Reg G. Garratt began his career with Knowles in 1977 as Vice President of
Marketing. He subsequently served as Senior Vice President and President before
assuming the position of Chief Executive Officer of Knowles in 1992. He became
Chairman and Chief Executive Officer in 1997. Prior to joining Knowles, he
worked 19 years in various management positions for Honeywell, Inc. Mr. Garratt
is an engineering graduate of Aston University and currently serves on the Board
of the Hearing Industries Association.
James E. Knowles is president of The Finance 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.
Kenneth John Terry is a partner of Doughty Hanson & Co. Limited, where he
has spent his entire professional career since its foundation in 1986. Mr. Terry
currently serves on the Board of Directors of Impress Metal Packaging Holdings
BV and Dunlop Standard Aerospace Group Limited. 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.
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 in 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 his time at 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 F. Brace joined Knowles in January 2000 as Vice President and Chief
Financial Officer. He was elected Executive Vice President and Chief Financial
Officer in April 2000. Mr. Brace served as Senior Vice President and Chief
Financial Officer of Argent Healthcare Financial Services during 1999, as Vice
President, Treasurer and Chief Financial Officer of Littelfuse, Inc. from 1992
to 1998, and as Vice President, Treasurer and Chief Financial Officer of Sanford
Inc. from 1987 to 1992. Mr. Brace is a graduate of Princeton University and the
University of Chicago.
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<PAGE> 59
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.
David Yang joined Knowles in 1994 as General Manager of Knowles Taiwan and
Regional Sales and Marketing Manager for the Asia/Pacific region. He was
promoted to Vice President and General Manager of Emkay in February 1997. Prior
to joining Knowles, Mr. Yang was Sales and Marketing Manager for the Asia
Pacific region for Molex Inc. for nine years. He is a graduate of the National
Chiao Tong University in Taiwan and graduated from an Executive program at
Harvard University in 1990.
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 of Finance in September 1999. Mr. Petersen is
a graduate of Augustana College and holds a Master of Management degree from
Northwestern University. Mr. Petersen is a certified public accountant.
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table provides information concerning the compensation we
paid to our senior officers for 1999, 1998 and 1997:
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION ------------
------------------------------------ SECURITIES
OTHER ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS/SARS COMPENSATION(3)
--------------------------- ---- -------- ---------- ------------ ------------ ---------------
<S> <C> <C> <C> <C> <C> <C>
Reg G. Garratt............ 1999 $410,294 $ 483,975 -- -- $3,715,691
Chairman and Chief 1998 398,700 487,989 -- -- 6,195
Executive Officer 1997 389,729 1,218,393 -- -- 8,354
Doug Brander.............. 1999 210,640 101,417 -- -- 445,196
Vice President & General 1998 173,682 105,999 -- -- 2,351
Manager KE(1) 1997 165,784 22,621 -- -- 2,351
Patrick W. Cavanagh....... 1999 173,821 63,147 $23,746(2) -- 441,113
Vice President & General 1998 162,090 111,932 29,137(2) 100 2,565
Manager Automotive 1997 138,483 26,216 -- 150 2,166
Components
David Yang................ 1999 160,502 65,286 -- -- 405,090
Vice President & General 1998 132,412 42,208 -- 200 678
Manager Emkay 1997 126,880 36,940 -- 200 129
Bernard J. Smith.......... 1999 166,829 158,856 -- -- 545,495
Vice President Finance(1) 1998 160,402 93,198 -- -- 2,594
1997 156,862 17,835 -- 200 2,652
</TABLE>
------------
(1) Doug Brander, Vice President and General Manager of the KE Division since
1996, left Knowles on January 28, 2000, and Bernard J. Smith, Vice President
of Finance, retired on February 15, 2000.
(2) Expenses and allowances associated with Mr. Cavanagh's two year relocation
to Germany.
(3) The following chart is a breakdown of the payments made to the executive
officers under the heading "All Other Compensation." The Success Bonuses
represent one-time payments made to the executive officers in 1999 in
connection with the sale of the company. Similarly, the Tenure Bonuses
represent a one-time payment made to each employee in connection with the
sale of company. Payments were made to the executive officers under the
Supplemental Executive Retirement Plan in connection with the Plan's
termination in 1999. The Company also made contributions to the Knowles
Electronics, Inc. Employee Retirement Savings 401(k) Plan on behalf of the
executive officers and paid life insurance premiums on behalf of the
executive officers in the amounts set forth in the chart.
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<PAGE> 60
<TABLE>
<CAPTION>
SUPPLEMENTAL KNOWLES
EXECUTIVE 401(K) PLAN LIFE INSURANCE
EXECUTIVE YEAR SUCCESS BONUS TENURE BONUS RETIREMENT PLAN CONTRIBUTIONS PREMIUMS
--------- ---- ------------- ------------ --------------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Reg G. Garratt........ 1999 $2,226,000 $2,100 $1,483,406 $1,600 $2,585
1998 1,600 4,595
1997 1,600 4,754
Doug Brander.......... 1999 397,500 600 44,745 1,600 751
1998 1,600 751
1997 1,600 751
Patrick W.
Cavanaugh........... 1999 397,500 350 40,918 1,287 1,058
1998 1,600 965
1997 1,201 965
David Yang............ 1999 397,500 654 5,336 1,600 --
1998 678 --
1997 129 --
Bernard J. Smith...... 1999 400,000 1,000 141,889 1,278 1,328
1998 1,266 1,328
1997 1,324 1,328
</TABLE>
EXECUTIVE STOCK OPTIONS AND STOCK APPRECIATION RIGHTS
We did not grant any stock options or stock appreciation rights to our
senior officers in 1999.
In connection with our recapitalization all outstanding stock appreciation
rights and options were surrendered in exchange for a cash payment. Our senior
officers surrendered their then outstanding stock appreciation rights and
options in exchange for a cash payment equal to the aggregate book value
increases in the value of the underlying stock through December 31, 1998. As a
result, Reg G. Garratt, Doug Brander, Patrick W. Cavanagh, David Yang and
Bernard J. Smith received $818,080, $315,794, $221,180, $103,338 and $170,201,
respectively. The SAR Plan was terminated as of our recapitalization.
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).
<TABLE>
<CAPTION>
YEARS OF SERVICE
-------------------------------------------------------
REMUNERATION 15 20 25 30 35
------------ ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
$125,000............................. $34,000 $46,000 $57,000 $57,000 $57,000
150,000............................. 42,000 55,000 69,000 69,000 69,000
175,000............................. 45,000 59,000 74,000 74,000 74,000
200,000............................. 45,000 59,000 74,000 74,000 74,000
225,000............................. 45,000 59,000 74,000 74,000 74,000
250,000............................. 45,000 59,000 74,000 74,000 74,000
275,000............................. 45,000 59,000 74,000 74,000 74,000
300,000............................. 45,000 59,000 74,000 74,000 74,000
325,000............................. 45,000 59,000 74,000 74,000 74,000
350,000............................. 45,000 59,000 74,000 74,000 74,000
400,000............................. 45,000 59,000 74,000 74,000 74,000
450,000............................. 45,000 59,000 74,000 74,000 74,000
500,000............................. 45,000 59,000 74,000 74,000 74,000
</TABLE>
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, 1999, Reg G. Garratt, Doug Brander, Patrick W.
Cavanagh, David Yang and Bernard J. Smith have 22, 6, 7, 2 and 15 credited years
of service, respectively. Under the plan, a participant who terminates
employment on or after attaining his or her normal retirement age is entitled to
receive a monthly pension benefit commencing on his or her normal or deferred
retirement date. The 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
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<PAGE> 61
each year of credited service up to a maximum of twenty-five, 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 (1) the
participant's years of credited service up to a maximum of twenty-five years and
(2) the lesser of: (A) the participant's average monthly earnings over the three
years prior to determination or (B) 1/12th of the average of the Social Security
taxable wage bases for the 35 year period ending with the last day of the
calendar year in which the participant attains Social Security retirement age.
Effective January 1, 1998, we established the Supplemental Executive
Retirement Plan, an excess benefit plan designed to provide certain of our
employees with benefits in excess of those otherwise permitted under our pension
plan due to the compensation and benefit limitations placed on qualified
retirement plans under the Internal Revenue Code of 1986, as amended. Benefits
under the Supplemental Executive Retirement Plan were paid to the following
individuals in the corresponding amounts immediately prior to our
recapitalization and the Supplemental Executive Retirement Plan was terminated
as of the recapitalization: Mr. Garratt: $1,483,406; Mr. Smith: $141,889; Mr.
Brander: $44,745; Mr. Cavanagh: $40,918; and Mr. Yang: $5,336.
The following table provides information regarding the estimated lump sum
compensation payable to employees of Knowles Electronics Taiwan, Ltd. on their
retirement (as described below).
<TABLE>
<CAPTION>
YEARS OF SERVICE
------------------------------------------------------------------
REMUNERATION 15 20 25 30 35
------------ ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
$125,000..................... $ 312,500 $ 364,583 $ 416,666 $ 468,750 $ 468,750
150,000..................... 375,000 437,500 500,000 562,500 562,500
175,000..................... 437,500 510,416 583,333 656,250 656,250
200,000..................... 500,000 583,333 666,666 750,000 750,000
225,000..................... 562,500 656,250 750,000 843,750 843,750
250,000..................... 625,000 729,166 833,333 937,500 937,500
275,000..................... 687,500 802,083 916,666 1,031,250 1,031,250
300,000..................... 750,000 875,000 1,000,000 1,125,000 1,125,000
325,000..................... 812,500 947,916 1,083,333 1,218,750 1,218,750
350,000..................... 875,000 1,020,833 1,166,666 1,312,500 1,312,500
375,000..................... 937,500 1,093,750 1,250,000 1,406,250 1,406,250
400,000..................... 1,000,000 1,166,666 1,333,333 1,500,000 1,500,000
425,000..................... 1,062,500 1,239,583 1,416,666 1,593,750 1,593,750
450,000..................... 1,125,000 1,312,500 1,500,000 1,687,500 1,687,500
475,000..................... 1,187,500 1,385,416 1,583,333 1,781,250 1,781,250
500,000..................... 1,250,000 1,458,333 1,666,666 1,875,000 1,875,000
</TABLE>
David Yang is entitled to receive pension benefits as defined in the
employee retirement plan of Knowles Electronics Taiwan, Ltd., a non-contributory
defined benefit plan which became effective on December 13, 1986. Mr. Yang will
have five credited years of service. Under the plan, the payment is equal to the
sum of (1) two times the participant's average monthly pay for each of the
participant's first fifteen years of service, (2) half of the participant's
average monthly pay for each year of service in excess of fifteen years prior to
August 1, 1984, and (3) the participant's average monthly pay for each year of
service in excess of fifteen years after August 1, 1984. The maximum retirement
benefit payable under the plan is forty-five times average monthly pay.
Participants are eligible for retirement benefits under the plan upon (1)
compulsory retirement at age 60, (2) voluntary retirement at age 55 with 15
years of service or (3) retirement upon completion of 25 years of service. The
plan also provides for disability benefits which are calculated in the same
manner as the retirement benefit, except that the payment may be increased by
20% if the participant's disability was induced through the participant's
employment with Knowles Electronics Taiwan, Ltd.
EMPLOYMENT ARRANGEMENTS
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 our
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. John J. Zei was appointed President and
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<PAGE> 62
Chief Executive Officer as of April 1, 2000. Mr. Garratt will continue to serve
as chairman until December 31, 2003, at his ongoing salary plus bonus. If we
terminate Mr. Garratt's employment without cause before December 31, 2003, Mr.
Garratt is entitled to receive his base salary in effect on the date of
termination through December 31, 2003, a pro-rata portion of the bonus to which
he was entitled on the date of termination, and a lump sum payment of $60,000.
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." The loan will be repayable in full on the earlier of the sale of
Knowles and the fifth anniversary of the purchase date. In addition, Mr. Zei
will be required to mandatorily prepay a portion of the loan if he sells any of
his common stock. Knowles has also agreed to pay up to six months of reasonable
interest on any bridge loan, not to exceed $750,000, Mr. Zei incurs in
connection with his relocation expenses.
Effective January, 2000, James Brace became the Vice President and Chief
Financial Officer of Knowles, with an annual salary of $225,000 and eligibility
to participate in certain bonus plans generally available for senior management
of Knowles. In the event that Mr. Brace's employment with Knowles is terminated
by Knowles without cause, Mr. Brace will be entitled to receive salary and
benefit continuation for six months. Mr. Brace was appointed Executive Vice
President and Chief Financial Officer on April 1, 2000.
In connection with the commencement of his employment, Mr. Brace has
purchased $200,000 of common stock with his own funds and will have the
opportunity to purchase an additional $125,000 worth of Knowles' common stock at
$30 per share with his own funds. The stock is subject to the Stockholders' and
Registration Rights Agreements described under the heading "Related Party
Transactions."
Severance Arrangements
We maintain a Change in Control Severance Pay Plan to provide for the
payment of severance benefits to selected executives whose employment terminates
in connection with a change in control of Knowles Electronics, Inc. Doug
Brander, Patrick W. Cavanagh, David Yang and Bernard J. Smith participate in the
Change in Control Severance Pay Plan. According to the terms of the Change in
Control Severance Pay Plan, the executive is entitled to receive up to two times
his annual base salary and bonus, less any salary and bonus paid to the
executive after the change in control, if we terminate a participating
executive's employment without cause or the executive terminates his employment
as a result of an adverse modification to the terms of the executive's
employment during the two-year period following a change in control of Knowles.
The Recapitalization constitutes a change in control under the Change in Control
Severance Pay Plan.
In addition, we maintain a special severance commitment with Bernard J.
Smith which supplements Mr. Smith's benefits under the Change in Control
Severance Pay Plan. The special severance commitment provides that if Mr. Smith
terminates his employment during the second year of the protection period
applicable under the Change in Control Severance Pay Plan or we terminate Mr.
Smith's employment without cause or as a result of Mr. Smith's disability during
the one-year following the end of the protection period, we will pay Mr. Smith
an amount equal to his base salary, bonus and any other wages, continue Mr.
Smith's participation in Knowles' qualified pension plans for one year following
the termination of his employment and
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pay Mr. Smith a lump sum payment representing the present value of projected
medical insurance costs for Mr. Smith and his wife from the date of termination
through his 65th birthday.
Mr. Smith retired on February 15, 2000 and is currently receiving benefits
under the Change in Control Severance Pay Plan and special severance commitment.
In 1998, we entered into success bonus agreements with each of our five
senior officers to provide incentives for such officers to assist in a
successful sale of the business. Except for the agreement with Bernard J. Smith,
which provided that we pay Mr. Smith a lump-sum of $400,000 upon the successful
sale of Knowles, the agreements provide for us to pay the senior officers a
percentage of the sale price of Knowles in the form of a "Success Bonus" as
follows: Reg G. Garratt: 0.42%; Doug Brander: 0.075%; Patrick W. Cavanagh:
0.075%; and David Yang: 0.075%. Payment was made under each of the success bonus
agreements at the time of our recapitalization.
COMPENSATION OF DIRECTORS
Prior to our recapitalization, directors who were not employees were paid a
quarterly fee of $4,500, plus a fee of $3,750 for each Board meeting attended,
$2,500 for each special meeting and, as committee members, received $500 per
committee meeting attended. Directors also received a fee of $300 per hour for
each additional hour worked. Employees and officers who are directors received
no additional compensation for services rendered as directors.
Effective January 13, 1997, we adopted the Retirement Plan for Outside
Directors, which allows a participating director to defer all or any portion of
his or her director fees until the earlier of the director's termination of
service or the 65th birthday. Benefits under the Retirement Plan for Outside
Directors were unfunded and were paid from Knowles' general assets. The
Retirement Plan for Outside Directors was terminated in connection with our
recapitalization.
Following the recapitalization, our directors no longer receive any fees or
other compensation for services rendered in their capacity as directors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to the recapitalization in 1999, the following individuals served on
the compensation committee of Knowles: E.L. Keyes, R.E. Goodson, C.L. Knowles
and R.G. Garratt. In connection with the recapitalization, Kenneth John Terry
and Kevin Luzak served on an interim compensation committee. Effective as of
March 14, 2000, the compensation committee was reconstituted and now consists of
the following individuals: Kenneth John Terry and John Zei. John Zei also serves
as the President and Chief Executive Officer of Knowles.
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PRINCIPAL STOCKHOLDERS
Set forth below is certain information, as of June 30, 2000, 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. 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.
<TABLE>
<CAPTION>
AMOUNT
BENEFICIALLY PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER(1) OWNED(2) OF CLASS
--------------------------------------- ------------ --------
<S> <C> <C>
Key Acquisition, L.L.C.
c/o Doughty Hanson & Co. Limited
Times Place, 45 Pall Mall, London SW1Y 5JG, England....... 800,000 81.4%
Doughty Hanson & Co. Limited(3)
Times Place, 45 Pall Mall, London SW1Y 5JG, England....... 800,000 81.4%
</TABLE>
------------
(1) After our 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 10.2% 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 Securities Exchange Act of 1934.
(2) Class A Common Stock.
(3) Consists only of shares of Knowles owned by Key Acquisition, L.L.C., all of
whose membership interests are held by limited partnerships for which
Doughty Hanson acts as general partner.
SECURITY OWNERSHIP OF DIRECTORS AND MANAGEMENT
<TABLE>
<CAPTION>
AMOUNT
BENEFICIALLY PERCENT
NAME OF BENEFICIAL OWNER TITLE OF CLASS OWNED OF CLASS
------------------------ ------------------ ------------ --------
<S> <C> <C> <C>
Reg G. Garratt(1)................................... Class A Common 20,000 2.0%
James E. Knowles.................................... Class A Common 9,947 1.0
Series A Preferred 2,045 0.2
Kenneth John Terry.................................. -- -- --
Kevin Luzak......................................... -- -- --
John J. Zei(1)...................................... Class A Common 16,667 1.7
James F. Brace(1)................................... Class A Common 6,667 0.7
Patrick W. Cavanagh(1).............................. Class A Common 10,000 1.0
David Yang(1)....................................... Class A Common 8,333 0.8
Stephen D. Petersen(1).............................. Class A Common 3,333 0.3
------------------ --------- ------
Combined holdings of directors and executive Class A Common 76,992 7.8%
officers as a group............................... Series A Preferred 2,045 0.2%
--------- ------
--------- ------
</TABLE>
------------
(1) The shares were purchased pursuant to an Executive Stock Purchase Agreement
which provides that if the executive's employment with Knowles and its
subsidiaries terminates under certain circumstances, the executive or his
permitted transferees may require Knowles to repurchase or Knowles may
require the executive to resell the shares. For certain executives and
depending upon the circumstances surrounding the termination of employment,
the repurchase may be made at a price that is greater or less than the fair
market value of the shares.
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RELATED PARTY TRANSACTIONS
DISTRIBUTION OF THE EQUIPMENT FINANCING BUSINESS
On June 29, 1999, Knowles' equipment financing business (The Finance
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 Finance
Corporation of Illinois.
SERVICE AND COMMISSION AGREEMENTS
In connection with our 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 our 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 our recapitalization, Knowles and the holders of its
common stock, including Key Acquisition and Reg G. Garratt, Doug Brander,
Patrick W. Cavanagh, David Yang, Bernard J. Smith, James F. Brace and John J.
Zei, entered into a stockholders' agreement dated as of June 30, 1999 and a
registration rights agreement dated as of June 30, 1999. Among other things, the
stockholders' agreement and the registration rights agreement (1) impose certain
restrictions on the transfer of shares of common stock by such holders and (2)
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 executive
officers of the company to date have purchased 76,992 shares of common stock
which are subject to the stockholders' agreement and the registration rights
agreement.
SOFTWARE CONTRACTS BETWEEN KNOWLES AND SEAN R. GARRATT
Effective January 23, 1998, we entered into a software development
agreement with Daystrom Software Ltd., a limited liability company owned by Reg
G. Garratt's son, Sean R. Garratt. Pursuant to the software development
agreement, Daystrom agreed to develop and assist in the maintenance of certain
voice command and control engine software for Knowles in exchange for a fee. We
renewed the software development agreement in January 1999, and it was
terminated on June 16, 1999. Pursuant to the software development agreement, we
paid $96,080 to Daystrom. We entered into a new six month software development
agreement on July 2, 1999 for an automatic system for optimizing hearing aid
instruments. Pursuant to the new agreement, we paid Daystrom $116,580. Effective
February 29, 2000, this agreement was terminated.
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 and
to pay up to six months of reasonable interest on any bridge loan, not to exceed
$750,000, Mr. Zei incurs in connection with his relocation expenses (see the
description of these items under "Employment Arrangements").
LOAN TO JAMES F. BRACE
Knowles has loaned $50,000 to Mr. Brace, due on or before May 31, 2002, in
connection with his employment.
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DESCRIPTION OF OTHER INDEBTEDNESS
We entered into the Credit Agreement, dated June 28, 1999 and amended and
restated as of July 21, 1999, and amended on December 23, 1999 and April 10,
2000, with the Lenders named therein, 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 consists of (i) a $50 million seven-year term loan
facility ("Term Loan A"), (ii) a $150 million eight-year term loan facility
("Term Loan B") and (iii) a $50 million seven-year revolving credit facility
(the "Revolving Facility"), subject to certain conditions. Under the terms of
the Credit Agreement, and in order to provide financing for our
recapitalization, Term Loan A and Term Loan B were fully drawn on June 30, 1999,
the closing date of the recapitalization. The Revolving Facility will be
available for working capital and general corporate purposes.
TERM LOAN A
Term Loan A will amortize quarterly, with the following payments being made
at the end of each quarter during the following periods.
<TABLE>
<CAPTION>
REPAYMENT DATES AMOUNT
--------------- -----------
<S> <C>
September 30, 2000 to June 30, 2001......................... $ 1,250,000
September 30, 2001 to June 30, 2003......................... 1,875,000
September 30, 2003 to June 30, 2006......................... 2,500,000
-----------
Total.................................................. $50,000,000
===========
</TABLE>
TERM LOAN B
Term Loan B will amortize quarterly, with the following payments being made
at the end of each quarter during the following periods.
<TABLE>
<CAPTION>
REPAYMENT DATES AMOUNT
--------------- ------------
<S> <C>
September 30, 2000 to June 30, 2006......................... $ 375,000
September 30, 2006 to June 29, 2007......................... 35,250,000
------------
Total.................................................. $150,000,000
============
</TABLE>
REVOLVING FACILITY
The Revolving Facility is available as revolving credit advances or letters
of credit. This facility has no scheduled reduction in availability. Final
repayment is due on all amounts outstanding under this facility on June 30,
2006. The Credit Agreement provides for certain limitations governing advances
under the Revolving Facility, in particular limits on the amount of letters of
credit and swingline loans outstanding at any one time.
PREPAYMENT
In addition to the scheduled repayment dates described above, in certain
circumstances the Credit Agreement requires us to make mandatory prepayments of
outstanding amounts under Term Loans A and B, when we or our subsidiaries
receive proceeds of certain material dispositions and insurance claims or issue
certain indebtedness, and commencing in 2001 and depending on our leverage
ratio, when we have a positive adjusted cash flow in the prior year.
Indebtedness under the Credit Agreement may be voluntarily prepaid by us in
whole or in part without premium or penalty. Any such prepayment of Term Loans A
or B will be made pro rata with each other, unless, in the case of mandatory
prepayments, lenders of Term Loan B elect not to be prepaid, in which case Funds
which would have been used for such payments will be applied to prepay Term Loan
A.
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. The
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<PAGE> 67
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. The
covenants and restrictions were modified to provide us greater flexibility by an
amendment to the Credit Agreement on April 10, 2000.
INTEREST RATE AND FEES
In connection with the April 10, 2000 amendment to the Credit Agreement, we
agreed to increase the interest rate for all amounts borrowed by 0.25%. Amounts
outstanding under Term Loan A and 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 2.75% 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 1.75%.
Amounts outstanding under Term Loan B will bear interest, at our option, at
either (1) one-, two-, three- or six-month LIBOR plus an initial interest margin
of 3.25% or (2) the Alternate Base Rate plus an initial margin of 2.25%. 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.
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
Our obligations under the Credit Agreement are guaranteed by our U.S.
subsidiaries.
SECURITY
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.
EVENTS OF DEFAULT
The Credit Agreement contains events of default customary for senior
leveraged recapitalization financings, including non-payment of principal and
interest thereunder, defaults with respect to certain other indebtedness,
failure to observe certain covenants set forth in the Credit Agreement, certain
judgment defaults and certain bankruptcy-related events. In addition, an event
of default will occur if funds managed by Doughty Hanson cease to hold at least
51% of the voting shares and aggregate equity of us prior to an initial public
offering and at least 35% thereafter or certain other events constituting an
occurrence of change of control.
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<PAGE> 68
DESCRIPTION OF THE EXCHANGE NOTES
We issued the initial notes and will issue the exchange notes under an
indenture, dated as of October 1, 1999 (the "Indenture"), among us, the
Subsidiary Guarantors and the Bank of New York, as Trustee (the "Trustee"). The
terms of the exchange notes include those stated in the Indenture and those made
a part of the Indenture by reference to the Trust Indenture Act of 1939 (the
"TIA").
We summarize below certain provisions of the Indenture, but do not restate
the Indenture in its entirety. We urge you to read the Indenture because it, and
not this description, defines your rights as a Holder of the exchange notes. You
can obtain a copy of the Indenture from us upon request.
Key terms used in this section are defined under "Certain Definitions."
When we refer to "Knowles Electronics Holdings" in this section, we mean Knowles
Electronics Holdings, Inc. and not its subsidiaries.
GENERAL
The exchange notes will:
-- be general unsecured obligations of Knowles Electronics Holdings,
-- rank subordinate to all Senior Indebtedness of Knowles Electronics
Holdings, and pari passu or senior to all other Indebtedness of
Knowles Electronics Holdings, and
-- be unconditionally guaranteed on a general unsecured senior
subordinated basis by all of Knowles Electronics Holdings' existing
and future domestic Restricted Subsidiaries and any other Restricted
Subsidiaries of Knowles Electronics Holdings that guarantee Knowles
Electronics Holdings' indebtedness under the Credit Agreement.
PRINCIPAL, MATURITY AND INTEREST
Knowles Electronics Holdings will issue $153,200,000 aggregate principal
amount of exchange notes under the exchange offer 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, Knowles Electronics Holdings may issue additional notes under the
Indenture. The notes offered hereby and any additional notes subsequently issued
will be treated as a single class for all purposes under the Indenture.
Interest on the notes will accrue at the rate of 13 1/8% per annum and will
be payable semi-annually in arrears on each April 15 and October 15 (each, an
"Interest Payment Date"), commencing on April 15, 2000. Payments will be made to
the persons who are registered Holders at the close of business on April 1 and
October 1, respectively (each, a "Regular Record Date"), immediately preceding
the applicable interest payment date.
Interest on the notes will accrue from the most recent date to which
interest has been paid. Interest will be computed on a U.S. corporate bond basis
of a 360-day year comprised of twelve 30-day months. The redemption of notes
with unpaid and accrued interest to the date of redemption will not affect the
right of Holders of record on a prior record date to receive interest due on an
interest payment date.
Initially, the Trustee will act as Paying Agent and Registrar for the
exchange notes. Knowles Electronics Holdings may change the Paying Agent and
Registrar without notice to Holders. All payments on the exchange notes will be
made at the office or agency of the Paying Agent and Registrar in New York City
unless Knowles Electronics Holdings elects to make interest payments by check
mailed to the registered Holders at their registered addresses.
OPTIONAL REDEMPTION
Knowles Electronics Holdings may, at its option, on or after October 15,
2004, upon not less than 30 nor more than 60 days prior notice mailed by first
class mail to each Holder's last address as it appears in the
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<PAGE> 69
Security Register, redeem all or part of the notes at the following Redemption
Prices (expressed in percentages of principal amount), plus accrued and unpaid
interest, if any, to the Redemption Date (subject to the right of Holders of
record on the relevant Regular Record Date that is on or prior to the Redemption
Date to receive interest due on an Interest Payment Date), if redeemed during
the 12-month period commencing October 15, of the years set forth below:
<TABLE>
<CAPTION>
YEAR REDEMPTION PRICE
---- ----------------
<S> <C>
2004......................................... 106.563%
2005......................................... 104.375
2006......................................... 102.188
2007 and thereafter.......................... 100.000%
</TABLE>
In addition, at any time prior to October 15, 2002, Knowles Electronics
Holdings may redeem, at any time or from time to time in part, up to 35% of the
principal amount of the notes with the Net Cash Proceeds of one or more sales of
Capital Stock of Knowles Electronics Holdings (other than Disqualified Stock) at
a Redemption Price (expressed as a percentage of principal amount) of 113.125%,
plus accrued and unpaid interest to the Redemption Date (subject to the rights
of Holders of record on the relevant Regular Record Date that is prior to the
Redemption Date to receive interest due on an Interest Payment Date); provided
that:
-- at least 65% of the aggregate principal amount of notes originally
issued on October 1, 1999 remains outstanding after each such
redemption and
-- notice of any such redemption is mailed within 60 days of each such
sale of capital stock.
In the case of any partial redemption, selection of the notes for
redemption will be made by the Trustee in compliance with the requirements of
the principal national securities exchange, if any, on which the notes are
listed or, if the notes are not listed on a national securities exchange, by lot
or by such other method as the Trustee in its sole discretion shall deem to be
fair and appropriate. No note of $1,000 in principal amount or less shall be
redeemed in part. If any note is to be redeemed in part only, the notice of
redemption relating to such note shall state the portion of the principal amount
thereof to be redeemed. A new note in principal amount equal to the unredeemed
portion thereof will be issued in the name of the Holder thereof upon
cancellation of the original 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 Knowles Electronics Holdings (the "Subsidiary
Guarantors"), each of which has guaranteed Indebtedness of Knowles Electronics
Holdings incurred under the Credit Agreement. All current and future Restricted
Subsidiaries of Knowles Electronics Holdings 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 Knowles
Electronics Holdings incurred under the Credit Agreement, Knowles Electronics
Holdings will cause such Restricted Subsidiary to guarantee Knowles Electronics
Holdings' obligations under the notes. Foreign Subsidiaries of Knowles
Electronics Holdings, which have substantial assets, liabilities, net sales and
income, will not initially guarantee the notes, and Knowles Electronics Holdings
does not anticipate that any Foreign Subsidiary will at any time become a
Subsidiary Guarantor. See "--Covenants--Limitation on Issuances of Guarantees by
Restricted Subsidiaries; Release of Guarantees."
Each Subsidiary Guarantor's obligation under its Note Guarantee may be
subject to avoidance under federal or state fraudulent transfer law in the event
of the Subsidiary Guarantor's bankruptcy or other financial difficulty. See
"Risk Factors--The Exchange Notes and Guarantees May be Unenforceable due to
Fraudulent Conveyance Statutes." The Indenture will limit each Guarantor's
obligation under its Note Guarantee to the maximum amount that the Subsidiary
Guarantor could incur or pay without the incurrence or payment constituting a
fraudulent transfer under those laws. There is no assurance that, if this
limitation is effective, the assets of the Subsidiary Guarantors whose Note
Guarantees are not avoided would be sufficient to repay the notes in full.
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<PAGE> 70
The Note Guarantee of any Subsidiary Guarantor may be released in certain
circumstances. See "-- Covenants -- Limitations on Issuances of Guarantees by
Restricted Subsidiaries; Release of Guarantees."
RANKING
The notes will be senior subordinated Indebtedness of Knowles Electronics
Holdings. The payment of the notes will, to the extent set forth in the
Indenture, be subordinated in right of payment to the prior payment in full, in
cash or cash equivalents, of all existing and future Senior Indebtedness of
Knowles Electronics Holdings. The notes will be guaranteed by the Subsidiary
Guarantors on a senior subordinated basis. Payments under the Note Guarantees
will, to the extent set forth in the Indenture, be subordinated in right of
payment to the prior payment in full, in cash or cash equivalents, of all
existing and future Senior Indebtedness of the Subsidiary Guarantors. As of June
30, 2000, Knowles Electronics Holdings and the Subsidiary Guarantors had $200
million of Indebtedness outstanding in addition to the notes, all of which was
Senior Indebtedness.
Indebtedness incurred under the Credit Agreement, in addition to being
guaranteed on a senior basis by the Subsidiary Guarantors, is secured by
substantially all of the assets of Knowles Electronics Holdings, including the
stock of the Subsidiary Guarantors and other assets and is also secured by
substantially all of the assets of the Subsidiary Guarantors.
In addition, the notes will be effectively subordinated to all liabilities
of Non-Guarantor Subsidiaries of Knowles Electronics Holdings; as of June 30,
2000, the amount of such liabilities was $55.7 million. See "Risk Factors -- The
Exchange Notes are Subordinated to Our Indebtedness and Indebtedness of Our
Subsidiaries."
Upon any payment or distribution of assets or securities of Knowles
Electronics Holdings or any Subsidiary Guarantor of any kind or character,
whether in cash, property or securities, in connection with any dissolution or
winding up or total or partial liquidation or reorganization of Knowles
Electronics Holdings or any Subsidiary Guarantor, whether voluntary or
involuntary or in bankruptcy, insolvency, receivership or other proceedings, or
upon any assignment or marshalling of assets for the benefit of creditors, all
amounts due or to become due upon all Senior Indebtedness shall first be paid in
full, in cash or cash equivalents, before the Holders of the notes or the
Trustee on behalf of the Holders of the notes shall be entitled to receive any
payment by, or on behalf of, Knowles Electronics Holdings or any Subsidiary
Guarantor on account of the notes, whether in cash, property or securities. In
such event, before any payment may be made by, or on behalf of, Knowles
Electronics Holdings or any Subsidiary Guarantor on the notes, any payment or
distribution of assets or securities of Knowles Electronics Holdings or any
Subsidiary Guarantor of any kind or character, whether in cash, property or
securities, to which the Holders of the notes or the Trustee on behalf of the
Holders of the notes would be entitled, but for the subordination provisions of
the Indenture, shall be made by Knowles Electronics Holdings, such Subsidiary
Guarantor or by any receiver, trustee in bankruptcy, liquidating trustee, agent
or other similar Person making such payment or distribution or by the Holders of
the notes or the Trustee if received by them or it directly to the holders of
the Senior Indebtedness to the extent necessary to pay all such Senior
Indebtedness in full, in cash or cash equivalents after giving effect to any
concurrent payment, distribution or provision therefor to or for the holders of
such Senior Indebtedness.
No direct or indirect payment or distribution by or on behalf of Knowles
Electronics Holdings or any Subsidiary Guarantor of the notes, whether pursuant
to the terms of the notes or upon acceleration or otherwise shall be made if, at
the time of such payment, (1) there exists a default in the payment of all or
any portion of the obligations on any Senior Indebtedness of Knowles Electronics
Holdings or such Subsidiary Guarantor and such default shall not have been cured
or waived or the benefits of this sentence waived by or on behalf of the holders
of such Senior Indebtedness or (2) the maturity of any Senior Indebtedness has
been accelerated in accordance with its terms. In addition, during the
continuance of any other event of default with respect to any Designated Senior
Indebtedness pursuant to which the maturity thereof may be accelerated, upon
receipt by the Trustee of written notice from the trustee or other
representative for the holders of such Designated Senior Indebtedness (or the
holders of at least a majority in principal amount of such Designated Senior
Indebtedness then outstanding), no payment or distribution may be made by or on
behalf of Knowles
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Electronics Holdings or the applicable Subsidiary Guarantor upon or in respect
of the notes for a period (a "Payment Blockage Period") commencing on the date
of receipt of such notice and ending 179 days thereafter (unless, in each case,
such Payment Blockage Period shall be terminated by written notice to the
Trustee from such trustee of, or other representatives for, such holders or by
payment in full in cash or cash equivalents of such Designated Senior
Indebtedness or such event of default has been cured or waived).
Not more than one Payment Blockage Period may be commenced with respect to
the notes during any period of 360 consecutive days; provided that if any
Payment Blockage Period within such 360-day period is initiated by or on behalf
of any holders of Designated Senior Indebtedness other than the representative
of the holders of Indebtedness under the Credit Agreement, the representative of
the holders of Indebtedness under the Credit Agreement may initiate a Payment
Blockage Period within such period. Notwithstanding anything in the Indenture to
the contrary, there must be 180 consecutive days in any 360-day period in which
no Payment Blockage Period is in effect. No event of default that existed or was
continuing (it being acknowledged that any subsequent action that would give
rise to an event of default pursuant to any provision under which an event of
default previously existed or was continuing shall constitute a new event of
default for this purpose) on the date of the commencement of any Payment
Blockage Period with respect to the Designated Senior Indebtedness initiating
such Payment Blockage Period shall be, or shall be made, the basis for the
commencement of a second Payment Blockage Period by the representative for, or
the holders of, such Designated Senior Indebtedness, whether or not within a
period of 360 consecutive days, unless such event of default shall have been
cured or waived for a period of not less that 90 consecutive days.
To the extent any payment of Senior Indebtedness (whether by or on behalf
of Knowles Electronics Holdings or any Subsidiary Guarantor, as proceeds of
security or enforcement of any right of setoff or otherwise) is declared to be
fraudulent or preferential, set aside or required to be paid to any receiver,
trustee in bankruptcy, liquidating trustee, agent or other similar Person under
any bankruptcy, insolvency, receivership, fraudulent conveyance or similar law,
then if such payment is recovered by, or paid over to, such receiver, trustee in
bankruptcy, liquidating trustee, agent or other similar Person, the Senior
Indebtedness or part thereof originally intended to be satisfied shall be deemed
to be reinstated and outstanding as if such payment had not occurred. To the
extent the obligation to repay any Senior Indebtedness is declared to be
fraudulent, invalid, or otherwise set aside under any bankruptcy, insolvency,
receivership, fraudulent conveyance or similar law, then the obligation so
declared fraudulent, invalid or otherwise set aside (and all other amounts that
would come due with respect thereto had such obligation not been so affected)
shall be deemed to be reinstated and outstanding as Senior Indebtedness for all
purposes hereof as if such declaration, invalidity or setting aside had not
occurred.
By reason of the subordination provisions described above, in the event of
liquidation or insolvency, creditors of Knowles Electronics Holdings or a
Subsidiary Guarantor who are not holders of Senior Indebtedness may recover
less, ratably, than holders of Senior Indebtedness and may recover more,
ratably, than Holders of the notes.
Notwithstanding the foregoing, payment from the money or the proceeds of
U.S. Government Obligations held in any defeasance trust described under
"-- Defeasance" below will not be contractually subordinated in right of payment
to any Senior Indebtedness or subject to restrictions described herein.
COVENANTS
LIMITATION ON INDEBTEDNESS
(a) Knowles Electronics Holdings will not, and will not permit any of its
Restricted Subsidiaries to, Incur any Indebtedness (other than the initial
notes, the exchange notes, the Note Guarantees and Indebtedness existing on
October 1,1999); provided that Knowles Electronics Holdings and any Restricted
Subsidiary may Incur Indebtedness if, after giving effect to the Incurrence of
such Indebtedness and the receipt and application of the proceeds therefrom, the
Interest Coverage Ratio would be greater than 2:1 with respect to any Incurrence
prior to April 1, 2001, 2.25:1 with respect to any Incurrence on or after April
1, 2001 and prior to October 1, 2002, and 2.5:1 with respect to any Incurrence
on or after October 1, 2002.
Notwithstanding the foregoing, Knowles Electronics Holdings and any
Restricted Subsidiary (except as specified below) may Incur each and all of the
following:
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(1) Indebtedness of Knowles Electronics Holdings or any Restricted
Subsidiary under the Credit Agreement outstanding at any time in an
aggregate principal amount (together with any refinancing thereof) not to
exceed the greater of (A) $250 million or (B) the sum of (x) $200 million
plus (y) 80% of accounts receivable and 50% of inventory, in each case net
of reserves and as shown on the most recent consolidated balance sheet of
Knowles Electronics Holdings (excluding Unrestricted Subsidiaries) prepared
in accordance with GAAP and filed with the Commission or provided to the
Trustee, excluding, in either case, for purposes of calculating such
aggregate principal amount, the principal amount of any Interest Rate
Agreements or Currency Agreements, Guarantees and indemnification payments
due under the Credit Agreement, and less, in the case of the amounts
specified in clause (A) and subclause (B)(x), any amount of Indebtedness
under the Credit Agreement permanently repaid as provided under the
"Limitation on Asset Sales" covenant described below;
(2) Indebtedness owed (A) to Knowles Electronics Holdings or (B) to
any Restricted Subsidiary; provided that any event which results in any
such Restricted Subsidiary ceasing to be a Restricted Subsidiary or any
subsequent transfer of such Indebtedness (other than to Knowles Electronics
Holdings or another Restricted Subsidiary) shall be deemed, in each case,
to constitute an Incurrence of such Indebtedness not permitted by this
clause (2);
(3) Indebtedness issued in exchange for, or the net proceeds of which
are used to refinance or refund, then outstanding Indebtedness and any
refinancings thereof in an amount not to exceed the amount so refinanced or
refunded, including committed but undrawn amounts (plus premiums, accrued
interest, fees and expenses); provided that Indebtedness the proceeds of
which are used to refinance or refund the notes or Indebtedness that is
pari passu with, or subordinated in right of payment to, the notes or the
Note Guarantees shall only be permitted under this clause (3) if (A) in
case the notes are refinanced in part or the Indebtedness to be refinanced
is pari passu with the notes or Note Guarantees, such new Indebtedness, by
its terms or by the terms of any agreement or instrument pursuant to which
such new Indebtedness is outstanding, is expressly made pari passu with, or
subordinate in right of payment to, the remaining notes or Note Guarantees,
as the case may be, (B) in case the Indebtedness to be refinanced is
subordinated in right of payment to the notes or Note Guarantees, such new
Indebtedness, by its terms or by the terms of any agreement or instrument
pursuant to which such new Indebtedness is issued or remains outstanding,
is expressly made subordinate in right of payment to the notes or Note
Guarantees at least to the extent that the Indebtedness to be refinanced is
subordinated to the notes or the Note Guarantees and (C) such new
Indebtedness, determined as of the date of Incurrence of such new
Indebtedness, does not mature prior to the Stated Maturity of the
Indebtedness to be refinanced or refunded, and the Average Life of such new
Indebtedness is at least equal to the remaining Average Life of the
Indebtedness to be refinanced or refunded; and provided further that this
clause (C) shall not apply to refinancings, refundings or renewals of
indebtedness described in clause (1) above;
(4) Indebtedness (A) in respect of performance, surety or appeal
bonds or stand-by letters of credit provided in the ordinary course of
business, (B) under Currency Agreements, Commodities Agreements and
Interest Rate Agreements; provided that such agreements (x) are designed
solely to protect Knowles Electronics Holdings or its Restricted
Subsidiaries against fluctuations in foreign currency exchange rates,
commodities prices or interest rates and (y) do not increase the
Indebtedness of the obligor outstanding at any time other than as a result
of fluctuations in foreign currency exchange rates, commodities prices or
interest rates or by reason of fees, indemnities and compensation payable
or cash calls thereunder, and (C) arising from agreements providing for
indemnification, adjustment of purchase price or similar obligations, or
from Guarantees or letters of credit, surety bonds or performance bonds
securing any obligations of Knowles Electronics Holdings or any of its
Restricted Subsidiaries pursuant to such agreements, in any case Incurred
in connection with the Recapitalization or the disposition of any business
or assets of Knowles Electronics Holdings or any Restricted Subsidiary or
the disposition of any Restricted Subsidiary (other than Guarantees of
Indebtedness Incurred by any Person acquiring all or any portion of such
business, assets or Restricted Subsidiary for the purpose of financing such
acquisition), in a principal amount not to exceed the gross proceeds
actually received by Knowles Electronics Holdings or any Restricted
Subsidiary in connection with such disposition;
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(5) Indebtedness of Knowles Electronics Holdings, to the extent the
net proceeds thereof are promptly (A) used to purchase notes tendered in an
Offer to Purchase made as a result of a Change in Control or (B) deposited
to defease the notes as described below under "Defeasance";
(6) (A) Guarantees of the notes, (B) Guarantees of Indebtedness of
Knowles Electronics Holdings by any Restricted Subsidiary and (C)
Guarantees of Indebtedness of any Restricted Subsidiary by another
Restricted Subsidiary or by Knowles Electronics Holdings;
(7) Indebtedness of Knowles Electronics Holdings or any Restricted
Subsidiary Incurred to finance the acquisition, construction or improvement
of any fixed or capital assets (including related fees and expenses),
including Capital Lease Obligations and any Indebtedness assumed in
connection with the acquisition of any such assets or secured by a Lien on
any such assets prior to the acquisition thereof, provided that such
Indebtedness is Incurred prior to or within 180 days after such acquisition
or the completion of such construction or improvement, and extensions,
renewals and replacements of any such Indebtedness that do not increase the
outstanding principal amount thereof or result in an earlier Stated
Maturity or decreased Average Life thereof, provided that the aggregate
principal amount of Indebtedness permitted by this clause (7) (together
with refinancings thereof) shall not exceed the greater of (A) $20 million
or (B) 10% of Adjusted Consolidated Net Tangible Assets at any time
outstanding;
(8) Acquired Indebtedness in an aggregate principal amount at any
time outstanding (together with refinancings thereof) not to exceed $25
million;
(9) any obligation of Knowles Electronics Holdings to pay any
purchase price adjustment in connection with the recapitalization pursuant
to Section 2.4 of the Recapitalization Agreement;
(10) the Junior Subordinated Exchange Notes issued in exchange for,
and in an aggregate principal amount not in excess of the liquidation value
of, plus all accumulated and all accrued and unpaid but not yet accumulated
dividends on, the Series A-1 Preferred Stock; and
(11) Indebtedness of Knowles Electronics Holdings or any Restricted
Subsidiary (in addition to Indebtedness permitted under clauses (1) through
(10) above) in an aggregate principal amount outstanding at any time
(together with refinancings thereof) not to exceed $30 million.
(b) Notwithstanding any other provision of this "Limitation on
Indebtedness" covenant, the maximum amount of Indebtedness that Knowles
Electronics Holdings or a Restricted Subsidiary may Incur pursuant to this
"Limitation on Indebtedness" covenant shall not be deemed to be exceeded, with
respect to any outstanding Indebtedness to be refinanced in the same currency
and in the same or a lesser principal amount, due solely to the result of
fluctuations in the exchange rates of currencies.
(c) For purposes of determining any particular amount of Indebtedness
under this "Limitation on Indebtedness" covenant, (1) Indebtedness Incurred
under the Credit Agreement on or prior to the Issue Date shall be treated as
Incurred pursuant to clause (1) of the second paragraph of this "Limitation on
Indebtedness" covenant, (2) Guarantees, Liens or obligations with respect to
letters of credit supporting Indebtedness otherwise included in the
determination of such particular amount shall not be included and (3) any Liens
granted pursuant to the equal and ratable provisions referred to in the
"Limitation on Liens" covenant described below shall not be treated as
Indebtedness. For purposes of determining compliance with this "Limitation on
Indebtedness" covenant, in the event that an item of Indebtedness meets the
criteria of more than one of the types of Indebtedness described in the above
clauses (other than Indebtedness referred to in clause (1) of the preceding
sentence), Knowles Electronics Holdings, in its sole discretion, shall classify,
and from time to time may reclassify, such item of Indebtedness and only be
required to include the amount and type of such Indebtedness in one of such
clauses.
LIMITATION ON SENIOR SUBORDINATED INDEBTEDNESS
Knowles Electronics Holdings will not, and will not permit any Subsidiary
Guarantor to, Incur any Indebtedness that is subordinate in right of payment to
any Senior Indebtedness of such Person unless such Indebtedness is pari passu
with, or subordinated in right of payment to, the notes or the Note Guarantee of
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such Subsidiary Guarantor, as the case may be; provided that the foregoing
limitation shall not apply to distinctions between categories of Senior
Indebtedness of Knowles Electronics Holdings or any Subsidiary Guarantor that
exist by reason of any Liens or Guarantees arising or created in respect of some
but not all such Senior Indebtedness.
LIMITATION ON RESTRICTED PAYMENTS
Knowles Electronics Holdings will not, and will not permit any Restricted
Subsidiary to, directly or indirectly:
(1) declare or pay any dividend or make any distribution on or with
respect to its Capital Stock (other than (x) dividends or distributions
payable solely in shares of its Capital Stock (other than Disqualified
Stock) or in options, warrants or other rights to acquire shares of such
Capital Stock and (y) pro rata dividends or distributions on Common Stock
of Restricted Subsidiaries held by minority stockholders) held by Persons
other than Knowles Electronics Holdings or any of its Restricted
Subsidiaries;
(2) purchase, redeem, retire or otherwise acquire for value any shares
of Capital Stock of Knowles Electronics Holdings;
(3) make any voluntary or optional principal payment, or voluntary or
optional redemption, repurchase, defeasance, or other acquisition or
retirement for value, of Indebtedness of Knowles Electronics Holdings that
is subordinated in right of payment to the notes; or
(4) make any Investment, other than a Permitted Investment, in any
Person
(such payments or any other actions described in clauses (1) through (4) above
being collectively "Restricted Payments") if, at the time of, and after giving
effect to, the proposed Restricted Payment:
(A) a Default or Event of Default shall have occurred and be
continuing
(B) Knowles Electronics Holdings could not Incur at least $1.00 of
Indebtedness under the first paragraph of the "Limitation on Indebtedness"
covenant or
(C) the aggregate amount of all Restricted Payments (the amount, if
other than in cash, to be determined in good faith by the Board of
Directors, whose determination shall be conclusive and evidenced by a Board
Resolution) made after the Issue Date shall exceed the sum, without
duplication, of:
(1) 50% of the aggregate amount of the Adjusted Consolidated Net
Income (or, if the Adjusted Consolidated Net Income is a loss, minus
100% of the amount of such loss) accrued on a cumulative basis during
the period (taken as one accounting period) beginning on the first day
of the fiscal quarter immediately preceding the Issue Date and ending on
the last fiscal quarter preceding the Transaction Date for which reports
have been filed with the Commission or provided to the Trustee plus
(2) 100% of the aggregate Net Cash Proceeds received by Knowles
Electronics Holdings or any Restricted Subsidiary after the Issue Date
as a capital contribution or from the issuance and sale permitted by the
Indenture of the Capital Stock (other than Disqualified Stock) of
Knowles Electronics Holdings or a Restricted Subsidiary to a Person who
is not Knowles Electronics Holdings or a Subsidiary of Knowles
Electronics Holdings, including an issuance or sale permitted by the
Indenture of Indebtedness of Knowles Electronics Holdings or any
Restricted Subsidiary for cash subsequent to the Issue Date upon the
conversion of such Indebtedness into Capital Stock (other than
Disqualified Stock) of Knowles Electronics Holdings or a Restricted
Subsidiary, or from the issuance to a Person who is not Knowles
Electronics Holdings or a Subsidiary of Knowles Electronics Holdings of
any options, warrants or other rights to acquire Capital Stock of
Knowles Electronics Holdings or any Restricted Subsidiary (in each case,
exclusive of any Disqualified Stock or any options, warrants or other
rights that are redeemable at the option of the holder, or are required
to be redeemed, prior to the Stated Maturity of the notes) plus
(3) an amount equal to the net reduction in Investments (other
than reductions in Permitted Investments) in any Person resulting from
payments of interest on Indebtedness, dividends,
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repayments of loans or advances, release of Guarantees (other than
pursuant to the payment thereunder), or other transfers of assets, in
each case to Knowles Electronics Holdings or any Restricted Subsidiary
or from the Net Cash Proceeds from the sale of any such Investment
(except, in each case, to the extent any such payment or proceeds are
included in the calculation of Adjusted Consolidated Net Income), or
from redesignations of Unrestricted Subsidiaries as Restricted
Subsidiaries (valued in each case as provided in the definition of
"Investments"), not to exceed, in each case, the amount of Investments
previously made by Knowles Electronics Holdings or any Restricted
Subsidiary in such Person or Unrestricted Subsidiary plus
(4) $10 million.
The foregoing provision shall not be violated by reason of:
(1) the payment of any dividend within 60 days after the date of
declaration thereof if, at said date of declaration, such payment would
comply with the foregoing paragraph;
(2) the redemption, repurchase, defeasance or other acquisition or
retirement for value of Indebtedness that is subordinated in right of
payment to the notes including premium, if any, and accrued and unpaid
interest, with the proceeds of, or in exchange for, Indebtedness Incurred
under clause (3) of the second paragraph of part (a) of the "Limitation on
Indebtedness" covenant;
(3) the repurchase, redemption or other acquisition of Capital Stock
of Knowles Electronics Holdings or an Unrestricted Subsidiary (or options,
warrants or other rights to acquire such Capital Stock) in exchange for, or
out of the proceeds of a substantially concurrent offering of, shares of
Capital Stock (other than Disqualified Stock) of Knowles Electronics
Holdings (or options, warrants or other rights to acquire such Capital
Stock);
(4) the making of any principal payment or the repurchase,
redemption, retirement, defeasance or other acquisition for value of
Indebtedness of Knowles Electronics Holdings which is subordinated in right
of payment to the notes in exchange for, or out of proceeds of, a
substantially concurrent offering of, shares of the Capital Stock (other
than Disqualified Stock) of Knowles Electronics Holdings (or options,
warrants or other rights to acquire such Capital Stock);
(5) payments or distributions to dissenting stockholders, pursuant to
applicable law, pursuant to or in connection with a consolidation, merger
or transfer of assets that complies with the provisions of the Indenture
applicable to mergers, consolidations and transfers of all or substantially
all of the property and assets of Knowles Electronics Holdings;
(6) Investments acquired as a capital contribution or in exchange
for, or out of the proceeds of a substantially concurrent offering of,
shares of Capital Stock (other than Disqualified Stock) of Knowles
Electronics Holdings (or options, warrants or other rights to acquire such
Capital Stock);
(7) the declaration or payment of dividends on the Capital Stock
(other than Disqualified Stock) of Knowles Electronics Holdings in an
aggregate annual amount not to exceed 6% of the gross cash proceeds
received by Knowles Electronics Holdings after the Issue Date from the sale
of such Capital Stock;
(8) Restricted Payments, not exceeding $1.5 million during any fiscal
year, pursuant to and in accordance with stock option plans or other
benefit plans for management or employees of Knowles Electronics Holdings
or its Subsidiaries;
(9) the purchase, redemption, retirement or other acquisition of
Capital Stock or options, warrants or other rights to purchase Capital
Stock of Knowles Electronics Holdings owned by directors, employees or
officers, or former directors, employees or officers of Knowles Electronics
Holdings or its Subsidiaries or their assigns, estates, or beneficiaries
under the estates and heirs, upon the death, retirement, disability,
termination of employment or pursuant to the terms of any agreement under
which such shares of Capital Stock or options, warrants or other rights
were issued, in aggregate amount during any fiscal year not in excess of
the sum of (A) $2 million plus (B) the Net Cash Proceeds received by
Knowles Electronics
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Holdings during such fiscal year from the issuance of its Capital Stock to
directors, employees or officers of Knowles Electronics Holdings or its
Subsidiaries to the extent such Net Cash Proceeds are not used to make a
Restricted Payment pursuant to clause (C) of the first paragraph, or
clauses (3), (4), (6) or (11) of the second paragraph, of this "Limitation
on Restricted Payments" covenant;
(10) the repurchase of shares of its Capital Stock from stockholders
who were stockholders of Knowles Electronics Holdings immediately prior to
the Recapitalization or their assignees, at a price not in excess of fair
market value determined in good faith by the Board of Directors in an
aggregate amount not in excess of $1.5 million during any fiscal year;
(11) upon the occurrence of an IPO, Knowles Electronics Holdings may
redeem all or a portion of the Series A-1 Preferred Stock for an aggregate
redemption price not in excess of the Net Cash Proceeds received by Knowles
Electronics Holdings from such IPO to the extent such Net Cash Proceeds are
not used to make a Restricted Payment pursuant to clause (C) of the first
paragraph, or clause (3), (4), (6) or (9) of the second paragraph, of this
"Limitation on Restricted Payments" covenant;
(12) the exchange of the Series A-1 Preferred Stock for the Junior
Subordinated Exchange Notes;
(13) the exercise of any options, warrants or other rights and the
conversion of any convertible security into the common stock of Knowles
Electronics Holdings; and
(14) other Restricted Payments not to exceed $15 million;
provided that, except in the case of clauses (1), (3), (4), (5), (6) and (13),
no Default or Event of Default shall have occurred and be continuing or occur as
a consequence of the actions or payments set forth therein.
Each Restricted Payment, other than Restricted Payments specified in
clauses (2), (3), (4), (6), (8), (9), (10), (11), (12) and (13), of the
preceding paragraph shall be included in calculating whether the conditions of
clause (C) of the first paragraph of this "Limitation on Restricted Payments"
covenant have been met with respect to any subsequent Restricted Payments. The
Net Cash Proceeds from any issuances of Capital Stock referred to in, and used
to make a Restricted Payment pursuant to, clauses (3), (4), (6), (9) and (11)
shall be excluded in calculating the amount of Restricted Payments that may be
made pursuant to clause (C) of the first paragraph of this "Limitation of
Restricted Payments" covenant. In the event the proceeds of an issuance of
Capital Stock of Knowles Electronics Holdings are used for the redemption,
repurchase or other acquisition of the notes, or Indebtedness that is pari passu
with the notes, then the Net Cash Proceeds of such issuance shall be included in
clause (C) of the first paragraph of this "Limitation on Restricted Payments"
covenant only to the extent such proceeds are not used for such redemption,
repurchase or other acquisition of Indebtedness.
LIMITATION ON DIVIDEND AND OTHER PAYMENT RESTRICTIONS AFFECTING RESTRICTED
SUBSIDIARIES
Knowles Electronics Holdings will not, and will not permit any Restricted
Subsidiary to, create or otherwise cause or suffer to exist or become effective
any consensual encumbrance or restriction of any kind on the ability of any
Restricted Subsidiary to:
(1) pay dividends or make any other distributions permitted by
applicable law on any Capital Stock of such Restricted Subsidiary owned by
Knowles Electronics Holdings or any other Restricted Subsidiary;
(2) pay any Indebtedness owed to Knowles Electronics Holdings or any
other Restricted Subsidiary;
(3) make loans or advances to Knowles Electronics Holdings or any
other Restricted Subsidiary; or
(4) transfer any of its property or assets to Knowles Electronics
Holdings or any other Restricted Subsidiary.
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The foregoing provisions shall not restrict any encumbrances or
restrictions:
(1) existing on the Issue Date in the Credit Agreement, the Indenture
or any other agreements in effect on the Issue Date, and any extensions,
refinancings, renewals or replacements of such agreements; provided that,
with respect to encumbrances and restrictions under agreements other than
the Credit Agreement, the encumbrances and restrictions in any such
extensions, refinancings, renewals or replacements are no less favorable in
the aggregate in any material respect to the Holders than those
encumbrances or restrictions that are then in effect and that are being
extended, refinanced, renewed or replaced;
(2) existing under or by reason of applicable law;
(3) existing with respect to any Person or the property or assets of
such Person acquired by Knowles Electronics Holdings or any Restricted
Subsidiary, existing at the time of such acquisition or at the time such
Person becomes a Restricted Subsidiary and not incurred in contemplation
thereof, which encumbrances or restrictions are not applicable to any
Person or the property or assets of any Person other than such Person or
the property or assets of such Person so acquired or that becomes a
Restricted Subsidiary;
(4) in the case of clause (4) of the first paragraph of this
"Limitation on Dividend and Other Payment Restrictions Affecting Restricted
Subsidiaries" covenant, (A) that restrict in a customary manner the
subletting, assignment or transfer of any property or asset that is a
lease, license, conveyance or contract or similar property or asset, (B)
existing by virtue of any transfer of, agreement to transfer, option or
right with respect to, or Lien on, any property or assets of Knowles
Electronics Holdings or any Restricted Subsidiary not otherwise prohibited
by the Indenture or (C) arising or agreed to in the ordinary course of
business, not relating to any Indebtedness, and that do not, individually
or in the aggregate, detract from the value of property or assets of
Knowles Electronics Holdings or any Restricted Subsidiary in any manner
material to Knowles Electronics Holdings or any Restricted Subsidiary;
(5) existing in contracts for the sale of assets permitted by the
"Limitation on Asset Sales" covenant, including, without limitation, with
respect to a Restricted Subsidiary and imposed pursuant to an agreement
that has been entered into for the sale or disposition of all or
substantially all of the Capital Stock of, or property and assets of, such
Restricted Subsidiary;
(6) contained in the terms of any Indebtedness or any agreement
pursuant to which such Indebtedness was issued if (A) either (x) the
encumbrance or restriction applies only in the event of a payment default
or a default with respect to a financial covenant contained in such
Indebtedness or agreement or (y) the encumbrance or restriction is not
materially more disadvantageous to the Holders of the Notes than is
customary in comparable financings (as determined by Knowles Electronics
Holdings) and (B) Knowles Electronics Holdings determines that any such
encumbrance or restriction will not materially affect Knowles Electronics
Holdings' ability to make principal or interest payments on the notes;
(7) contained in Interest Rate Agreements, Commodities Agreements and
Currency Agreements not prohibited by the Indenture; or
(8) contained in any agreement relating to secured Indebtedness or
Liens not prohibited by the Indenture, if such encumbrance or restriction
applies only to the property or assets securing such Indebtedness or Liens.
Nothing contained in this "Limitation on Dividend and Other Payment Restrictions
Affecting Restricted Subsidiaries" covenant shall prevent Knowles Electronics
Holdings or any Restricted Subsidiary from (a) creating, incurring, assuming or
suffering to exist any Liens otherwise not prohibited in the "Limitation on
Liens" covenant or (b) restricting the sale or other disposition of property or
assets of Knowles Electronics Holdings or any of its Restricted Subsidiaries
that secure Indebtedness of Knowles Electronics Holdings or any of its
Restricted Subsidiaries.
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LIMITATION ON THE ISSUANCE AND SALE OF CAPITAL STOCK OF RESTRICTED
SUBSIDIARIES
Knowles Electronics Holdings will not sell, and will not permit any
Restricted Subsidiary, directly or indirectly, to issue or sell, any shares of
Capital Stock of a Restricted Subsidiary (including options, warrants or other
rights to purchase shares of such Capital Stock) except:
(1) to Knowles Electronics Holdings or a Restricted Subsidiary;
(2) issuances of director's qualifying shares or sales to foreign
nationals of shares of Capital Stock of foreign Restricted Subsidiaries, to
the extent required by applicable law;
(3) if, immediately after giving effect to such issuance or sale,
such Restricted Subsidiary would no longer constitute a Restricted
Subsidiary and any Investment in such Person remaining after giving effect
to such issuance or sale would have been permitted to be made under the
"Limitation on Restricted Payments" covenant if made on the date of such
issuance or sale;
(4) issuances or sales of Capital Stock of a Restricted Subsidiary
which is a Subsidiary Guarantor or Common Stock of a Restricted Subsidiary
which is not a Subsidiary Guarantor (including options, warrants or other
rights to purchase shares of such Capital Stock), provided that (x) Knowles
Electronics Holdings or such Restricted Subsidiary applies the Net Cash
Proceeds, if any, of any such sale in accordance with clause (A) or (B) of
the "Limitation on Asset Sales" covenant or (y) in the case of issuances or
sales of such Capital Stock (including options, warrants or other rights to
purchase shares of Capital Stock) of a non-Wholly Owned Restricted
Subsidiary, after giving effect to such issuance or sale, Knowles
Electronics Holdings maintains its percentage ownership on a fully-diluted
basis in such non-Wholly Owned Restricted Subsidiary; or
(5) the issuance of up to additional 5% of the total nominal capital
of Ruf electronics GmbH pursuant to the Shareholders and Employment
Agreement, dated September 23, 1996, between Knowles Electronics Holdings
and Herbert Hafner.
LIMITATION ON ISSUANCES OF GUARANTEES BY RESTRICTED SUBSIDIARIES; RELEASE OF
GUARANTEES
Each Restricted Subsidiary of Knowles Electronics Holdings which is not a
Foreign Subsidiary will Guarantee the notes on a senior subordinated basis and
Knowles Electronics Holdings will cause each future Restricted Subsidiary which
is not a Foreign Subsidiary to execute a supplemental Indenture pursuant to
which such Restricted Subsidiary will Guarantee the obligations of Knowles
Electronics Holdings under the notes. In addition, Knowles Electronics Holdings
will cause any Foreign Restricted Subsidiary which Guarantees Knowles
Electronics Holdings' obligations under the Credit Agreement to Guarantee the
obligations of Knowles Electronics Holdings under the notes on a senior
subordinated basis for as long as Indebtedness under the Credit Agreement is
guaranteed by such Foreign Restricted Subsidiary.
In addition, Knowles Electronics Holdings will not permit any Restricted
Subsidiary that is not a Subsidiary Guarantor, directly or indirectly, to
Guarantee any Indebtedness of Knowles Electronics Holdings or any Subsidiary
Guarantor which is pari passu with or subordinate in right of payment to the
notes or the Note Guarantees ("Subordinate Guaranteed Indebtedness"), unless
(1) such Restricted Subsidiary simultaneously executes and delivers a
supplemental indenture to the Indenture providing for a Guarantee of
payment of the notes by such Restricted Subsidiary and
(2) such Restricted Subsidiary waives and will not in any manner
whatsoever claim or take the benefit or advantage of, any rights of
reimbursement, indemnity or subrogation or any other rights against Knowles
Electronics Holdings or any other Restricted Subsidiary as a result of any
payment by such Restricted Subsidiary under its Note Guarantee;
provided that this paragraph shall not be applicable to any Guarantee of any
Restricted Subsidiary that existed at the time such Person became a Restricted
Subsidiary and was not Incurred in connection with, or in contemplation of, such
Person becoming a Restricted Subsidiary. If the Subordinate Guaranteed
Indebtedness is (A) pari passu with the notes or the Note Guarantees, then the
Guarantee of such Subordinate Guaranteed
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Indebtedness shall be pari passu with, or subordinated to, such Restricted
Subsidiary's Note Guarantee or (B) subordinated to the notes or the Note
Guarantees, then the Guarantee of such Subordinate Guaranteed Indebtedness shall
be subordinated to such Restricted Subsidiary's Note Guarantee at least to the
extent that the Subordinate Guaranteed Indebtedness is subordinated to the notes
or Note Guarantees.
Any Note Guarantee by a Subsidiary Guarantor, whether given at the time the
notes are issued or thereafter, shall be automatically and unconditionally
released and discharged upon (1) any sale, transfer or other disposition of all
or substantially all of the assets of such Subsidiary by way of merger,
consolidation or otherwise, or a sale, transfer or other disposition (including,
without limitation, by foreclosure or a transfer in lieu of foreclosure) of at
least a majority of the Voting Stock of such Subsidiary or a direct or indirect
parent of such Subsidiary beneficially owning at least a majority of the Voting
Stock of such Subsidiary to any Person not a Subsidiary, (2) the release or
discharge of the Guarantee which resulted in the creation of such Note
Guarantee, except a discharge or release by or as a result of payment under such
Guarantee, or (3) the designation of such Subsidiary as an Unrestricted
Subsidiary.
LIMITATION ON TRANSACTIONS WITH SHAREHOLDERS AND AFFILIATES
Knowles Electronics Holdings will not, and will not permit any Restricted
Subsidiary to, directly or indirectly, enter into, renew or extend any
transaction (including, without limitation, the purchase, sale, lease or
exchange of property or assets, or the rendering of any service) with any
Affiliate of Knowles Electronics Holdings or any Restricted Subsidiary, except
upon fair and reasonable terms no less favorable to Knowles Electronics Holdings
or such Restricted Subsidiary than could be obtained, at the time of such
transaction or, if such transaction is pursuant to a written agreement, at the
time of the execution of the agreement providing therefor, in a comparable
arm's-length transaction with a Person that is not such a holder or an
Affiliate.
The foregoing limitation does not limit, and will not apply to:
(1) transactions (A) approved by a majority of the disinterested
members of the Board of Directors or (B) for which Knowles Electronics
Holdings or a Restricted Subsidiary delivers to the Trustee a written
opinion of a nationally recognized investment banking firm stating that the
transaction is fair to Knowles Electronics Holdings or such Restricted
Subsidiary from a financial point of view;
(2) any transaction solely between Knowles Electronics Holdings and
any of its Restricted Subsidiaries or solely between Restricted
Subsidiaries;
(3) the payment of reasonable and customary regular fees, expenses,
compensation and indemnities to directors, officers, employees or
consultants of Knowles Electronics Holdings or any of its Restricted
Subsidiaries, including ordinary course loans and advances;
(4) any payments or other transactions pursuant to any tax-sharing
agreement between Knowles Electronics Holdings and any other Person with
which Knowles Electronics Holdings files a consolidated tax return or with
which Knowles Electronics Holdings is part of a consolidated group for tax
purposes;
(5) any issuance or sale of shares of Capital Stock (other than
Disqualified Stock) of Knowles Electronics Holdings;
(6) any Restricted Payments not prohibited by the "Limitation on
Restricted Payments" covenant or any transactions permitted by the
"Limitation on Indebtedness," "Limitation on Asset Sales," and
"Consolidation, Merger and Sale of Assets" covenants;
(7) the payment of management and other similar fees to Doughty
Hanson or any of its Affiliates in an aggregate amount not to exceed $2
million in any calendar year;
(8) transactions contemplated by employment agreements approved by
the Board of Directors of Knowles Electronics Holdings; or
(9) any transaction contemplated by an employee stock option or
similar incentive equity plan approved by the Board of Directors of Knowles
Electronics Holdings.
Notwithstanding the foregoing, any transaction or series of related transactions
covered by the first paragraph of this "Limitation on Transactions with
Shareholders and Affiliates" covenant and not covered by clauses (2) through (9)
of this paragraph, (a) the aggregate amount of which exceeds $5 million in
value, must be
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approved or determined to be fair in the manner provided for in clause (1)(A) or
(B) above and (b) the aggregate amount of which exceeds $10 million in value,
must be determined to be fair in the manner provided for in clause (1)(B) above.
LIMITATION ON LIENS
Knowles Electronics Holdings will not Incur and will not permit any
Subsidiary Guarantor to Incur, any Indebtedness secured by a Lien ("Secured
Indebtedness") which is not Senior Indebtedness unless contemporaneously
therewith effective provision is made to secure the notes if such Indebtedness
is issued by Knowles Electronics Holdings or the Note Guarantee issued by the
Subsidiary Guarantor if such Indebtedness is issued by such Subsidiary Guarantor
equally and ratably with (or, if the Secured Indebtedness is subordinated in
right of payment to the notes and the Note Guarantees, prior to) such Secured
Indebtedness for so long as such Secured Indebtedness is secured by a Lien.
LIMITATION ON ASSET SALES
Knowles Electronics Holdings will not, and will not permit any Restricted
Subsidiary to, consummate any Asset Sale, unless:
(1) the consideration received by Knowles Electronics Holdings or
such Restricted Subsidiary is at least equal to the fair market value of
the assets sold or disposed of; and
(2) at least 75% of the consideration received consists of:
(A) Replacement Assets (as defined in clause (1)(B) below); or
(B) cash or Temporary Cash Investments, provided that the amount
of:
(a) any liabilities (as shown on Knowles Electronics Holdings'
or such Restricted Subsidiary's most recent balance sheet) of Knowles
Electronics Holdings or any such Restricted Subsidiary that are
assumed by the transferee of any such assets, provided that Knowles
Electronics Holdings or such Restricted Subsidiary is irrevocably and
unconditionally released in writing from all such liabilities, or
(b) any notes or other obligations received by Knowles
Electronics Holdings or any such Restricted Subsidiary from such
transferee that are converted within 120 days by Knowles Electronics
Holdings or such Restricted Subsidiary into cash (to the extent of
the cash received),
shall be deemed to be cash for the purposes of determining the
percentage of cash or Temporary Cash Investments received by Knowles
Electronics Holdings or such Restricted Subsidiary.
In the event and to the extent that the Net Cash Proceeds received by
Knowles Electronics Holdings or any of its Restricted Subsidiaries from one or
more Asset Sales occurring on or after the Issue Date in any period of 385 days
exceed the greater of (A) $10 million or (B) 10% of Adjusted Consolidated Net
Tangible Assets (determined as of the date closest to the commencement of such
385 day period for which a consolidated balance sheet of Knowles Electronics
Holdings and its Subsidiaries has been filed with the Commission or provided to
the Trustee), then Knowles Electronics Holdings shall or shall cause the
relevant Restricted Subsidiary to:
(1) within 385 days after the date Net Cash Proceeds so received
exceed the greater of $10 million or 10% of Adjusted Consolidated Net
Tangible Assets
(A) apply an amount equal to such excess Net Cash Proceeds to
permanently repay Senior Indebtedness of Knowles Electronics Holdings or
any Restricted Subsidiary, in each case owing to a Person other than
Knowles Electronics Holdings or any of its Restricted Subsidiaries or
(B) invest an equal amount, or the amount not so applied pursuant
to clause (A) (or enter into a definitive agreement committing to so
invest within 385 days after the date of such
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agreement), in property or assets (other than current assets) of a
nature or type or that are used in a business (or in a company having
property and assets of a nature or type, or engaged in a business)
similar or related to the nature or type of the property and assets of,
or the business of, Knowles Electronics Holdings and its Restricted
Subsidiaries existing on the date of such investment ("Replacement
Assets") and
(2) apply (following the end of the 385 days referred to in clause
(1)) such excess Net Cash Proceeds (to the extent not applied pursuant to
clause (1)) as provided in the following paragraph of this "Limitation on
Asset Sales" covenant.
The amount of such excess Net Cash Proceeds required to be applied (or to be
committed to be applied) during such 385 days as set forth in clause (1) of the
preceding sentence and not applied as so required by the end of such period
shall constitute "Excess Proceeds."
If, as of the first day of any calendar month, the aggregate amount of
Excess Proceeds not theretofore subject to an Offer to Purchase pursuant to this
"Limitation on Asset Sales" covenant totals at least $10 million, Knowles
Electronics Holdings must commence, not later than the fifteenth Business Day of
such month, and consummate an Offer to Purchase from the Holders (and if
required by the terms of any Indebtedness that is pari passu with the notes
("Pari Passu Indebtedness"), from the holders of such Pari Passu Indebtedness)
on a pro rata basis an aggregate principal amount of notes (and Pari Passu
Indebtedness) equal to the Excess Proceeds on such date, at a purchase price
equal to 100% of the principal amount thereof, plus, in each case, accrued
interest (if any) to the Payment Date. To the extent that any Excess Proceeds
remain after consummation of an Offer to Purchase, Knowles Electronics Holdings
or such Restricted Subsidiary may use such Excess Proceeds for any purpose not
otherwise prohibited by the Indenture, and the amount of Excess Proceeds shall
be reset at zero.
REPURCHASE OF NOTES UPON A CHANGE OF CONTROL
Knowles Electronics Holdings 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 Knowles Electronics Holdings 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 Knowles
Electronics Holdings which might be outstanding at the time). The above covenant
requiring Knowles Electronics Holdings to repurchase the notes will, unless
consents are obtained, require Knowles Electronics Holdings to repay all
indebtedness then outstanding which by its terms would prohibit such note
repurchase, either prior to or concurrently with such note repurchase.
COMMISSION REPORTS AND REPORTS TO HOLDERS
At all times from and after the earlier of (1) the date of the commencement
of the exchange offer or the effectiveness of a shelf registration statement
relating to the notes (the "Registration") and (2) the date that is 210 days
after the Issue Date, in either case, whether or not Knowles Electronics
Holdings is then required to file reports with the Securities and Exchange
Commission, (the "Commission") but only if then permitted by the Commission,
Knowles Electronics Holdings will file with the Commission all such reports and
other information as it would be required to file with the Commission by Section
13(a) or 15(d) under the Securities Exchange Act of 1934 (the "Exchange Act") if
it were subject thereto. Knowles Electronics Holdings will supply the Trustee
and each Holder or shall supply to the Trustee for forwarding to each such
Holder, without cost to such Holder, copies of such reports and other
information.
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EVENTS OF DEFAULT
The following events are defined as "Events of Default" in the Indenture:
(a) default in the payment of principal of (or premium, if any, on)
any note when the same becomes due and payable at maturity, upon
acceleration, redemption or otherwise whether or not such payment is
prohibited by the provisions described above under "--Ranking";
(b) default in the payment of interest on any note when the same
becomes due and payable, and such default continues for a period of 30
consecutive days whether or not such payment is prohibited by the
provisions described above under "--Ranking";
(c) default in the performance or breach of the provisions of
"Consolidation, Merger or Sale of Assets" covenant or the failure to make
or consummate an Offer to Purchase in accordance with the "Limitation on
Asset Sales" or "Repurchase of Notes upon a Change of Control" covenant;
(d) Knowles Electronics Holdings defaults in the performance of or
breaches any other covenant or agreement of Knowles Electronics Holdings in
the Indenture or under the notes (other than a default specified in clause
(a), (b) or (c) above) and such default or breach continues for a period of
30 consecutive days after written notice by the Trustee or the Holders of
25% or more in aggregate principal amount of the notes;
(e) there occurs with respect to any issue or issues of Indebtedness
of Knowles Electronics Holdings or any Significant Subsidiary having an
outstanding principal amount of $15 million or more in the aggregate for
all such Persons, whether such Indebtedness now exists or shall hereafter
be created, (A) an event of default that has caused the holder thereof to
declare such Indebtedness to be due and payable prior to its Stated
Maturity and such Indebtedness has not been discharged in full or such
acceleration has not been rescinded or annulled within 30 days of such
acceleration and/or (B) the failure to make a principal payment at the
final (but not any interim) fixed maturity and such defaulted payment shall
not have been made, waived or extended within 30 days of such payment
default;
(f) any final judgment or order (not covered by insurance or subject
to an indemnity) for the payment of money in excess of $15 million in the
aggregate for all such final judgments or orders against all such Persons
(treating any deductibles, self-insurance or retention as not so covered)
shall be rendered against Knowles Electronics Holdings or any Significant
Subsidiary and shall not be paid or discharged, and there shall be any
period of 30 consecutive days following entry of the final judgment or
order that causes the aggregate amount for all such final judgments or
orders outstanding and not paid or discharged against all such Persons to
exceed $15 million during which a stay of enforcement of such final
judgment or order, by reason of a pending appeal or otherwise, shall not be
in effect;
(g) a court having jurisdiction in the premises enters a decree or
order for (A) relief in respect of Knowles Electronics Holdings or any
Significant Subsidiary in an involuntary case under any applicable
bankruptcy, insolvency or other similar law now or hereafter in effect, (B)
appointment of a receiver, liquidator, assignee, custodian, trustee,
sequestrator or similar official of Knowles Electronics Holdings or any
Significant Subsidiary or for all or substantially all of the property and
assets of Knowles Electronics Holdings or any Significant Subsidiary or (C)
the winding up or liquidation of the affairs of Knowles Electronics
Holdings or any Significant Subsidiary and, in each case, such decree or
order shall remain unstayed and in effect for a period of 30 consecutive
days;
(h) Knowles Electronics Holdings or any Significant Subsidiary (A)
commences a voluntary case under any applicable bankruptcy, insolvency or
other similar law now or hereafter in effect, or consents to the entry of
an order for relief in an involuntary case under any such law, (B) consents
to the appointment of or taking possession by a receiver, liquidator,
assignee, custodian, trustee, sequestrator or similar official of Knowles
Electronics Holdings or any Significant Subsidiary or for all or
substantially all of the property and assets of Knowles Electronics
Holdings or any Significant Subsidiary or (C) effects any general
assignment for the benefit of creditors; or
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(i) except as permitted by the Indenture, any Note Guarantee by a
Subsidiary Guarantor ceases to be in full force and effect or any
Subsidiary Guarantor repudiates its obligations under its Note Guarantee.
If an Event of Default (other than an Event of Default specified in clause
(g) or (h) above that occurs with respect to Knowles Electronics Holdings)
occurs and is continuing under the Indenture, the Trustee or the Holders of at
least 25% in aggregate principal amount of the notes then outstanding, by
written notice to Knowles Electronics Holdings (and to the Trustee if such
notice is given by the Holders), may, and the Trustee at the request of such
Holders shall, declare the principal of, and premium, if any, and accrued
interest on the notes to be immediately due and payable. Upon a declaration of
acceleration, such principal of, and premium, if any, and accrued interest shall
be immediately due and payable. In the event of a declaration of acceleration
because an Event of Default set forth in clause (e) above has occurred and is
continuing, such declaration of acceleration shall be automatically rescinded
and annulled if the event of default triggering such Event of Default pursuant
to clause (e) shall be remedied or cured by Knowles Electronics Holdings or the
relevant Significant Subsidiary or waived by the holders of the relevant
Indebtedness within 60 days after the declaration of acceleration with respect
thereto. If an Event of Default specified in clause (g) or (h) above occurs with
respect to Knowles Electronics Holdings, the principal of, and premium, if any,
and accrued interest on the notes then outstanding shall ipso facto become and
be immediately due and payable without any declaration or other act on the part
of the Trustee or any Holder. The Holders of at least a majority in principal
amount of the outstanding notes, by written notice to Knowles Electronics
Holdings and to the Trustee, may waive all past defaults and rescind and annul a
declaration of acceleration and its consequences if (1) all existing Events of
Default, other than the nonpayment of the principal of, and premium, if any, and
interest on the notes that have become due solely by such declaration of
acceleration, have been cured or waived and (2) the rescission would not
conflict with any judgment or decree of a court of competent jurisdiction.
Notwithstanding the foregoing, for so long as any Designated Senior
Indebtedness is outstanding, no declaration of acceleration shall be effective
until five business days after the agent or other representative for the holders
of the Designated Senior Indebtedness receives notice of such acceleration and
thereafter payment may be made only if and to the extent that the subordination
provisions described above permit such payment.
The Holders of at least a majority in aggregate principal amount of the
outstanding notes may direct the time, method and place of conducting any
proceeding for any remedy available to the Trustee or exercising any trust or
power conferred on the Trustee. However, the Trustee may refuse to follow any
direction that conflicts with law or the Indenture, that may involve the Trustee
in personal liability, or that the Trustee determines in good faith may be
unduly prejudicial to the rights of Holders of notes not joining in the giving
of such direction and may take any other action it deems proper that is not
inconsistent with any such direction received from Holders of notes. A Holder
may not pursue any remedy with respect to the Indenture or the notes unless:
(1) the Holder gives the Trustee written notice of a continuing Event
of Default;
(2) the Holders of at least 25% in aggregate principal amount of
outstanding notes make a written request to the Trustee to pursue the
remedy;
(3) such Holder or Holders offer the Trustee indemnity satisfactory
to the Trustee against any costs, liability or expense;
(4) the Trustee does not comply with the request within 60 days after
receipt of the request and the offer of indemnity; and
(5) during such 60-day period, the Holders of a majority in aggregate
principal amount of the outstanding notes do not give the Trustee a
direction that is inconsistent with the request.
However, such limitations do not apply to the right of any Holder of a note to
receive payment of the principal of, and premium, if any, or interest on, such
note or to bring suit for the enforcement of any such payment, on or after the
due date expressed in the notes, which right shall not be impaired or affected
without the consent of the Holder.
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The Indenture requires certain officers of Knowles Electronics Holdings to
certify, on or before a date not more than 90 days after the end of each fiscal
year, that a review has been conducted of the activities of Knowles Electronics
Holdings and its Restricted Subsidiaries and the Knowles Electronics Holdings'
and its Restricted Subsidiaries' performance under the Indenture and that
Knowles Electronics Holdings and the Subsidiary Guarantors have fulfilled all
obligations thereunder, or, if there has been a default in the fulfillment of
any such obligation, specifying each such default and the nature and status
thereof. Knowles Electronics Holdings will also be obligated to notify the
Trustee of any default or defaults in the performance of any covenants or
agreements under the Indenture.
CONSOLIDATION, MERGER AND SALE OF ASSETS
Knowles Electronics Holdings will not consolidate with, merge with or into,
or sell, convey, transfer, lease or otherwise dispose of all or substantially
all of its property and assets (as an entirety or substantially an entirety in
one transaction or a series of related transactions) to, any Person (other than
a Restricted Subsidiary) or permit any Person (other than a Restricted
Subsidiary) to merge with or into Knowles Electronics Holdings unless:
(1) Knowles Electronics Holdings shall be the continuing Person, or
the Person (if other than Knowles Electronics Holdings) formed by such
consolidation or into which the Knowles Electronics Holdings is merged or
that acquired or leased such property and assets of the Knowles Electronics
Holdings shall be a corporation organized and validly existing under the
laws of the United States of America or any jurisdiction thereof and shall
expressly assume, by a supplemental indenture, executed and delivered to
the Trustee, all of the obligations of Knowles Electronics Holdings on all
of the notes and under the Indenture;
(2) immediately after giving effect to such transaction, no Default
or Event of Default shall have occurred and be continuing;
(3) immediately after giving effect to such transaction on a pro
forma basis Knowles Electronics Holdings, or any Person becoming the
successor obligor of the notes, as the case may be, could Incur at least
$1.00 of Indebtedness under the first paragraph of the "Limitation on
Indebtedness" covenant; provided that this clause (3) shall not apply to a
consolidation, merger or sale of all (but not less than all) of the assets
of Knowles Electronics Holdings if all Liens and Indebtedness of Knowles
Electronics Holdings or any Person becoming the successor obligor on the
notes, as the case may be, and its Restricted Subsidiaries outstanding
immediately after such transaction would, if Incurred at such time, have
been permitted to be Incurred (and all such Liens and Indebtedness, other
than Liens and Indebtedness of Knowles Electronics Holdings and its
Restricted Subsidiaries outstanding immediately prior to the transaction,
shall be deemed to have been Incurred) for all purposes of the Indenture;
(4) Knowles Electronics Holdings delivers to the Trustee an Officers'
Certificate (attaching the arithmetic computations to demonstrate
compliance with clause (3)) and an Opinion of Counsel, in each case stating
that such consolidation, merger or transfer and such supplemental indenture
complies with this provision and that all conditions precedent provided for
herein relating to such transaction have been complied with; and
(5) each Subsidiary Guarantor, unless such Guarantor is the Person
with which Knowles Electronics Holdings has entered into a transaction
under this "Consolidation, Merger and Sale of Assets," shall have, by
executing an amendment to the Indenture, confirmed that its Note Guarantee
shall apply to the obligations of the surviving entity in accordance with
the terms of the Indenture;
provided, however, that clause (3) above does not apply if, in the good faith
determination of the Board of Directors of Knowles Electronics Holdings, whose
determination shall be evidenced by a Board Resolution, the principal purpose of
such transaction is to change the state of incorporation of Knowles Electronics
Holdings and any such transaction shall not have as one of its purposes the
evasion of the foregoing limitations.
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DEFEASANCE
Defeasance and Discharge. The Indenture provides that Knowles Electronics
Holdings will be deemed to have paid and Knowles Electronics Holdings and the
Subsidiary Guarantors will be discharged from any and all obligations in respect
of the notes and the Note Guarantees on the 123rd day after the deposit referred
to below, and the provisions of the Indenture will no longer be in effect with
respect to the notes and the Note Guarantees (except for, among other matters,
certain obligations to replace stolen, lost or mutilated notes, to maintain
paying agencies and to hold monies for payment in trust) if, among other things:
(A) Knowles Electronics Holdings has deposited with the Trustee, in
trust, money and/or U.S. Government Obligations that through the payment of
interest and principal in respect thereof in accordance with their terms
will provide money in an amount sufficient to pay the principal of, and
premium, if any, and accrued interest on the notes on the Stated Maturity
of such payments in accordance with the terms of the Indenture and the
notes;
(B) Knowles Electronics Holdings has delivered to the Trustee (1)
either (x) an Opinion of Counsel to the effect that Holders will not
recognize income, gain or loss for federal income tax purposes as a result
of Knowles Electronics Holdings' exercise of its option under this
"Defeasance" provision and will be subject to federal income tax on the
same amount and in the same manner at the same times as would have been the
case if such deposit, defeasance and discharge had not occurred, which
Opinion of Counsel must be based upon (and accompanied by a copy of) a
ruling of the Internal Revenue Service to the same effect unless there has
been a change in applicable federal income tax law after October 1, 1999
such that a ruling is no longer required or (y) a ruling directed to the
Trustee received from the Internal Revenue Service to the same effect as
the aforementioned Opinion of Counsel and (2) an Opinion of Counsel to the
effect that the creation of the defeasance trust does not violate the
Investment Company Act of 1940 and, after the passage of 123 days following
the deposit, the trust fund will not be subject to the effect of Section
547 of the United States Bankruptcy Code or Section 15 of the New York
Debtor and Creditor Law;
(C) immediately after giving effect to such deposit on a pro forma
basis, no Event of Default, or event that after the giving of notice or
lapse of time or both would become an Event of Default, shall have occurred
and be continuing on the date of such deposit or during the period ending
on the 123rd day after the date of such deposit, and such deposit shall not
result in a breach or violation of, or constitute a default under, any
other agreement or instrument to which Knowles Electronics Holdings or any
of its Subsidiaries is a party or by which Knowles Electronics Holdings or
any of its Subsidiaries is bound;
(D) Knowles Electronics Holdings is not prohibited from making
payments in respect of the notes by the provisions described under
"-- Ranking;" and
(E) if at such time the notes are listed on a national securities
exchange, Knowles Electronics Holdings has delivered to the Trustee an
Opinion of Counsel to the effect that the notes will not be delisted as a
result of such deposit, defeasance and discharge.
Defeasance of Certain Covenants and Certain Events of Default. The
Indenture further provides that the provisions of the Indenture will no longer
be in effect with respect to clause (3) under "Consolidation, Merger and Sale of
Assets" and all the covenants described herein under "Covenants," clause (c)
under "Events of Default" with respect to such clause (3) under "Consolidation,
Merger and Sale of Assets," clause (d) under "Events of Default" with respect to
such other covenants and clauses (e) and (f) under "Events of Default" shall be
deemed not to be Events of Default upon, among other things, the deposit with
the Trustee, in trust, of money and/or U.S. Government Obligations that through
the payment of interest and principal in respect thereof in accordance with
their terms will provide money in an amount sufficient to pay the principal of,
and premium, if any, and accrued interest on the notes on the Stated Maturity of
such payments in accordance with the terms of the Indenture and the notes, the
satisfaction of the provisions described in clauses (B)(2), (C), (D) and (E) of
the preceding paragraph and the delivery by Knowles Electronics Holdings to the
Trustee of an Opinion of Counsel to the effect that, among other things, the
Holders will not recognize income, gain or loss for federal income tax purposes
as a result of such deposit and
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defeasance of certain covenants and Events of Default and will be subject to
federal income tax on the same amount and in the same manner and at the same
times as would have been the case if such deposit and defeasance had not
occurred.
Defeasance and Certain Other Events of Default. In the event Knowles
Electronics Holdings exercises its option to omit compliance with certain
covenants and provisions of the Indenture with respect to the notes as described
in the immediately preceding paragraph and the notes are declared due and
payable because of the occurrence of an Event of Default that remains
applicable, the amount of money and/or U.S. Government Obligations on deposit
with the Trustee will be sufficient to pay amounts due on the notes at the time
of their Stated Maturity but may not be sufficient to pay amounts due on the
notes at the time of the acceleration resulting from such Event of Default.
However, Knowles Electronics Holdings will remain liable for such payments and
the Note Guarantees with respect to such payments will remain in effect.
MODIFICATION AND WAIVER
The Indenture may be amended, without the consent of any Holder, to:
(1) cure any ambiguity, defect or inconsistency in the Indenture;
(2) comply with the provisions described under "Consolidation, Merger
and Sale of Assets";
(3) comply with any requirements of the Commission in connection with
the qualification of the Indenture under the Trust Indenture Act;
(4) evidence and provide for the acceptance of appointment by a
successor Trustee; or
(5) make any change that, in the good faith opinion of the Board of
Directors, does not materially and adversely affect the rights of any
Holder.
Modifications and amendments of the Indenture may be made by Knowles
Electronics Holdings, the Subsidiary Guarantors and the Trustee with the consent
of the Holders of not less than a majority in aggregate principal amount of the
outstanding notes, provided, however, that no such modification or amendment
may, without the consent of each Holder affected thereby:
(1) change the Stated Maturity of the principal of, or any
installment of interest on, any note;
(2) reduce the principal amount of, or premium, if any, or interest
on, any note;
(3) change the place or currency of payment of principal of, or
premium, if any, or interest on, any note;
(4) impair the right to institute suit for the enforcement of any
payment on or after the Stated Maturity (or, in the case of a redemption,
on or after the Redemption Date) of any note;
(5) waive a default in the payment of principal of, or premium, if
any, or interest on the notes;
(6) modify the subordination provisions in a manner adverse to the
Holders;
(7) release any Subsidiary Guarantor which is a Significant
Subsidiary from its Note Guarantee other than in accordance with provisions
of the Indenture; or
(8) reduce the percentage or aggregate principal amount of
outstanding notes the consent of whose Holders is necessary for waiver of
compliance with certain provisions of the Indenture or for waiver of
certain defaults.
NO PERSONAL LIABILITY OF INCORPORATORS, STOCKHOLDERS, OFFICERS, DIRECTORS OR
EMPLOYEES
The Indenture provides that no recourse for the payment of the principal
of, premium, if any, or interest on any of the notes or for any claim based
thereon or otherwise in respect thereof, and no recourse under or upon any
obligation, covenant or agreement of Knowles Electronics Holdings or any
Subsidiary Guarantor in the Indenture, or in any of the notes or Note Guarantees
or because of the creation of any Indebtedness represented thereby, shall be had
against any incorporator, stockholder, officer, director, employee or
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controlling person of Knowles Electronics Holdings, any Subsidiary Guarantor or
of any successor Person thereof. Each Holder, by accepting the notes, waives and
releases all such liability.
CONCERNING THE TRUSTEE
The Indenture and the provisions of the TIA incorporated by reference
therein provide that, except during the continuance of a Default, the Trustee
will not be liable, except for the performance of such duties as are
specifically set forth in the Indenture. If an Event of Default has occurred and
is continuing, the Trustee will use the same degree of care and skill in its
exercise of the rights and powers vested in it under the Indenture as a prudent
person would exercise under the circumstances in the conduct of such person's
own affairs.
The Indenture and provisions of the Trust Indenture Act of 1939, as
amended, incorporated by reference therein contain limitations on the rights of
the Trustee, should it become a creditor of Knowles Electronics Holdings, to
obtain payment of claims in certain cases or to realize on certain property
received by it in respect of any such claims, as security or otherwise. The
Trustee is permitted to engage in other transactions; provided, however, that if
it acquires any conflicting interest, it must eliminate such conflict or resign.
BOOK-ENTRY, DELIVERY AND FORM
The certificates representing the notes will be issued in the form of one
or more global notes (collectively, the "Global Note"). The Global Note will be
deposited with or on behalf of DTC and registered in the name of DTC or its
nominee. Except as set forth below, the Global Note may be transferred in whole
and not in part and only to DTC or other nominees of DTC.
Ownership of beneficial interests in the Global Note will be limited to
"participants" who have accounts with DTC or persons who hold interests through
participants. Ownership of beneficial interests in the Global Note will be shown
on, and the transfer of that ownership will be effected only through, records
maintained by DTC or its nominee (with respect to interests of participants) and
the records of participants (with respect to interests of persons other than
participants).
Knowles Electronics Holdings understands that DTC is:
-- a limited purpose trust company organized under the laws of the State
of New York,
-- a "banking organization" within the meaning of New York Banking Law,
-- a member of the Federal Reserve System,
-- a "clearing corporation" within the meaning of the Uniform Commercial
Code and
-- a "Clearing Agency" registered pursuant to the provisions of Section
17A of the Exchange Act.
DTC was created to hold securities for its participants and facilitate the
clearance and settlement of securities transactions between participants through
electronic book-entry changes in accounts of its participants, thereby
eliminating the need for physical movement of certificates. Indirect access to
the DTC system is available to others such as banks, brokers, dealers and trust
companies and certain other organizations that clear through or maintain a
custodial relationship with a participant, either directly or indirectly
("indirect participants").
So long as DTC, or its nominees, is the registered owner or holder of the
Global Note, DTC or such nominee, as the case may be, will be considered the
sole owner or holder of the notes represented by the Global Note for all
purposes under the Indenture and the notes. No beneficial owner of an interest
in the Global Note will be able to transfer that interest except in accordance
with DTC's applicable procedures, in addition to those provided for under the
Indenture and, if applicable, those of Morgan Guaranty Trust Company of New
York, Brussels office, as operator of the Euroclear System ("Euroclear"), and
Clearstream Banking, Luxembourg, societe anonyme ("Clearstream").
Payments of the principal of, and interest on, the Global Note will be made
to DTC or its nominee, as the case may be, as the registered owner thereof.
Neither Knowles Electronics Holdings, the Trustee nor any Paying Agent will have
any responsibility or liability for any aspect of the records relating to or
payments made on account of beneficial ownership interests in the Global Note or
for maintaining, supervising or reviewing any records relating to such
beneficial ownership interests.
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Knowles Electronics Holdings expects that DTC or its nominee, upon receipt
of any payment of principal or interest in respect of the Global Note, will
credit participants' accounts with payments in amounts proportionate to their
respective beneficial interests in the principal amount of the Global Note as
shown on the records of DTC or its nominee. Knowles Electronics Holdings also
expects that payments by participants to owners of beneficial interests in the
Global Note held through such participants will be governed by standing
instructions and customary practices, as is now the case with securities held
for the accounts of customers registered in the names of nominees for such
customers. Such payments will be the responsibility of such participants.
Knowles Electronics Holdings expects that DTC will take any action
permitted to be taken by a holder of notes (including the presentation of notes
for exchange as described below) only at the direction of one or more
participants to whose account the DTC interests in the Global Note is credited
and only in respect of such portion of the aggregate principal amount of notes
as to which such participant or participants has or have given such direction.
However, if there is an Event of Default under the notes, DTC will exchange the
applicable Global Note for registered certificated notes, which it will
distribute to its participants.
If DTC is at any time unwilling or unable to continue as a depositary for
the Global Note and a successor depositary is not appointed by Knowles
Electronics Holdings within 90 days, Knowles Electronics Holdings will issue
registered certificated notes without interest coupons in exchange for the
Global Note.
Transfers between participants in DTC will be effected in the ordinary way
in accordance with DTC rules and will be settled in same-day funds. Transfers
between participants in Euroclear and Clearstream will be effected in the
ordinary way in accordance with their respective rules and operating procedures.
Subject to compliance with the transfer restrictions applicable to the
exchange notes, cross-market transfers between participants in DTC, on the one
hand, and Euroclear or Clearstream accountholders, on the other hand, will be
effected through DTC in accordance with DTC's rules on behalf of Euroclear or
Clearstream, as the case may be, by its respective depositary. However, such
cross-market transactions will require delivery of instructions to Euroclear or
Clearstream, as the case may be, by the counterparty in such system in
accordance with the rules and procedures and within the established deadlines
(Brussels time) of such system. Euroclear or Clearstream, as the case may be,
will, if the transaction meets its settlement requirements, deliver instructions
to its respective depositary to take action to effected final settlement on its
behalf by delivering or receiving interests in the Global Note in DTC, and
making or receiving payment in accordance with normal procedures for same-day
funds settlement applicable to DTC. Euroclear accountholders and Clearstream
participants may not deliver instructions directly to the depositaries for
Euroclear or Clearstream.
Because of time zone differences, the securities account of a Euroclear or
Clearstream accountholder purchasing an interest in the Global Note from a
participant in DTC will be credited, and any such crediting will be reported to
the relevant Euroclear or Clearstream accountholder, during the securities
settlement processing day (which must be a business day for Euroclear and
Clearstream) immediately following the settlement date of DTC. Cash received in
Euroclear or Clearstream as a result of sales of interest in the Global Note by
or through a Euroclear or Clearstream accountholder to a participant in DTC will
be received with value on the settlement date of DTC but will be available in
the relevant Euroclear or Clearstream cash account only as of the business day
for Euroclear or Clearstream following DTC's settlement date.
Although DTC, Euroclear and Clearstream are expected to follow the
foregoing procedures in order to facilitate transfers of interests in the Global
Note among participants of DTC, Euroclear and Clearstream, they are under no
obligation to perform or continue to perform such procedures and such procedures
may be discontinued at any time. Neither Knowles Electronics Holdings nor the
Trustee will have any responsibility for the performance by DTC, Euroclear or
Clearstream or their respective participants or indirect participants of their
respective obligations under the rules and procedures governing their
operations.
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GOVERNING LAW
The Indenture provides that the Indenture and the notes will be governed
by, and construed in accordance with, the laws of the State of New York but
without giving effect to applicable principles of conflicts of law to the extent
that the application of the law of another jurisdiction would be required
thereby.
DEFINITIONS
Set forth below is a summary of some of the defined terms used in the
covenants and other provisions of the Indenture. Reference is made to the
Indenture for the full definition of all terms as well as any other capitalized
term used in this section for which no definition is provided.
"Acquired Indebtedness" means Indebtedness of a Person existing at the time
such Person is merged with or into or consolidated with or becomes a Restricted
Subsidiary or assumed in connection with an Asset Acquisition; provided that
Indebtedness of such Person which is redeemed, defeased, retired or otherwise
repaid at the time of or immediately upon consummation of the transactions by
which such Person becomes a Restricted Subsidiary or such Asset Acquisition or
merger or consolidation shall not be Acquired Indebtedness.
"Adjusted Consolidated Net Income" means, for any period, the aggregate net
income (or loss) of Knowles Electronics Holdings and its Restricted Subsidiaries
for such period determined in conformity with GAAP; provided that the following
items shall be excluded in computing Adjusted Consolidated Net Income (without
duplication):
(1) the net income of any Person that is not a Restricted Subsidiary,
except to the extent of the amount of dividends or other distributions
actually paid to Knowles Electronics Holdings or any of its Restricted
Subsidiaries by such Person during such period;
(2) solely for purposes of calculating the amount of Restricted
Payments that may be made pursuant to clause (C) of the first paragraph of
the "Limitation on Restricted Payment" covenant, the net income (or loss)
of any Person accrued prior to the date it becomes a Restricted Subsidiary
or is merged into or consolidated with Knowles Electronics Holdings or any
of its Restricted Subsidiaries or all or substantially all of the property
and assets of such Person are acquired by Knowles Electronics Holdings or
any of its Restricted Subsidiaries;
(3) solely for purposes of calculating the amount of Restricted
Payments that may be made pursuant to clause (C) of the first paragraph of
the "Limitation on Restricted Payment" covenant, the net income (or loss)
of any Restricted Subsidiary to the extent that the declaration or payment
of dividends or similar distributions by such Restricted Subsidiary of such
net income is not at the time permitted by the operation of the terms of
its charter or any agreement, instrument, judgment, decree, order, statute,
rule or governmental regulation applicable to such Restricted Subsidiary;
(4) any net gains or losses (on an after-tax basis) attributable to
Asset Sales;
(5) solely for purposes of calculating the amount of Restricted
Payments that may be made pursuant to clause (C) of the first paragraph of
the "Limitation on Restricted Payments" covenant, any amount paid or
accrued as dividends on Preferred Stock of Knowles Electronics Holdings
owned by Persons other than Knowles Electronics Holdings and any of its
Restricted Subsidiaries; and
(6) all extraordinary and non-recurring gains and losses.
"Adjusted Consolidated Net Tangible Assets" means the total amount of
assets of Knowles Electronics Holdings and its Restricted Subsidiaries (less
applicable depreciation, amortization and other valuation reserves), except to
the extent resulting from write-ups of capital assets (excluding write-ups in
connection with accounting for acquisitions in conformity with GAAP), after
deducting therefrom (1) all current liabilities of Knowles Electronics Holdings
and its Restricted Subsidiaries (excluding intercompany items) and (2) all
goodwill, trade names, trademarks, patents, unamortized debt discount and
expense and other like intangibles, all as set forth on the most recent
quarterly or annual consolidated balance sheet of Knowles Electronics Holdings,
excluding Unrestricted Subsidiaries, prepared in conformity with GAAP and filed
with the Commission or provided to the Trustee.
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"Affiliate" means, as applied to any Person, any other Person directly or
indirectly controlling, controlled by, or under direct or indirect common
control with, such Person. For purposes of this definition, "control"
(including, with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as applied to any Person, means the
possession, directly or indirectly, of the power to direct or cause the
direction of the management and policies of such Person, whether through the
ownership of voting securities, by contract or otherwise.
"Asset Acquisition" means:
(1) an investment by Knowles Electronics Holdings or any of its
Restricted Subsidiaries in any other Person pursuant to which such Person
shall become a Restricted Subsidiary or shall be merged into or
consolidated with Knowles Electronics Holdings or any of its Restricted
Subsidiaries; or
(2) an acquisition by Knowles Electronics Holdings or any of its
Restricted Subsidiaries of the property and assets of any Person (other
than Knowles Electronics Holdings or any of its Restricted Subsidiaries)
that constitute substantially all of a division or line of business of such
Person.
"Asset Disposition" means the sale or other disposition by Knowles
Electronics Holdings or any of its Restricted Subsidiaries (other than to
Knowles Electronics Holdings or another Restricted Subsidiary) of:
(1) all or substantially all of the Capital Stock of any Restricted
Subsidiary; or
(2) all or substantially all of the assets that constitute a division
or line of business of Knowles Electronics Holdings or any of its
Restricted Subsidiaries.
"Asset Sale" means any sale, transfer or other disposition (including by
way of merger, consolidation or sale-leaseback transaction) in one transaction
or a series of related transactions by Knowles Electronics Holdings or any of
its Restricted Subsidiaries to any Person other than Knowles Electronics
Holdings or any of its Restricted Subsidiaries of:
(1) all or any of the Capital Stock of any Restricted Subsidiary
(other than directors' qualifying shares or shares required by applicable
law to be held by Persons other than Knowles Electronics Holdings or a
Restricted Subsidiary), and other than the Capital Stock of a
non-Wholly-Owned Restricted Subsidiary if, after giving effect to such
sale, Knowles Electronics Holdings maintains its percentage ownership on a
fully-diluted basis of such non-Wholly-Owned Subsidiary;
(2) all or substantially all of the property and assets of an
operating unit or business of Knowles Electronics Holdings or any of its
Restricted Subsidiaries; or
(3) any other property and assets (other than the Capital Stock or
other Investment in an Unrestricted Subsidiary) of Knowles Electronics
Holdings or any of its Restricted Subsidiaries outside the ordinary course
of business of Knowles Electronics Holdings or such Restricted Subsidiary,
and, in the case of (1), (2) or (3), that is not governed by the provisions of
the Indenture applicable to mergers, consolidations and sales of assets of
Knowles Electronics Holdings, provided that "Asset Sale" shall not include:
(a) sales or other dispositions of inventory, receivables and other
current assets, licenses of intellectual property and sales or other
dispositions of other assets in the ordinary course of business;
(b) sales or other dispositions of assets constituting a Restricted
Payment permitted to be made under the "Limitation on Restricted Payments"
covenant;
(c) sales or other dispositions of assets for consideration at least
equal to the fair market value of the assets sold or disposed of, to the
extent that the consideration received would constitute Replacement Assets
as defined in the "Limitation on Asset Sales" covenant;
(d) trade-ins, trade-ups and other similar exchanges of equipment of
Knowles Electronics Holdings and its Restricted Subsidiaries for other
equipment to be used in the ordinary course of business;
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(e) sales or other dispositions of assets that have become obsolete,
worn out or surplus for the purpose for which such assets are normally used
or which are no longer required for use in connection with the business of
Knowles Electronics Holdings or any of its Restricted Subsidiaries;
(f) the making of a Permitted Investment; or
(g) sales or other dispositions of assets (other than assets disposed
in accordance with clauses (a) through (f) above) in a maximum aggregate
amount of $2 million in a fiscal year.
"Average Life" means, at any date of determination with respect to any debt
security, the quotient obtained by dividing (1) the sum of the products of (a)
the number of years from such date of determination to the dates of each
successive scheduled principal payment of such debt security and (b) the amount
of such principal payment by (2) the sum of all such principal payments.
"Capital Stock" means, with respect to any Person, any and all shares,
interests, participations or other equivalents (however designated, whether
voting or non-voting) in equity of such Person, whether outstanding on the Issue
Date or issued thereafter, including, without limitation, all Common Stock and
Preferred Stock.
"Capitalized Lease" means, as applied to any Person, any lease of any
property (whether real, personal or mixed) of which the discounted present value
of the rental obligations of such Person as lessee, in conformity with GAAP, is
required to be capitalized on the balance sheet of such Person.
"Capitalized Lease Obligations" means the discounted present value of the
rental obligations under a Capitalized Lease.
"Change of Control" means such time as
(1) (a) prior to a Public Equity Offering, a "person" or "group"
(within the meaning of Sections 13(d) and 14(d)(2) of the Exchange Act)
other than the Existing Stockholders becomes the ultimate "beneficial
owner" (as defined in Rule 13d-3 under the Exchange Act) of Voting Stock
representing a greater percentage of the total voting power of the Voting
Stock of Knowles Electronics Holdings, on a fully diluted basis, than is
held by the Existing Stockholders on such date and (b) after a Public
Equity Offering, a "person" or "group" (within the meaning of Sections
13(d) and 14(d)(2) of the Exchange Act) other than the Existing
Stockholders becomes the ultimate "beneficial owner" (as defined in Rule
13d-3 under the Exchange Act) of more than 35% of the total voting power of
the Voting Stock of Knowles Electronics Holdings on a fully diluted basis
and such ownership represents a greater percentage of the total voting
power of the Voting Stock of Knowles Electronics Holdings, on a fully
diluted basis, than is held by the Existing Stockholders on such date; or
(2) during any consecutive two year period, individuals who at the
beginning of such period constitute the Board of Directors (together with
any new directors whose election by the Board of Directors or whose
nomination by the Board of Directors for election by Knowles Electronics
Holdings' stockholders was approved by a vote of at least a majority of the
members of the Board of Directors then in office who either were members of
the Board of Directors at the beginning of such period or whose election or
nomination for election was previously so approved or who are otherwise
elected by a majority vote of the Existing Stockholders) cease for any
reason to constitute a majority of the members of the Board of Directors
then in office.
"Commodities Agreement" means any commodity future or options contract or
other similar agreement or arrangement.
"Consolidated EBITDA" means, for any period, Adjusted Consolidated Net
Income for such period plus, to the extent such amount was deducted in
calculating such Adjusted Consolidated Net Income:
(1) Consolidated Interest Expense;
(2) income taxes (other than income taxes, either positive or
negative, attributable to extraordinary or non-recurring gains or losses);
(3) depreciation expense;
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(4) amortization expense; and
(5) all other non-cash items reducing Adjusted Consolidated Net
Income (other than items that will require cash payments and for which an
accrual or reserve is, or is required by GAAP to be, made),
less all non-cash items increasing Adjusted Consolidated Net Income, all as
determined on a consolidated basis for Knowles Electronics Holdings, excluding
Unrestricted Subsidiaries, in conformity with GAAP, provided that, if any
Restricted Subsidiary is not a Wholly Owned Restricted Subsidiary, Consolidated
EBITDA shall be reduced (to the extent not otherwise reduced in accordance with
GAAP) by an amount equal to (A) the amount of the Adjusted Consolidated Net
Income attributable to such Restricted Subsidiary multiplied by (B) the
percentage ownership interest in the income of such Restricted Subsidiary not
owned on the last day of such period by Knowles Electronics Holdings or any of
its Restricted Subsidiaries.
"Consolidated Interest Expense" means, for any period, the aggregate amount
of interest in respect of Indebtedness (including, without limitation,
amortization of original issue discount on any Indebtedness and the interest
portion of any deferred payment obligation, calculated in accordance with the
effective interest method of accounting; all commissions, discounts and other
fees and charges owed with respect to letters of credit and bankers' acceptance
financing; the net costs associated with Interest Rate Agreements; and
Indebtedness that is Guaranteed or secured by Knowles Electronics Holdings or
any of its Restricted Subsidiaries) and all but the principal component of
rentals in respect of Capitalized Lease Obligations paid, accrued or scheduled
to be paid or to be accrued by Knowles Electronics Holdings and its Restricted
Subsidiaries during such period; excluding, however, (1) any amount of such
interest of any Restricted Subsidiary if the net income of such Restricted
Subsidiary is excluded in the calculation of Consolidated EBITDA pursuant to the
definition of Adjusted Consolidated Net Income or the definition of Consolidated
EBITDA (but only in the same proportion as the net income of such Restricted
Subsidiary is excluded from the calculation of Consolidated EBITDA pursuant to
the definition of Adjusted Consolidated Net Income or the definition of
Consolidated EBITDA) and (2) any premiums, fees and expenses (and any
amortization thereof) payable in connection with the Recapitalization and the
offering of the notes, all as determined on a consolidated basis (without taking
into account Unrestricted Subsidiaries) in conformity with GAAP.
"Credit Agreement" means the Credit Agreement dated as of June 28, 1999, as
amended and restated as of July 21, 1999, among Knowles Electronics Holdings,
The Chase Manhattan Bank, as administrative agent, Morgan Stanley Senior
Funding, Inc., as syndication agent, Chase Securities Inc., as lead arranger and
book manager, and the lenders party thereto, providing for a senior secured
credit facility, as the same may be amended (including any amendment and
restatement thereof), modified, supplemented, extended, renewed, restated,
refunded, refinanced, restructured or replaced from time to time.
"Currency Agreement" means any foreign exchange contract, currency future
or options contract, currency swap agreement or other similar agreement or
arrangement.
"Default" means any event that is, or after notice or passage of time or
both would be, an Event of Default.
"Designated Senior Indebtedness" means:
(1) any Indebtedness under the Credit Agreement; and
(2) any other Indebtedness constituting Senior Indebtedness that, at
the date of determination, has an aggregate principal amount outstanding of
at least $25 million and that is specifically designated by Knowles
Electronics Holdings in the instrument creating or evidencing such Senior
Indebtedness as "Designated Senior Indebtedness," as long as such
designation is consented to by the Required Lenders (as defined in the
Credit Agreement).
"Disqualified Stock" means any class or series of Capital Stock of any
Person that by its terms or otherwise is:
(1) required to be redeemed prior to the Stated Maturity of the
notes;
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(2) redeemable at the option of the holder of such class or series of
Capital Stock at any time prior to the Stated Maturity of the notes; or
(3) convertible into or exchangeable for Capital Stock referred to in
clause (i) or (ii) above or Indebtedness having a scheduled maturity prior
to the Stated Maturity of the notes;
provided that any Capital Stock that would not constitute Disqualified Stock but
for provisions thereof giving holders thereof the right to require such Person
to repurchase or redeem such Capital Stock upon the occurrence of an "asset
sale" or "change of control" occurring prior to the Stated Maturity of the notes
shall not constitute Disqualified Stock if the "asset sale" or "change of
control" provisions applicable to such Capital Stock are no more favorable to
the holders of such Capital Stock than the provisions contained in "Limitation
on Asset Sales" and "Repurchase of Notes upon a Change of Control" covenants
described below and such Capital Stock specifically provides that such Person
will not repurchase or redeem any such stock pursuant to such provision prior to
Knowles Electronics Holdings' repurchase of such notes as are required to be
repurchased pursuant to the "Limitation on Asset Sales" and "Repurchase of Notes
upon a Change of Control" covenants described below.
"Existing Stockholders" means Doughty Hanson & Co. Limited or any of its
Affiliates, any limited partnership of which any of them is general partner and
any investment fund controlled or managed by any of them or under common control
therewith.
"fair market value" means the price that would be paid in an arm's-length
transaction between an informed and willing seller under no compulsion to sell
and an informed and willing buyer under no compulsion to buy, as determined in
good faith by the Board of Directors, whose determination shall be conclusive if
evidenced by a Board Resolution.
"GAAP" means generally accepted accounting principles in the United States
of America as in effect as of October 1, 1999, including, without limitation,
those set forth in the opinions and pronouncements of the Accounting Principles
Board of the American Institute of Certified Public Accountants and statements
and pronouncements of the Financial Accounting Standards Board or in such other
statements by such other entity as approved by a significant segment of the
accounting profession. All ratios and computations contained or referred to in
the Indenture shall be computed in conformity with GAAP applied on a consistent
basis, except that calculations made for purposes of determining compliance with
the terms of the covenants and with other provisions of the Indenture shall be
made without giving effect to (1) any fees or expenses incurred in connection
with the Recapitalization or any fees or expenses incurred in connection with
the offering of the notes and (2) except as otherwise provided, the amortization
of any amounts required or permitted to be amortized by Accounting Principles
Board Opinion Nos. 16 and 17.
"Guarantee" means any obligation, contingent or otherwise, of any Person
directly or indirectly guaranteeing any Indebtedness of any other Person and,
without limiting the generality of the foregoing, any obligation, direct or
indirect, contingent or otherwise, of such Person:
(1) to purchase or pay (or advance or supply funds for the purchase
or payment of) such Indebtedness of such other Person (whether arising by
virtue of partnership arrangements, or by agreements to keep-well, to
purchase assets, goods, securities or services (unless such purchase
arrangements are on arm's-length terms and are entered into in the ordinary
course of business), to take-or-pay, or to maintain financial statement
conditions or otherwise); or
(2) entered into for purposes of assuring in any other manner the
obligee of such Indebtedness of the payment thereof or to protect such
obligee against loss in respect thereof (in whole or in part);
provided that the term "Guarantee" shall not include endorsements for collection
or deposit in the ordinary course of business. The term "Guarantee" used as a
verb has a corresponding meaning.
"Incur" means, with respect to any Indebtedness, to incur, create, issue,
assume, Guarantee or otherwise become liable for or with respect to the payment
of, contingently or otherwise, such Indebtedness, including an "Incurrence" of
Acquired Indebtedness, provided that neither the accrual of interest nor the
accretion of original issue discount shall be considered an Incurrence of
Indebtedness.
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"Indebtedness" means, with respect to any Person at any date of
determination (without duplication):
(1) all indebtedness of such Person for borrowed money;
(2) all obligations of such Person evidenced by bonds, debentures,
notes or other similar instruments;
(3) all obligations of such Person in respect of letters of credit or
other similar instruments (including reimbursement obligations with respect
thereto, but excluding obligations with respect to letters of credit
(including trade letters of credit) securing obligations (other than
obligations described in (1) or (2) above or (5), (6) or (7) below) entered
into in the ordinary course of business of such Person to the extent such
letters of credit are not drawn upon or, if drawn upon, to the extent such
drawing is reimbursed no later than the third Business Day following
receipt by such Person of a demand for reimbursement);
(4) all obligations of such Person to pay the deferred and unpaid
purchase price of property or services, which purchase price is due more
than six months after the date of placing such property in service or
taking delivery and title thereto or the completion of such services,
except Trade Payables;
(5) all Capitalized Lease Obligations;
(6) all Indebtedness of other Persons secured by a Lien on any asset
of such Person, whether or not such Indebtedness is assumed by such Person;
provided that the amount of such Indebtedness shall be the lesser of (A)
the fair market value of such asset at such date of determination and (B)
the amount of such Indebtedness;
(7) all Indebtedness of other Persons Guaranteed by such Person to
the extent such Indebtedness is Guaranteed by such Person; and
(8) to the extent not otherwise included in this definition, net
obligations under Currency Agreements, Commodities Agreements and Interest
Rate Agreements other than such agreements entered into in the ordinary
course of business designed solely to protect Knowles Electronics Holdings
and its Subsidiaries against foreign currency exchange rates, fluctuations
in commodities prices or fluctuations in interest rates.
The amount of Indebtedness of any Person at any date shall be the outstanding
balance at such date of all unconditional obligations as described above and,
with respect to contingent obligations, the maximum liability upon the
occurrence of the contingency giving rise to the obligation, provided (A) that
the amount outstanding at any time of any Indebtedness issued with original
issue discount is the face amount of such Indebtedness less the remaining
unamortized portion of the original issue discount of such Indebtedness at such
time as determined in conformity with GAAP, (B) that money borrowed and set
aside at the time of the Incurrence of any Indebtedness in order to prefund the
payment of the interest on such Indebtedness shall not be deemed to be
"Indebtedness" so long as such money is held to secure the payment of such
interest and such Debt and (C) that Indebtedness shall not include any liability
for federal, state, local or other taxes.
"Interest Coverage Ratio" means, on any Transaction Date, the ratio of (x)
the aggregate amount of Consolidated EBITDA for the then most recent four fiscal
quarters prior to such Transaction Date for which reports have filed with the
Commission or provided to the Trustee (the "Four Quarter Period") to (y) the
aggregate Consolidated Interest Expense during such Four Quarter Period. In
making the foregoing calculation,
(A) pro forma effect shall be given to any Indebtedness Incurred or
repaid during the period (the "Reference Period") commencing on the first
day of the Four Quarter Period and ending on the Transaction Date (other
than Indebtedness Incurred or repaid under a revolving credit or similar
arrangement in effect on the last day of such Four Quarter Period except to
the extent of any portion of such Indebtedness is projected, in the
reasonable judgment of the senior management of Knowles Electronics
Holdings, to remain outstanding for a period in excess of 12 months from
the date of the Incurrence thereof), in each case as if such Indebtedness
had been Incurred or repaid on the first day of such Reference Period;
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(B) Consolidated Interest Expense attributable to interest on any
Indebtedness (whether existing or being Incurred) computed on a pro forma
basis and bearing a floating interest rate shall be computed as if the rate
in effect on the Transaction Date (taking into account any Interest Rate
Agreement or Currency Agreement applicable to such Indebtedness if such
Interest Rate Agreement or Currency Agreement has a remaining term in
excess of 12 months or, if shorter, at least equal to the remaining term of
such Indebtedness) had been the applicable rate for the entire period;
(C) pro forma effect shall be given to Asset Dispositions and Asset
Acquisitions (including giving pro forma effect to the application of
proceeds of any Asset Disposition) that occur during such Reference Period
as if they had occurred and such proceeds had been applied on the first day
of such Reference Period; and
(D) pro forma effect shall be given to asset dispositions and asset
acquisitions (including giving pro forma effect to the application of
proceeds of any asset disposition) that have been made by any Person that
has become a Restricted Subsidiary or has been merged with or into Knowles
Electronics Holdings or any Restricted Subsidiary during such Reference
Period and that would have constituted Asset Dispositions or Asset
Acquisitions had such transactions occurred when such Person was a
Restricted Subsidiary as if such asset dispositions or asset acquisitions
were Asset Dispositions or Asset Acquisitions that occurred on the first
day of such Reference Period;
provided that to the extent that clause (C) or (D) of this sentence requires
that pro forma effect be given to an Asset Acquisition or Asset Disposition,
such pro forma calculation shall be based upon the four full fiscal quarters
immediately preceding the Transaction Date of the Person, or division or line of
business of the Person, that is acquired or disposed for which financial
information is available. In addition, to the extent that clauses (C) and (D) of
the preceding sentence require that pro forma effect be given to an asset
acquisition, the Consolidated EBITDA of the acquired entities shall be included
after giving effect to cost savings resulting from employee terminations,
facilities consolidations and closings, standardisation of employee benefits and
compensation practices, consolidation of property, casualty and other insurance
coverage and policies, standardisation of sales and other distribution methods,
reduction in taxes other than income taxes and other cost savings reasonably
expected to be realised from such acquisition, as determined in good faith by an
officer of Knowles Electronics Holdings, provided that such cost savings could
be reflected in pro forma financial statements under GAAP.
"Interest Rate Agreement" means any interest rate protection agreement,
interest rate future agreement, interest rate option agreement, interest rate
swap agreement, interest rate cap agreement, interest rate collar agreement,
interest rate hedge agreement, option or future contract or other similar
agreement or arrangement.
"Investment" in any Person means any direct or indirect advance, loan or
other extension of credit (including, without limitation, by way of Guarantee or
similar arrangement but excluding advances to customers in the ordinary course
of business that are, in conformity with GAAP, recorded as accounts receivable
on the balance sheet of Knowles Electronics Holdings or its Restricted
Subsidiaries) or capital contribution to (by means of any transfer of cash or
other property to others or any payment for property or services for the account
or use of others), or any purchase or acquisition of Capital Stock, bonds,
notes, debentures or other similar instruments issued by, such Person and shall
include:
(1) the designation of a Restricted Subsidiary as an Unrestricted
Subsidiary; and
(2) the retention of the Capital Stock (or any other Investment) by
Knowles Electronics Holdings or any of its Restricted Subsidiaries, of (or
in) any Person that has ceased to be a Restricted Subsidiary, including
without limitation, by reason of any transaction permitted by clause (3) of
the "Limitation on the Issuance and Sale of Capital Stock of Restricted
Subsidiaries" covenant.
For purposes of the definition of "Unrestricted Subsidiary" and the "Limitation
on Restricted Payments" covenant, (1) "Investment" shall include the fair market
value of the assets (net of liabilities (other than liabilities to Knowles
Electronics Holdings or any of its Restricted Subsidiaries)) of any Restricted
Subsidiary at the time that such Restricted Subsidiary is designated an
Unrestricted Subsidiary, (2) the fair market value of the assets (net of
liabilities (other than liabilities to Knowles Electronics Holdings or any of
its Restricted Subsidiaries)) of any Unrestricted Subsidiary at the time that
such Unrestricted Subsidiary is designated a
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Restricted Subsidiary shall be considered a reduction in outstanding
Investments, (3) any property transferred to or from an Unrestricted Subsidiary
shall be valued at its fair market value at the time of such transfer and (4)
the amount of, or reduction in, an Investment shall be equal to the fair market
value thereof at the time such investment is made or reduced.
"IPO" means an initial registered public offering of Knowles Electronics
Holdings' common stock which is a primary offering.
"Issue Date" means October 1, 1999, the date on which the notes were
originally issued under the Indenture.
"Junior Subordinated Exchange Notes" means the junior subordinated exchange
notes of Knowles Electronics Holdings, substantially in the form annexed to
Knowles Electronics Holdings' Restated Certificate of Incorporation as in effect
on the Issue Date, that are subordinated in right of payment to the notes and
issued in exchange for the Series A-1 Preferred Stock of Knowles Electronics
Holdings.
"Lien" means any mortgage, pledge, security interest, encumbrance, lien or
charge of any kind (including, without limitation, any conditional sale or other
title retention agreement or lease in the nature thereof or any agreement to
give any security interest).
"Moody's" means Moody's Investors Service, Inc. and its successors.
"Net Cash Proceeds" means:
(a) with respect to any Asset Sale, the proceeds of such Asset Sale
in the form of cash or cash equivalents, including payments in respect of
deferred payment obligations (to the extent corresponding to the principal,
but not interest, component thereof) when received in the form of cash or
cash equivalents and proceeds from the conversion of other property
received when converted to cash or cash equivalents, net of (1) brokerage
commissions and other fees and expenses (including fees and expenses of
counsel, consultants and investment bankers) related to such Asset Sale,
(2) provisions for all taxes (whether or not such taxes will actually be
paid or are payable) as a result of such Asset Sale without regard to the
consolidated results of operations of Knowles Electronics Holdings and its
Restricted Subsidiaries, taken as a whole, (3) payments made to repay
Indebtedness or any other obligation outstanding at the time of such Asset
Sale that either (A) is secured by a Lien on the property or assets sold or
(B) is required to be paid as a result of such sale and (4) appropriate
amounts to be provided by Knowles Electronics Holdings or any Restricted
Subsidiary as a reserve against any liabilities associated with such Asset
Sale, including, without limitation, pension and other post-employment
benefit liabilities, liabilities related to environmental matters and
liabilities under any indemnification obligations associated with such
Asset Sale, all as determined in conformity with GAAP; and
(b) with respect to any issuance or sale of Capital Stock, the
proceeds of such issuance or sale in the form of cash or cash equivalents,
including payments in respect of deferred payment obligations (to the
extent corresponding to the principal, but not interest, component thereof)
when received in the form of cash or cash equivalents and proceeds from the
conversion of other property received when converted to cash or cash
equivalents, net of attorney's fees, accountants' fees, underwriters' or
placement agents' fees, discounts or commissions and brokerage, consultant
and other fees incurred in connection with such issuance or sale and net of
taxes paid or payable as a result thereof.
"Note Guarantees" means the Guarantees of the notes by the Subsidiary
Guarantors pursuant to the Indenture.
"Offer to Purchase" means an offer to purchase notes by Knowles Electronics
Holdings from the Holders commenced by mailing a notice to the Trustee and each
Holder stating:
(1) the covenant pursuant to which the offer is being made and that
all notes validly tendered will be accepted for payment on a pro rata
basis;
(2) the purchase price and the date of purchase (which shall be a
Business Day no earlier than 30 days nor later than 60 days from the date
such notice is mailed)(the "Payment Date");
(3) that any note not tendered will continue to accrue interest
pursuant to its terms;
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(4) that, unless Knowles Electronics Holdings defaults in the payment
of the purchase price, any note accepted for payment pursuant to the Offer
to Purchase shall cease to accrue interest on and after the Payment Date;
(5) that Holders electing to have a note purchased pursuant to the
Offer to Purchase will be required to surrender the note, together with the
form entitled "Option of the Holder to Elect Purchase" on the reverse side
of the note completed, to the Paying Agent at the address specified in the
notice prior to the close of business on the Business Day immediately
preceding the Payment Date;
(6) that Holders will be entitled to withdraw their election if the
Paying Agent receives, not later than the close of business on the third
Business Day immediately preceding the Payment Date, a telegram, facsimile
transmission or letter setting forth the name of such Holder, the principal
amount of notes delivered for purchase and a statement that such Holder is
withdrawing his election to have such notes purchased; and
(7) that Holders whose notes are being purchased only in part will be
issued new notes equal in principal amount to the unpurchased portion of
the notes surrendered; provided that each note purchased and each new note
issued shall be in a principal amount of $1,000 or integral multiples
thereof.
On the Payment Date, Knowles Electronics Holdings will:
(1) accept for payment on a pro rata basis notes or portions thereof
tendered pursuant to an Offer to Purchase;
(2) deposit with the Paying Agent money sufficient to pay the
purchase price of all notes or portions thereof so accepted; and
(3) deliver, or cause to be delivered, to the Trustee all notes or
portions thereof so accepted together with an Officers' Certificate
specifying the notes or portions thereof accepted for payment by Knowles
Electronics Holdings.
The Paying Agent shall promptly mail to the Holders of notes so accepted payment
in an amount equal to the purchase price, and the Trustee shall promptly
authenticate and mail to such Holders a new note equal in principal amount to
any unpurchased portion of the note surrendered; provided that each note
purchased and each new note issued shall be in a principal amount of $1,000 or
integral multiples thereof. The Trustee shall act as the Paying Agent for an
Offer to Purchase. Knowles Electronics Holdings will comply with Rule 14e-1
under the Exchange Act and any other securities laws and regulations thereunder
to the extent such laws and regulations are applicable, in the event that
Knowles Electronics Holdings is required to repurchase notes pursuant to an
Offer to Purchase.
"Permitted Investment" means:
(1) an Investment in Knowles Electronics Holdings or a Restricted
Subsidiary or a Person which will, upon the making of such Investment,
become a Restricted Subsidiary or be merged or consolidated with or into or
transfer or convey all or substantially all its assets to, Knowles
Electronics Holdings or a Restricted Subsidiary;
(2) Temporary Cash Investments;
(3) payroll, travel and similar advances to cover matters that are
expected at the time of such advances ultimately to be treated as expenses
in accordance with GAAP;
(4) stock, obligations or securities received in satisfaction of
judgments or investments received in connection with the bankruptcy or
reorganization of, or settlement of delinquent accounts and disputes with,
customers and suppliers, in each case in the ordinary course of business;
(5) an Investment in an Unrestricted Subsidiary consisting solely of
an Investment in another Unrestricted Subsidiary;
(6) Interest Rate Agreements, Commodities Agreements and Currency
Agreements designed solely to protect Knowles Electronics Holdings or its
Restricted Subsidiaries against fluctuations in interest rates, commodities
prices or foreign currency exchange rates;
(7) accounts receivable or other extensions of trade credit owing to
Knowles Electronics Holdings or a Restricted Subsidiary;
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(8) loans or advances to employees, officers or directors of Knowles
Electronics Holdings and its Restricted Subsidiaries in their capacity as
such, in an aggregate principal amount not to exceed $3 million at any one
time outstanding;
(9) Investments constituting non-cash proceeds of any sale, transfer
or other disposition made in accordance with the provisions of "Limitations
on Asset Sales" covenant;
(10) Investments permitted by the provisions of the "Limitation on
Transactions with Shareholders and Affiliates" Covenant other than those
permitted by clause (i) thereof; and
(11) other Investments in an aggregate principal amount not to exceed
$15 million at any one time outstanding.
"Public Equity Offering" means an underwritten primary public offering of
Common Stock of Knowles Electronics Holdings or, to the extent that net proceeds
are received by Knowles Electronics Holdings, any direct or indirect parent
holding company of Knowles Electronics Holdings, pursuant to an effective
registration statement under the Securities Act.
"Recapitalization" means the Recapitalization pursuant to the
Recapitalization Agreement pursuant to which Key Acquisition L.L.C. acquired
control of Knowles Electronics Holdings.
"Recapitalization Agreement" means the Recapitalization Agreement dated as
of June 23, 1999 among Key Acquisitions, L.L.C., Knowles Electronics Holdings
and the holders of Common Stock of Knowles Electronics Holdings named therein.
"Restricted Subsidiary" means any Subsidiary of Knowles Electronics
Holdings other than an Unrestricted Subsidiary.
"S&P" means Standard & Poor's Ratings Group, a division of The McGraw-Hill
Companies, and its successors.
"Senior Indebtedness" means the following obligations of Knowles
Electronics Holdings or any Subsidiary Guarantor, as the case may be, whether
outstanding on October 1, 1999 or thereafter Incurred:
(1) all Indebtedness and all other monetary obligations (including,
without limitation, expenses, fees, principal, interest, reimbursement
obligations under letters of credit and indemnities payable in connection
therewith) of Knowles Electronics Holdings or any Subsidiary Guarantor
under (or in respect of) the Credit Agreement or any Interest Rate
Agreement or Currency Agreement relating to the Indebtedness under the
Credit Agreement; and
(2) all other Indebtedness and all other monetary obligations related
thereto of Knowles Electronics Holdings (other than the notes) or any
Subsidiary Guarantor (other than the Note Guarantees), including principal
and interest on such Indebtedness, unless such Indebtedness, by its express
terms or by the express terms of any agreement or instrument pursuant to
which such Indebtedness is issued, is pari passu with, or subordinated in
right of payment to, the notes and the Note Guarantees;
provided that the term "Senior Indebtedness" shall not include (a) any
Indebtedness of Knowles Electronics Holdings or any Subsidiary Guarantor that,
when Incurred, was without recourse to Knowles Electronics Holdings or such
Subsidiary Guarantor, (b) any Indebtedness of Knowles Electronics Holdings or
any Subsidiary Guarantor to a Subsidiary of Knowles Electronics Holdings, or to
a joint venture in which Knowles Electronics Holdings or any Subsidiary
Guarantor has an interest, (c) any Indebtedness of Knowles Electronics Holdings,
to the extent not permitted by the "Limitation on Indebtedness" covenant or the
"Limitation on Senior Subordinated Indebtedness" covenant, (d) any repurchase,
redemption or other obligation in respect of Disqualified Stock, (e) any
Indebtedness to any employee of Knowles Electronics Holdings or any of its
respective Subsidiaries, (f) any liability for taxes owed or owing by Knowles
Electronics Holdings or any Subsidiary Guarantor or (g) any Trade Payables.
"Series A-1 Preferred Stock" means the Series A-1 Preferred Stock, par
value $.001 per share, of Knowles Electronics Holdings.
"Significant Subsidiary" means, at any date of determination, any
Restricted Subsidiary that, together with its Subsidiaries, (i) for the most
recent fiscal year of Knowles Electronics Holdings, accounted for more than 10%
of the consolidated revenues of Knowles Electronics Holdings and its Restricted
Subsidiaries or
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(ii) as of the end of such fiscal year, was the owner of more than 10% of the
consolidated assets of Knowles Electronics Holdings and its Restricted
Subsidiaries, all as set forth on the most recently available consolidated
financial statements of Knowles Electronics Holdings for such fiscal year.
"Stated Maturity" means:
(1) with respect to any debt security, the date specified in such
debt security as the fixed date on which the final installment of principal
of such debt security is due and payable; and
(2) with respect to any scheduled installment of principal of or
interest on any debt security, the date specified in such debt security as
the fixed date on which such installment is due and payable.
"Subsidiary" means, with respect to any Person, any corporation,
association or other business entity of which more than 50% of the voting power
of the outstanding Voting Stock is owned, directly or indirectly, by such Person
and one or more other Subsidiaries of such Person.
"Subsidiary Guarantors" means the subsidiaries of Knowles Electronics
Holdings that guarantee the notes.
"Temporary Cash Investment" means any of the following:
(1) direct obligations of the United States of America or any agency
thereof or obligations fully and unconditionally guaranteed or insured by
the United States of America or any agency thereof, maturing not more than
2 years after the date of acquisition;
(2) time deposit accounts, certificates of deposit, money market
deposits and bankers' acceptances maturing within one year of the date of
acquisition thereof issued by a bank or trust company which is organized
under the laws of the United States of America, any state thereof, the
District of Columbia or any foreign country recognized by the United States
of America, and which bank or trust company issues (or the parent of which
issues) commercial paper rated as described in clause (4) of this
definition and has capital, surplus and undivided profits of not less than
$500 million;
(3) repurchase obligations with a term of not more than 270 days for
underlying securities of the types described in clause (1) above entered
into with a bank or trust company meeting the qualifications described in
clause (2) above;
(4) commercial paper, maturing not more than 270 days after the date
of acquisition, issued by a corporation (other than an Affiliate of Knowles
Electronics Holdings) organized and in existence under the laws of the
United States of America, any state thereof, the District of Columbia or
any foreign country recognized by the United States of America with a
rating at the time as of which any investment therein is made up of "P-1"
(or higher) according to Moody's or "A-1" (or higher) according to S&P;
(5) securities with maturities of one year or less from the date of
acquisition issued or fully and unconditionally guaranteed by any state,
commonwealth or territory of the United States of America, or by any
political subdivision or taxing authority thereof, and rated at least "A"
by S&P or Moody's; and
(6) mutual funds 90% of whose assets are invested in any of the
foregoing.
"Trade Payables" means, with respect to any Person, any accounts payable or
any other indebtedness or monetary obligation to trade creditors created,
assumed or Guaranteed by such Person or any of its Subsidiaries arising in the
ordinary course of business in connection with the acquisition of goods or
services.
"Transaction Date" means, with respect to the Incurrence of any
Indebtedness by Knowles Electronics Holdings or any of its Restricted
Subsidiaries, the date such Indebtedness is to be Incurred and, with respect to
any Restricted Payment, the date such Restricted Payment is to be made.
"Unrestricted Subsidiary" means:
(1) any Subsidiary of Knowles Electronics Holdings that at the time
of determination shall be designated an Unrestricted Subsidiary by the
Board of Directors in the manner provided below; and
(2) any Subsidiary of an Unrestricted Subsidiary.
The Board of Directors may designate any Restricted Subsidiary (including any
newly acquired or newly formed Subsidiary of Knowles Electronics Holdings) to be
an Unrestricted Subsidiary unless such Subsidiary owns any Capital Stock of, or
owns or holds any Lien on any property of, Knowles Electronics Holdings or any
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Restricted Subsidiary; provided that (A) any Guarantee by Knowles Electronics
Holdings or any Restricted Subsidiary of any Indebtedness of the Subsidiary
being so designated shall be deemed an "Incurrence" of such Indebtedness and an
"Investment" by Knowles Electronics Holdings or such Restricted Subsidiary (or
both, if applicable) at the time of such designation; (B) either (1) the
Subsidiary to be so designated has total assets of $1,000 or less or (2) if such
Subsidiary has assets greater than $1,000, such designation would be permitted
under the "Limitation on Restricted Payments" covenant; and (C) if applicable,
the Incurrence of Indebtedness and the Investment referred to in clause (A) of
this proviso would be permitted under the "Limitation on Indebtedness" and
"Limitation on Restricted Payments" covenants.
The Board of Directors may designate any Unrestricted Subsidiary to be a
Restricted Subsidiary; provided that (1) no Default or Event of Default shall
have occurred and be continuing at the time of or after giving effect to such
designation and (2) all Liens and Indebtedness of such Unrestricted Subsidiary
outstanding immediately after such designation would, if Incurred at such time,
have been permitted to be Incurred (and shall be deemed to have been Incurred)
for all purposes of the Indenture. Any such designation by the Board of
Directors shall be evidenced to the Trustee by promptly filing with the Trustee
a copy of the Board Resolution giving effect to such designation and an
Officers' Certificate certifying that such designation complied with the
foregoing provisions.
"U.S. Government Obligations" means securities that are:
(1) direct obligations of the United States of America for the
payment of which its full faith and credit is pledged; or
(2) obligations of a Person controlled or supervised by and acting as an
agency or instrumentality of the United States of America the payment of which
is unconditionally guaranteed as a full faith and credit obligation by the
United States of America, which, in either case, are not callable or redeemable
at the option of the issuer thereof at any time prior to the Stated Maturity of
the notes, and shall also include a depositary receipt issued by a bank or trust
company as custodian with respect to any such U.S. Government Obligation or a
specific payment of interest on or principal of any such U.S. Government
Obligation held by such custodian for the account of the holder of a depository
receipt, provided that (except as required by law) such custodian is not
authorized to make any deduction from the amount payable to the holder of such
depository receipt from any amount received by the custodian in respect of the
U.S. Government Obligation or the specific payment of interest on or principal
of the U.S. Government Obligation evidenced by such depository receipt.
"Voting Stock" means with respect to any Person, Capital Stock of any class
or kind ordinarily having the power to vote for the election of directors,
managers or other voting members of the governing body of such Person.
"Wholly Owned" means, with respect to any Subsidiary of any Person, the
ownership of all of the outstanding Capital Stock of such Subsidiary (other than
any director's qualifying shares or Investments by foreign nationals mandated by
applicable law) by such Person or one or more Wholly Owned Subsidiaries of such
Person; provided, however, that Ruf electronics GmbH and Knowles Electronics
Taiwan, Ltd., respectively shall be deemed to be a Wholly Owned Subsidiary of
Knowles Electronics Holdings so long as Knowles Electronics Holdings or one or
more of its Wholly Owned Subsidiaries owns at least 95% of the outstanding
Capital Stock of Ruf electronics GmBH and Knowles Electronics Taiwan, Ltd.,
respectively (excluding from such calculation any director's qualifying shares
or investments by foreign nationals mandated by applicable law).
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REGISTRATION RIGHTS AGREEMENT
When we refer to Knowles Electronics Holdings in this section, we mean
Knowles Electronics Holding, Inc. and not its subsidiaries.
Knowles Electronics Holdings and the placement agents in the offering of
the initial notes entered into a registration rights agreement (the
"Registration Rights Agreement") concurrently with the issuance of the initial
notes. Pursuant to the Registration Rights Agreement, Knowles Electronics
Holdings is required to
-- use its best efforts to file with the Commission a registration
statement (the "Exchange Offer Registration Statement") relating to a
registered exchange offer for the initial notes under the Securities
Act and have the Exchange Offer Registration Statement remain
effective until the closing of the exchange offer,
-- commence the exchange offer promptly after the registration statement
has been declared effective by the Securities and Exchange
Commission,
-- use its best efforts to cause the exchange offer to be consummated no
later than 60 days after the effective date and
-- keep the registration statement effective for not less than 20
business days after the date on which notice of the exchange offer is
mailed to the holders of the initial notes, and Knowles Electronics
Holdings may, at its discretion, accept tenders after the date that
Knowles Electronics Holdings consummates the exchange offer.
The Registration Rights Agreement requires that if:
(1) because it would violate applicable law or applicable
interpretations thereof by the staff of the SEC, Knowles Electronics
Holdings is not permitted to effect the exchange offer;
(2) the exchange offer is not for any other reason consummated by
April 28, 2000; or
(3) the exchange offer has been completed and in the opinion of
counsel for the placement agents a Registration Statement must be filed and
a prospectus must be delivered by the placement agents in connection with
any offering and sale of initial notes,
then Knowles Electronics Holdings will use its best efforts to file with the SEC
as soon as practical following the occurrence of any of the foregoing events
listed under (1) through (3) a shelf registration statement (the "Shelf
Registration Statement") to cover resales of Transfer Restricted Securities (as
defined below) by such holders who satisfy certain conditions relating to the
provision of information in connection with the Shelf Registration Statement.
For purposes of the foregoing, "Transfer Restricted Securities" means each
initial note until
-- the date on which such initial note has been disposed of pursuant to
the Shelf Registration Statement,
-- the date on which such initial note has ceased to be outstanding or
-- the date on which such initial note is eligible to be sold to the
public pursuant to Rule 144(k) under the Securities Act.
If applicable, Knowles Electronics Holdings will use its reasonable best
efforts to have the Shelf Registration Statement declared effective by the SEC
as promptly as practicable after the filing thereof and to keep the Shelf
Registration Statement effective for a period of two years after the Issue Date
or such shorter period that will terminate when all of the registrable
securities covered by the Shelf Registration Statement have been sold pursuant
to the Shelf Registration Statement or cease to be outstanding.
Because the exchange offer had not yet been consummated and the Shelf
Registration Statement had not been declared effective, on April 28, 2000 the
interest rate on the initial notes increased by 0.5% per annum until the
exchange offer is consummated or the Shelf Registration Statement is declared
effective.
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The exchange offer being made hereby will satisfy the requirements of the
Registration Rights Agreement such that Knowles Electronics Holdings will no
longer be required to pay additional interest from the date the exchange offer
is consummated.
The Registration Rights Agreement also provides that Knowles Electronics
Holdings
-- make available for a period of 180 days after the consummation of the
exchange offer a prospectus meeting the requirements of the
Securities Act to any broker-dealer for use in connection with any
resale of any such exchange notes and
-- pay all expenses incident to the exchange offer (including the
expense of one counsel to the holders of the initial notes) and
jointly and severally indemnify holders of the initial notes
(including any broker-dealer) against certain liabilities, including
liabilities under the Securities Act. A broker-dealer which delivers
such a prospectus to purchasers in connection with such resales will
be subject to certain of the civil liability provisions under the
Securities Act and will be bound by the provisions of the
Registration Rights Agreement (including certain indemnification
rights and obligations).
Each holder of initial notes who wishes to exchange such initial notes for
exchange notes in the exchange offer is required to make certain
representations, including representations that
(1) any exchange notes to be received by it have been acquired in the
ordinary course of its business,
(2) it has no arrangement or understanding with any person to
participate in the distribution of the exchange notes,
(3) it is not an "affiliate" or "promoter" (as defined in Rule 405
under the Securities Act) of Knowles Electronics Holdings, or if it is an
affiliate, that it will comply with the registration and prospectus
delivery requirements of the Securities Act to the extent applicable and
(4) if it is a broker-dealer, it will deliver a prospectus in
connection with any resale of the exchange notes.
Holders of the initial notes are required to make certain representations
to Knowles Electronics Holdings (as described above) in order to participate in
the exchange offer and will be required to deliver information to be used in
connection with the Shelf Registration Statement in order to have their initial
notes included in the Shelf Registration Statement and benefit from the
provisions regarding liquidated damages set forth in the preceding paragraphs. A
holder who sells initial notes pursuant to the Shelf Registration Statement
generally will be required to be named as a selling securityholder in the
related prospectus and to deliver a prospectus to purchasers, will be subject to
certain of the civil liability provisions under the Securities Act in connection
with such sales and will be bound by the provisions of the Registration Rights
Agreement which are applicable to such a holder (including certain
indemnification obligations).
The Registration Rights Agreement is included as an exhibit to the
Registration Statement and you should read it in its entirety.
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UNITED STATES FEDERAL TAX CONSIDERATIONS FOR NON-U.S. HOLDERS
The following is a general discussion of certain United States federal
income and estate tax considerations relating to the ownership and disposition
of notes by a person that is not a "United States person" for United States
federal income tax purposes (a "Non-U.S. Holder"). A "United States person" is a
citizen or resident of the United States, a corporation, partnership or other
entity created or organized in or under the laws of the United States or any
political subdivision thereof, an estate the income of which is subject to
United States federal income taxation regardless of its source or a trust if (1)
a U.S. court is able to exercise primary supervision over the trust's
administration and (2) one or more United States persons have the authority to
control all of the trust's substantial decisions. This discussion is based on
provisions of the Internal Revenue Code of 1986, as amended, Treasury
regulations issued thereunder and interpretations thereof as of the date hereof,
all of which are subject to change. In addition, the discussion does not
consider specific facts and circumstances that may be relevant to a particular
non-U.S. holder's tax position. Accordingly, each non-U.S. holder is urged to
consult its own tax advisor with respect to the United States tax consequences
of the ownership and disposition of notes, as well as any tax consequences that
may arise under the laws of any state, municipality, foreign country or other
taxing jurisdiction.
Payments on a note by Knowles or the Trustee to a Non-U.S. Holder will not
be subject to withholding of United States federal income tax, provided that,
with respect to payments of interest, (1) the holder does not actually or
constructively own 10 percent or more of the combined voting power of all
classes of stock of Knowles and is not a controlled foreign corporation related
to Knowles through stock ownership and (2) the beneficial owner provides a
statement signed under penalties of perjury (generally on IRS Form W-8 or Form
W-8BEN) that includes its name and address and certifies that it is a Non-U.S.
Holder in compliance with applicable requirements (or, with respect to payments
made after December 31, 2000, satisfies certain documentary evidence
requirements for establishing that it is a Non-U.S. Holder). If a Non-U.S.
Holder does not satisfy the foregoing conditions, payments of interest on any
notes held by such Non-U.S. Holder will be subject to withholding tax at a rate
of 30 percent, unless (a) the Non-U.S. Holder qualifies for the benefits of an
income tax treaty that provides an exemption or a lower rate or (b) the interest
income is effectively connected with a U.S. trade or business conducted by the
Non-U.S. Holder.
A Non-U.S. Holder will not be subject to United States federal income tax
on gain realized on the sale, exchange or redemption of a note, unless (1) such
gain is effectively connected with the conduct by the holder of a trade or
business in the United States or (2) in the case of gain realized by an
individual holder, the holder is present in the United States for 183 days or
more in the taxable year of the sale and either (A) such gain or income is
attributable to an office or other fixed place of business maintained in the
United States by such holder or (B) such holder has a tax home in the United
States.
A note will not be included in the estate of a holder who is not a citizen
or resident of the United States for U.S. federal estate tax purposes, provided
that such holder did not at the time of death actually or constructively own 10
percent or more of the combined voting power of all classes of stock of Knowles
and, at the time of such holder's death, payments of interest on such note would
not have been effectively connected with the conduct by such holder of a trade
or business in the United States.
United States information reporting requirements and backup withholding tax
will not apply to payments on a note owned by a Non-U.S. Holder if the statement
described in clause (2) of the second paragraph of this section is duly provided
to the Trustee. Backup withholding tax is not an additional tax and may be
refunded (or credited against the Non-U.S. Holder's U.S. federal income tax
liability, if any), provided that certain required information is furnished.
With respect to payments made after December 31, 2000, for purposes of
applying the rules set forth under this heading "United States Federal Tax
Considerations for Non-U.S. Holders" to an entity that is treated as fiscally
transparent (e.g., a partnership) for U.S. federal income tax purposes, the
beneficial owner means each of the ultimate beneficial owners of the entity.
103
<PAGE> 104
PLAN OF DISTRIBUTION
Each broker-dealer that receives exchange notes for its own account
pursuant to the exchange offer in exchange for existing notes that were acquired
by it as a result of market-making activities or other trading activities may be
deemed to be an "underwriter" within the meaning of the Securities Act and must
acknowledge that it will deliver a prospectus in connection with any resale of
such exchange notes. This prospectus, as it may be amended or supplemented from
time to time, may be used by a broker-dealer in connection with resales of
exchange notes received in exchange for initial notes where such initial notes
were acquired as a result of market-making activities or other trading
activities. Knowles Electronics Holdings has agreed that, for a period of 180
days after the expiration date, it will make this prospectus, as amended or
supplemented, available to any broker-dealer for use in connection with any such
resale. In addition, until April 17, 2001, all dealers effecting transactions in
the exchange notes may be required to deliver a prospectus.
Knowles will not receive any proceeds from any sale of exchange notes by
broker-dealers. Exchange notes received by broker-dealers for their own account
pursuant to the exchange offer may be sold from time to time in one or more
transactions in the over-the-counter market, in negotiated transactions, through
the writing of options on the exchange notes or a combination of such methods of
resale, at market prices prevailing at the time of resale, at prices related to
such prevailing market prices or at negotiated prices. Any such resale may be
made directly to purchasers or to or through brokers or dealers who may receive
compensation in the form of commissions or concessions from any such
broker-dealer or the purchasers of any such exchange notes. Any broker-dealer
that resells exchange notes that were received by it for its own account
pursuant to the exchange offer and any broker or dealer that participates in a
distribution of such exchange notes may be deemed to be an "underwriter" within
the meaning of the Securities Act and any profit on any such resale of exchange
notes and any commission or concessions received by any such person may be
deemed to be underwriting compensation under the Securities Act. The letter of
transmittal states that, by acknowledging that it will deliver and by delivering
a prospectus, a broker-dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act.
For a period of 180 days after the expiration date, Knowles Electronics
Holdings will promptly send additional copies of this prospectus and any
amendment or supplement to this prospectus to any broker-dealer that requests
such documents in the letter of transmittal. Knowles Electronics Holdings has
agreed to pay all expenses incident to the exchange offer (including the
expenses of one counsel for the holders of the initial notes) other than
commissions or concessions of any broker-dealers and will indemnify the holders
of the initial notes (including any broker-dealers) against certain liabilities,
including liabilities under the Securities Act.
LEGAL MATTERS
The validity of the notes will be passed upon for Knowles by Cleary,
Gottlieb, Steen & Hamilton, New York, New York.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements at December 31, 1999 and 1998, and for each of the three
years in the period ended December 31, 1999 as set forth in their report. We
have included our financial statements in the prospectus and elsewhere in the
registration statement in reliance on Ernst & Young LLP's report given on their
authority as experts in accounting and auditing.
104
<PAGE> 105
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors.............................. F-2
Consolidated Balance Sheets as of December 31, 1998 and
1999...................................................... F-3
Consolidated Statements of Operations for the Years Ended
December 31, 1997, 1998 and 1999.......................... F-4
Consolidated Statements of Changes in Stockholders' Equity
(Deficit) for the Years Ended December 31, 1997, 1998 and
1999...................................................... F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1998 and 1999.......................... F-6
Notes to Consolidated Financial Statements.................. F-7
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS FOR THE SIX
MONTHS ENDED JUNE 30, 2000
Consolidated Balance Sheet as of June 30, 2000.............. F-22
Consolidated Statements of Operations for the Six Months
Ended June 30, 1999 and 2000.............................. F-23
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 1999 and 2000.............................. F-24
Notes to Consolidated Financial Statements.................. F-25
</TABLE>
F-1
<PAGE> 106
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders of
Knowles Electronics Holdings, Inc.
We have audited the accompanying consolidated balance sheets of Knowles
Electronics Holdings, Inc. as of December 31, 1999 and 1998, 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, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements 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, 1999 and 1998 and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1999 in conformity with generally accepted accounting
principles in the United States.
Ernst & Young LLP
March 29, 2000,
except for Note 4 as to which
the date is April 10, 2000
F-2
<PAGE> 107
KNOWLES ELECTRONICS HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1999 1998
--------- --------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 22,332 $ 5,594
Accounts receivable, less allowance for doubtful accounts
of $1,200 and $1,518................................... 43,412 39,629
Inventories............................................... 45,906 50,450
Prepaid expenses and other................................ 3,414 3,248
Net current assets of discontinued operations............. -- 41,364
--------- --------
Total current assets........................................ 115,064 140,285
Deferred income taxes....................................... -- 2,070
Property, plant, and equipment, at cost:
Land...................................................... 6,975 7,010
Buildings and improvements................................ 27,840 26,860
Machinery and equipment................................... 73,298 64,448
Furniture and fixtures.................................... 22,082 20,641
Construction in progress.................................. 3,637 7,044
--------- --------
133,832 126,003
Accumulated depreciation.................................. 74,943 65,629
--------- --------
58,889 60,374
Other assets, net........................................... 1,756 2,000
Deferred finance costs, net of accumulated amortization of
$4,750.................................................... 10,797 --
Net long-term assets of discontinued operations............. -- 60,944
--------- --------
Total assets................................................ $ 186,506 $265,673
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 8,237 $ 8,477
Income taxes.............................................. 1,541 4,352
Deferred income taxes..................................... 3,099 --
Accrued compensation and employee benefits................ 7,708 7,216
Accrued interest payable.................................. 8,370 --
Accrued warranty and rebates.............................. 7,575 4,706
Other liabilities......................................... 7,197 4,880
Current portion of notes payable.......................... 3,250 --
--------- --------
Total current liabilities................................... 46,977 29,631
Accrued pension liability................................... 9,231 6,945
Other noncurrent liabilities................................ 2,024 9,903
Notes payable............................................... 346,884 --
Preferred stock mandatorily redeemable in 2019 including
accumulating dividends of $9,250.......................... 194,250 --
Stockholders' equity (deficit):
Common stock, $1 par value, shares authorized and issued:
600,000 and 568,000, respectively at December 31,
1998................................................... -- 568
Common stock, Class A, $0.001 par value, 1,052,632 shares
authorized and 971,667 shares issued at December 31,
1999................................................... -- --
Common stock, Class B, $0.001 par value, 52,632 shares
authorized and none issued at December 31, 1999........ -- --
Capital in excess of par value............................ 15,223 17
Retained earnings (accumulated deficit)................... (424,550) 247,123
Accumulated other comprehensive income -- translation
adjustments............................................ (3,533) (1,206)
Less: Cost of 108,535 common shares in treasury............. -- 27,308
--------- --------
Total stockholders' equity (deficit)........................ (412,860) 219,194
--------- --------
Total liabilities and stockholders' equity (deficit)........ $ 186,506 $265,673
========= ========
</TABLE>
See accompanying notes.
F-3
<PAGE> 108
KNOWLES ELECTRONICS HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1999 1998 1997
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Net sales.................................................. $229,106 $234,899 $218,150
Cost of sales.............................................. 146,472 139,074 125,533
-------- -------- --------
Gross margin............................................... 82,634 95,825 92,617
Selling and administrative expense......................... 35,901 35,188 35,148
Research and development expense........................... 10,930 10,870 9,884
Recapitalization expense................................... 10,674 -- --
-------- -------- --------
Operating income........................................... 25,129 49,767 47,585
Other income (expense):
Interest income.......................................... 883 278 566
Interest expense......................................... (23,194) (634) (392)
Miscellaneous, net....................................... (123) (1,058) (1,455)
-------- -------- --------
Income from continuing operations before income taxes...... 2,695 48,353 46,304
Income taxes............................................... 8,980 7,107 9,856
-------- -------- --------
Income (loss) from continuing operations................... (6,285) 41,246 36,448
Income from discontinued operations less applicable income
taxes of $39, $106 and $103 in 1999, 1998 and 1997,
respectively............................................. 2,556 6,936 6,729
-------- -------- --------
Net income (loss).......................................... $ (3,729) $ 48,182 $ 43,177
======== ======== ========
Pro forma data (unaudited)(Note 1):
Pro forma income taxes................................... $ 19,125 $ 18,500 $ 11,600
======== ======== ========
Pro forma income (loss) from continuing operations
adjusted for income taxes............................. $(16,430) $ 29,853 $ 34,704
======== ======== ========
</TABLE>
See accompanying notes.
F-4
<PAGE> 109
KNOWLES ELECTRONICS HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
CAPITAL IN RETAINED COST OF ACCUMULATED
EXCESS OF EARNINGS COMMON OTHER
COMMON PAR (ACCUMULATED TREASURY COMPREHENSIVE
STOCK VALUE DEFICIT) SHARES INCOME TOTAL
------ ---------- ------------ -------- ------------- ---------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996........ $ 573 $ 17 $ 222,846 $(27,308) $ -- $ 196,128
Net income.......................... -- -- 43,177 -- -- 43,177
Other comprehensive income--Foreign
currency translation
adjustments....................... -- -- -- -- (2,811) (2,811)
---------
Comprehensive income................ -- -- -- -- -- 40,366
Dividends........................... -- -- (26,649) -- -- (26,649)
Other............................... (5) -- -- -- -- (5)
----- ------- --------- -------- ------- ---------
Balance at December 31, 1997........ 568 17 239,374 (27,308) (2,811) 209,840
Net income.......................... -- -- 48,182 -- -- 48,182
Other comprehensive income--Foreign
currency translation
adjustments....................... -- -- -- -- 1,605 1,605
---------
Comprehensive income................ -- -- -- -- -- 49,787
Dividends........................... -- -- (40,433) -- -- (40,433)
----- ------- --------- -------- ------- ---------
Balance at December 31, 1998........ 568 17 247,123 (27,308) (1,206) 219,194
Net loss............................ -- -- (3,729) -- -- (3,729)
Other comprehensive income--Foreign
currency translation
adjustments....................... -- -- -- -- (2,327) (2,327)
---------
Comprehensive loss.................. -- -- -- -- -- (6,056)
Other............................... -- -- (472) -- -- (472)
Issuance of common stock, Class A
and B, net........................ -- 15,223 -- -- -- 15,223
Repurchase, exchange and retirement
of common stock................... (511) (17) (531,344) -- -- (531,872)
Retirement of treasury stock........ -- -- (27,308) 27,308 -- --
Exchange of stock for assets........ (57) -- (74,759) -- -- (74,816)
Dividends........................... -- -- (34,061) -- -- (34,061)
----- ------- --------- -------- ------- ---------
Balance at December 31, 1999........ $ -- $15,223 $(424,550) $ -- $(3,533) $(412,860)
===== ======= ========= ======== ======= =========
</TABLE>
See accompanying notes.
F-5
<PAGE> 110
KNOWLES ELECTRONICS HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
--------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Income (loss) from continuing operations................... $ (6,285) $ 41,246 $ 36,448
Adjustments to reconcile income (loss) from continuing
operations to net cash provided by operating activities:
Depreciation and amortization............................ 12,638 11,235 10,348
Amortization of deferred financing fees and debt
discount.............................................. 4,818 -- --
Inventory obsolescence provision......................... 6,915 1,295 1,150
Change in assets and liabilities:
Accounts receivable................................... (3,783) (8,355) (2,093)
Inventories........................................... (2,371) (10,430) (7,315)
Other current assets.................................. 78 (2,766) 1,242
Deferred income taxes................................. 4,697 1,426 2,837
Accounts payable and other current liabilities........ 13,209 2,459 (1,264)
Other noncurrent liabilities.......................... (7,879) 1,695 (4,318)
Income taxes payable.................................. (2,811) (949) (1,742)
Net cash provided by discontinued operating activities..... 30,048 19,222 17,102
--------- -------- --------
Net cash provided by operating activities.................. 49,274 56,078 52,395
INVESTING ACTIVITIES
Purchases of property, plant, and equipment, net........... (14,500) (16,326) (12,129)
--------- -------- --------
Net cash used in investing activities...................... (14,500) (16,326) (12,129)
FINANCING ACTIVITIES
Dividends paid............................................. (24,811) (40,433) (38,969)
Payments on lines of credit................................ -- (1,300) (11,700)
Issuance of preferred stock and common stock,
Class A and B............................................ 190,594 -- --
Costs associated with equity transactions.................. (11,042) -- --
Payment of loan origination fees........................... (15,547) -- --
Debt proceeds.............................................. 350,066 -- --
Purchase of common stock................................... (508,315) -- --
--------- -------- --------
Net cash used in financing activities...................... (19,055) (41,733) (50,669)
Effect of exchange rate changes on cash.................... 1,019 169 (568)
--------- -------- --------
Net increase (decrease) in cash and cash equivalents....... 16,738 (1,812) (10,971)
Cash and cash equivalents at beginning of year............. 5,594 7,406 18,377
--------- -------- --------
Cash and cash equivalents at end of year................... $ 22,332 $ 5,594 $ 7,406
========= ======== ========
Cash paid for interest..................................... $ 10,014 $ 534 $ 442
========= ======== ========
Cash paid for taxes........................................ $ 6,141 $ 2,351 $ 2,418
========= ======== ========
</TABLE>
See Note 9 for discussion of non-cash financing and investing activities.
See accompanying notes.
F-6
<PAGE> 111
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31, 1999 AND 1998
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,
German, Hungarian, Chinese, Japanese, Malaysian, 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.
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, 1999, the liquidation value of the outstanding
Series A-1 Preferred Stock is $172,666 and the liquidation value of the
outstanding Series A-2 Preferred stock is $21,584.
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 percent per annum of the liquidated value
plus any accumulated dividends. Such dividends for the year ended December 31,
1999, amounted to $9,250. 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 having a value (calculated at the average price per
share at which Common Stock is sold in the initial public offering) equal to the
amount the shares being converted would have been entitled to receive had they
been mandatorily redeemed. 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 in part, 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.
On June 29, 1999, the Company distributed the equipment financing business
and certain real estate of the Company to certain preexisting stockholders in
exchange for 10% of the Common Stock (see Note 9). On
F-7
<PAGE> 112
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
June 30, 1999, the Company used the proceeds from the sale of the Preferred and
Common Stock in addition to funds obtained from a senior credit facility and
bridge notes (see Note 4) to finance the purchase of 90% of the remaining 90% of
the preexisting stockholders' common shares for $505,520. The Company also
agreed to pay a liability of $2,774 to the preexisting stockholders to reimburse
for certain tax implications of the Recapitalization. This amount represents an
additional cost of the common stock acquired from the preexisting stockholders,
subject to final purchase price adjustments. The preexisting stockholders also
exchanged their remaining shares for 100,000 shares of Common Stock and 20,556
shares of the newly authorized Series A-2 Preferred Stock.
The Recapitalization has been 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. The Company
incurred $13,927 of direct costs related to the purchases and sales of common
and preferred stock which have been charged to equity. The Company also incurred
expenses of $10,674 related to special bonuses and one-time recognition payments
to employees, termination expenses of a supplemental executive retirement plan,
and professional fees which are included as Recapitalization Expenses in the
Consolidated Statement of Operations.
After completion of the Recapitalization, the Investor's, preexisting
stockholders' and management's ownership percentage of the Company is
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 is subject to a post-closing
adjustment payable by the Company to the preexisting stockholders or by the
preexisting stockholders to the Investor. The amount of the post-closing
adjustment is currently under an arbitration proceeding as provided in the
purchase contract. In addition, the Company has agreed to indemnify the
preexisting stockholders for any damages they suffer as a result of any breach
of the various representations, warranties or agreements made by the Investor in
connection with the Recapitalization.
As a result of the Recapitalization, the Company terminated its S
Corporation status for federal income tax purposes effective June 30, 1999. For
informational purposes, the consolidated statements of operations include
unaudited pro forma information reflecting the income taxes which would have
been recorded if the Company had been a C Corporation during the periods
presented. This information was calculated using the Federal statutory rate in
effect in each period.
DESCRIPTION OF BUSINESS
The Company develops, manufactures, and supplies audio communications
components, primarily miniaturized electromagnetic microphones, and receivers
and ceramic and electric 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
automotive and industrial equipment and infrared remote control devices for the
consumer electronics market.
REVENUE RECOGNITION
Revenues from the Company's products are recognized when the products are
shipped, which is typically when title and the risks and rewards of ownership
transfer to the buyer.
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.
F-8
<PAGE> 113
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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.
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 or market. Cost is determined
using the first in, first out (FIFO) and last in, first out (LIFO) methods.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts reported in the Company's balance sheets for cash and
cash equivalents, trade accounts receivable and accounts payable, 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 $146,300 at
December 31, 1999.
DEPRECIATION
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 50 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.
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.
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
F-9
<PAGE> 114
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 1998, the Financial Accounting Standards Board issued Statement No.
133, Accounting for Derivatives Instruments and Hedging Activities, which is
required to be adopted in years beginning after June 15, 2000, but companies can
early adopt as of the beginning of any fiscal quarter. The new Statement
requires all derivatives to be recorded on the balance sheet at fair value. If
the derivative is a hedge, depending on the nature of the hedge, changes in the
fair value of the derivatives will either be offset against the changes in the
fair value of the hedged item through earnings, or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
Company expects to adopt this statement effective January 1, 2001. Management
does not anticipate that the adoption will have a material effect on the
Company's results of operations or on the financial position of the Company.
RECLASSIFICATIONS
Certain prior years' amounts have been reclassified to conform to the 1999
financial statement presentation.
2. INVENTORY
Inventories are as follows:
<TABLE>
<CAPTION>
1999 1998
------- -------
<S> <C> <C>
Raw materials............................................... $29,013 $28,775
Work in process............................................. 15,829 15,407
Finished goods.............................................. 15,537 16,549
------- -------
60,379 60,731
Less allowances for:
Adjustment to LIFO........................................ 2,362 4,036
Obsolescence and net realizable value..................... 12,111 6,245
------- -------
$45,906 $50,450
======= =======
</TABLE>
Approximately 52% and 50% of inventory is valued on the LIFO method at December
31, 1999 and 1998, respectively.
3. INCOME TAXES
Effective January 1, 1997, the stockholders of Knowles 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. Accordingly, Knowles was
generally not subject to federal income taxes effective January 1, 1997, and the
net deferred tax asset of $6,440 at December 31, 1996, was written off as a
charge to tax expense in 1997. Additionally, the LIFO recapture tax of $1,824
was recorded as a charge to tax expense in the income statement for the year
ended December 31, 1997.
As a result of the Recapitalization described in Note 1, the Company
terminated its S Corporation status effective June 29, 1999. Additionally,
deferred tax assets and liabilities were reinstated on a C Corporation basis as
of June 30, 1999. The reinstatement of the deferred taxes had no impact on the
overall tax provision as
F-10
<PAGE> 115
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
a full valuation allowance was established against the net deferred tax assets.
This resulted in net deferred tax assets and a corresponding valuation allowance
of $11,065 at June 30, 1999.
Income from continuing operations before income taxes consisted of the
following:
<TABLE>
<CAPTION>
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Domestic (U.S.)....................................... $(8,140) $32,639 $31,212
Foreign............................................... 10,835 15,714 15,092
------- ------- -------
$ 2,695 $48,353 $46,304
======= ======= =======
</TABLE>
A reconciliation of income tax expense from continuing operations to the
statutory federal rate of 35% was as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Statutory federal income tax expense................ $ 943 $16,923 $16,207
Effects of:
Income not subject to tax......................... (2,838) (11,423) (10,924)
State income taxes................................ 98 304 706
Foreign rate differential......................... (3,631) 1,303 (4,013)
Withholding taxes on unremitted foreign
earnings....................................... 3,142 -- --
Write off (establish) of net deferred tax asset... (11,065) -- 6,440
Valuation allowance............................... 24,310 -- --
Reduction of prior year taxes..................... (1,321) -- --
LIFO recapture tax................................ -- -- 1,824
Other, net........................................ (658) -- (384)
------- ------- -------
$ 8,980 $ 7,107 $ 9,856
======= ======= =======
</TABLE>
The income tax provision for the years ended December 31, 1999, 1998 and
1997, consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Current:
Federal.............................................. $ 207 $ -- $1,441
State................................................ 98 304 706
Foreign.............................................. 3,506 5,377 4,868
------ ------ ------
Total current.......................................... 3,811 5,681 7,015
Deferred............................................... 5,169 1,426 2,841
------ ------ ------
Total tax provision.................................... $8,980 $7,107 $9,856
====== ====== ======
</TABLE>
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.
F-11
<PAGE> 116
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Significant components of deferred tax assets and liabilities as of
December 31, 1999 and 1998, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1999 1998
-------- -------
<S> <C> <C>
Deferred tax assets:
Non-U.S. net operating loss carryforward.................. $ 5,856 $ 2,945
U.S. net operating loss carryforward...................... 4,692 --
Foreign tax credits carryforward.......................... 3,327 --
Pension................................................... 2,783 --
Inventory................................................. 2,065 --
Accrued expenses.......................................... 4,216 --
Other, net................................................ 1,851 608
-------- -------
Total deferred tax assets................................... 24,790 3,553
Deferred tax liabilities:
Withholding taxes on unremitted foreign earnings.......... (3,142) --
Other deferred tax liabilities............................ (437) (1,483)
-------- -------
Total deferred tax liabilities.............................. (3,579) (1,483)
Valuation allowance......................................... (24,310) --
-------- -------
Net deferred tax assets/(liabilities)....................... $ (3,099) $ 2,070
======== =======
</TABLE>
The Company had foreign net operating loss carryforwards of $10,647 and
$5,355 at December 31, 1999 and 1998, respectively, that have an indefinite
carryforward period. In 1999, the Company established a valuation allowance of
$6,303 related to these foreign NOL's as the Company determined based on their
future operating plan that the realizability of the benefit of such NOL's was
uncertain. In addition, the Company had U.S. federal and state net operating
loss carryforwards of $10,800 and $12,508, respectively, at December 31, 1999
that begin to expire in 2019. The Company's foreign tax credit carryforward of
$3,327 begins to expire in 2004. The Company has provided a valuation allowance
against these domestic NOLs and foreign tax credit carryforwards.
The Company's future operating plan is to repatriate all earnings not
needed for near term investment in that country. As a result, a substantial
portion of the unremitted earnings of the affected foreign subsidiaries are not
considered permanently reinvested at December 31, 1999. The December 31, 1999
deferred foreign provision includes a charge of $3,142 for the anticipated tax
liability on the unremitted foreign earnings which are not considered
permanently reinvested. The Company has no present intention of remitting
undistributed earnings of its foreign subsidiaries aggregating $20.2 million as
of December 31, 1999 and, accordingly, no deferred tax liability has been
established.
4. NOTES PAYABLE
As part of the Recapitalization transaction, the Company entered into a
senior credit agreement, dated June 28, 1999 and amended and restated as of July
21, 1999 and amended on December 23, 1999 and April 10, 2000, with certain
lenders ("Senior Credit Agreement"). The credit agreement consists of $250,000,
and provides for revolving loans of $50,000 (Revolving Credit Facility) for a
period of seven years, a Term A Facility of $50,000 (Term A Facility), which has
a maturity of seven years, and a Term B Facility of $150,000 (Term B Facility),
which has a maturity of eight years. 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 Notes).
F-12
<PAGE> 117
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Term A Facility and the Revolving Credit facility bear interest, at the
Company's option, at either (1) one-, two-, three-, or six-month LIBOR plus
2.50% or (2) the greater of the prime rate, a base certificate of deposit rate
plus 1.00%, or the federal funds effective rate plus 0.50% (the Alternate Base
Rate), in each case plus an initial margin of 1.50%. The rate in effect at
December 31, 1999 was 8.1%.
The Term B Facility bears interest, at the Company's option, at either (1)
one-, two-, three-, or six-month LIBOR plus 3.00% or (2) Alternate Base Rate
plus an initial margin on 2.00%. The rate in effect at December 31, 1999 was
8.6%.
The amendment to the Senior Credit Agreement dated April 10, 2000,
increased the interest rate spread for each of the Term A Facility, Revolving
Credit Facility and Term B Facility by 0.25%.
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 A Facility is due on June 30, 2006 and is payable in quarterly
installments during the following periods:
<TABLE>
<S> <C>
September 30, 2000 to June 30, 2001................. $1,250
September 30, 2001 to June 30, 2003................. 1,875
September 30, 2003 to June 30, 2006................. 2,500
</TABLE>
The Term B Facility is due on June 29, 2007 and is payable in quarterly
installments during the following periods:
<TABLE>
<S> <C>
September 30, 2000 to June 30, 2006................ $ 375
September 30, 2006 to June 29, 2007................ 35,250
</TABLE>
The Revolving Credit Facility is due on June 30, 2006. No amounts were
borrowed under this facility at December 31, 1999.
The balance under the Term A Facility, Term B Facility and the Senior
Subordinated Notes as of December 31, 1999 is as follows:
<TABLE>
<S> <C>
Term A facility................................... $ 50,000
Term B facility................................... 150,000
Senior Subordinated Notes, net of discount of
$3,066.......................................... 150,134
--------
350,134
Less: Current portion............................. 3,250
--------
Total long-term notes payable..................... $346,884
========
</TABLE>
The 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 intends to subsequently exchange all of the privately
placed Notes for a like amount of identical Notes registered with the Securities
and Exchange Commission. The 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 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 April 10,
2000 (the "Amendment") whereby the Company is in compliance with all its debt
covenants through the date of the
F-13
<PAGE> 118
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Amendment. As security for the obligations under the Senior Credit Agreement,
the Company has pledged all of the shares of its non-U.S. subsidiaries and has
granted the lenders a security interest in substantially all of its assets and
the assets of its U.S. subsidiaries.
The Notes are fully and 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, 1999 and 1998, and summarized income statement information for the
years ended December 31, 1999, 1998 and 1997. The column labeled "Parent
Company" represents the holding company for each of the Company's direct
subsidiaries which are guarantors of the Notes, all of which are wholly owned by
the parent company; and the column labeled "Nonguarantors" represents wholly
owned subsidiaries of the Guarantors and the parent company which are not
guarantors of the Notes. Pursuant to a contribution agreement effective August
30, 1999, Knowles Electronics, Inc., recognized in prior periods as the parent
company, contributed substantially all of its operating 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 Senior Credit Agreement and Subordinated Notes) to Knowles Electronics, LLC,
a newly created Delaware limited liability company. As a result of this
reorganization, Knowles Electronics, Inc., which changed its name to Knowles
Electronics Holdings, Inc., is now a holding company that does not conduct any
significant operations. Therefore, the 1999 presentation reflects the current
structure, which is not comparable to the other periods presented as some of the
amounts included in the Parent Company column in 1998 and 1997 are now included
in the Guarantors column in 1999. 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, 1999 and 1998 and for the three
years ended December 31, 1999, is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
------------------------------------------------------------------------
PARENT
COMPANY GUARANTORS NONGUARANTORS ELIMINATIONS CONSOLIDATED
--------- ---------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
ASSETS
Continuing operations:
Current assets............ $ 6,224 $ 68,373 $ 89,773 $(49,306) $ 115,064
Investments in and
advances to
subsidiaries........... 93,766 (44,539) -- (49,227) --
Noncurrent assets......... 10,798 28,908 32,203 (467) 71,442
--------- -------- -------- -------- ---------
$ 110,788 $ 52,742 $121,976 $(99,000) $ 186,506
========= ======== ======== ======== =========
LIABILITIES AND EQUITY
Current liabilities......... $ 14,326 $ 42,018 $ 37,624 $(46,991) $ 46,977
Noncurrent liabilities...... 541,135 7,252 4,182 (180) 552,389
Investments by and advances
from parent............... -- (4,039) 21,137 (17,098) --
Stockholders' equity
(deficit)................. (444,673) 7,511 59,033 (34,731) (412,860)
--------- -------- -------- -------- ---------
$ 110,788 $ 52,742 $121,976 $(99,000) $ 186,506
========= ======== ======== ======== =========
</TABLE>
F-14
<PAGE> 119
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31, 1998
------------------------------------------------------------------------
PARENT
COMPANY GUARANTORS NONGUARANTORS ELIMINATIONS CONSOLIDATED
--------- ---------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
ASSETS
Continuing operations:
Current assets............ $ 57,518 $ 9,386 $ 83,761 $(51,744) $ 98,921
Investments in and
advances to
subsidiaries........... 35,436 212 -- (35,648) --
Noncurrent assets......... 27,487 4,986 36,217 (4,246) 64,444
Discontinued operations..... 102,308 -- -- -- 102,308
--------- -------- -------- -------- ---------
$ 222,749 $ 14,584 $119,978 $(91,638) $ 265,673
========= ======== ======== ======== =========
LIABILITIES AND EQUITY
Current liabilities......... $ 30,570 $ 3,148 $ 49,486 $(53,573) $ 29,631
Noncurrent liabilities...... 12,055 1,548 2,488 757 16,848
Investments by and advances
from parent............... -- 8,213 27,435 (35,648) --
Stockholders' equity........ 180,124 1,675 40,569 (3,174) 219,194
--------- -------- -------- -------- ---------
$ 222,749 $ 14,584 $119,978 $(91,638) $ 265,673
========= ======== ======== ======== =========
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999
-----------------------------------------------------------------------
PARENT
COMPANY GUARANTORS NONGUARANTORS ELIMINATIONS CONSOLIDATED
-------- ---------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Net sales.................... $ 97,289 $ 74,745 $ 174,897 $(117,825) $ 229,106
Cost and expenses............ (85,627) (76,520) (168,169) 117,236 (213,080)
Net interest (expense)
income..................... (19,293) 263 (918) (2,363) (22,311)
-------- -------- --------- --------- ---------
Income (loss) from continuing
operations................. (7,631) (1,512) 5,810 (2,952) (6,285)
Income from discontinued
operations................. 2,556 -- -- -- 2,556
-------- -------- --------- --------- ---------
Net income (loss)............ $ (5,075) $ (1,512) $ 5,810 $ (2,952) $ (3,729)
======== ======== ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
------------------------------------------------------------------------
PARENT
COMPANY GUARANTORS NONGUARANTORS ELIMINATIONS CONSOLIDATED
--------- ---------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Net sales................... $ 135,810 $ 34,829 $ 171,612 $(107,352) $ 234,899
Cost and expenses........... (112,139) (29,159) (160,394) 108,395 (193,297)
Net interest (expense)
income.................... 873 51 (1,182) (98) (356)
--------- -------- --------- --------- ---------
Income from continuing
operations................ 24,544 5,721 10,036 945 41,246
Income from discontinued
operations................ 6,936 -- -- -- 6,936
--------- -------- --------- --------- ---------
Net income.................. $ 31,480 $ 5,721 $ 10,036 $ 945 $ 48,182
========= ======== ========= ========= =========
</TABLE>
F-15
<PAGE> 120
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
------------------------------------------------------------------------
PARENT
COMPANY GUARANTORS NONGUARANTORS ELIMINATIONS CONSOLIDATED
--------- ---------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Net sales................... $ 119,017 $ 36,159 $ 154,293 $ (91,319) $ 218,150
Cost and expenses........... (103,724) (29,706) (139,101) 90,655 (181,876)
Net interest (expense)
income.................... 1,374 (42) (1,211) 53 174
--------- -------- --------- --------- ---------
Income from continuing
operations................ 16,667 6,411 13,981 (611) 36,448
Income from discontinued
operations................ 6,729 -- -- -- 6,729
--------- -------- --------- --------- ---------
Net income (loss)........... $ 23,396 $ 6,411 $ 13,981 $ (611) $ 43,177
========= ======== ========= ========= =========
</TABLE>
5. OPERATING LEASES
The Company leases various manufacturing facilities and office space. Lease
terms are generally from two to four years. Future minimum payments under
operating leases with initial terms of one year or more are as follows:
<TABLE>
<S> <C>
2000........................................................ $2,253
2001........................................................ 1,127
2002........................................................ 520
2003........................................................ 350
2004........................................................ 301
Thereafter.................................................. 338
------
$4,889
======
</TABLE>
Rent expense was $2,385, $2,014 and $2,780 for the years ended December 31,
1999, 1998 and 1997, respectively.
6. RETIREMENT PLANS
The Company has several noncontributory defined benefit plans covering
approximately 60% of its U.S. employees. Benefits for salaried plans are
generally based on salary and years of service, while hourly plans are based
upon a fixed benefit rate in effect at retirement date and years of service. The
Company's funding of the
F-16
<PAGE> 121
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
plans is equal to the minimum contribution required by ERISA. The following
summarizes the activity related to the Company's domestic plans:
<TABLE>
<CAPTION>
1999 1998
------- -------
<S> <C> <C>
Change in benefit obligation:
Benefit obligation at beginning of year................ $56,554 $43,865
Service cost........................................... 2,548 2,590
Interest cost.......................................... 3,671 3,575
Actuarial loss (gain).................................. (7,551) 8,029
Benefits paid.......................................... (1,691) (1,505)
------- -------
Benefit obligation at end of year...................... 53,531 56,554
Change in plan assets:
Fair value of plan assets at beginning of year......... 55,337 48,297
Actual return on plan assets........................... 6,467 8,004
Employer contribution.................................. -- 541
Benefits paid.......................................... (1,691) (1,505)
------- -------
Fair value of plan assets at end of year............... 60,113 55,337
------- -------
Funded status.......................................... 6,582 (1,217)
Unrecognized actuarial gain............................ (15,267) (5,332)
Unrecognized transition asset.......................... (132) (397)
Unrecognized prior service cost........................ 1,565 1,899
------- -------
Net amount recognized.................................... $(7,252) $(5,047)
======= =======
Amounts recognized in the statement of financial position
consist of accrued benefit liability................... $(7,252) $(5,047)
======= =======
</TABLE>
<TABLE>
<CAPTION>
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Weighted-average assumption as of December 31:
Discount rate....................................... 7.50% 7.00% 7.00%
Expected return on plan assets...................... 8.00 8.00 8.00
Rate of compensation increase....................... 6.00 6.00 6.00
Components of net periodic benefit cost:
Service cost........................................ $ 2,548 $ 2,590 $ 1,778
Interest cost....................................... 3,671 3,575 2,803
Expected return on plan assets...................... (4,086) (3,818) (2,816)
Amortization of prior service cost.................. 333 333 333
Amortization of transitional asset.................. (265) (265) (265)
------- ------- -------
Net periodic benefit cost........................... $ 2,201 $ 2,415 $ 1,833
======= ======= =======
</TABLE>
The Company also has defined benefit plans covering certain of its foreign
employees. The accrued pension liability related to these plans was $1,979 and
$1,898 at December 31, 1999 and 1998, respectively. Deferred pension assets
related to these plans was $1,142 and $1,310 at December 31, 1999 and 1998,
respectively. The net periodic benefit cost related to these plans was $815,
$488 and $483 for the years ended December 31, 1999, 1998 and 1997,
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
F-17
<PAGE> 122
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 1999, 1998
and 1997 were $315, $319 and $320, respectively.
7. STOCK APPRECIATION RIGHTS PLAN FOR KEY EMPLOYEES
The Company had a Stock Appreciation Rights Plan for Key Employees (SAR
Plan). In connection with the Recapitalization of the Company at June 30, 1999,
the SAR Plan was terminated. During the six months ended June 30, 1999, the
Company paid $4,730 to the employees for the excess value of the Company's book
value per common share, as defined for all outstanding shares based upon the
value earned as of December 31, 1998. No amounts were expensed under the SAR
plan in 1999.
For the years ended December 31, 1999 and 1998, stock appreciation activity
under the SAR Plan was as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1999 1998
--------- ---------
(SHARES IN WHOLE NUMBERS)
<S> <C> <C>
Outstanding at beginning of year............................ 14,235 14,110
Granted..................................................... -- 300
Canceled.................................................... -- (75)
Exercised................................................... 14,235 (100)
------ ------
Outstanding at end of year.................................. -- 14,235
====== ======
</TABLE>
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.
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 computer telephony integration,
automotive communications and multi-media. The automotive component operating
segment designs, manufactures, and markets diesel engine solenoids, electronic
governors, and position sensors primarily for use in automobiles and trucks.
F-18
<PAGE> 123
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company uses the following financial information presented below to
assess performance and make resource allocation decisions:
<TABLE>
<CAPTION>
HEARING AID ACOUSTIC AND AUTOMOTIVE
COMPONENTS INFRARED TECHNOLOGY COMPONENTS TOTAL
----------- ------------------- ---------- --------
<S> <C> <C> <C> <C>
1999
Revenues from external customers....... $135,355 $32,311 $61,440 $229,106
Operating income....................... 38,682 1,293 (1,728) 38,247
1998
Revenues from external customers....... 134,103 31,588 69,208 234,899
Operating income....................... 40,410 5,388 7,456 53,254
1997
Revenues from external customers....... 121,911 24,884 71,355 218,150
Operating income....................... 40,260 4,412 7,048 51,720
</TABLE>
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, 1999, 1998 and 1997 were
$116,177, $115,669 and $94,974, respectively. Depreciation expense associated
with these assets was $7,462, $5,983 and $3,384 for the years ended December 31,
1999, 1998 and 1997, respectively. Total capital expenditures for the hearing
aid components operating segment and the acoustic and infrared technology
operating segment were $9,290, $12,048 and $7,380 for the years ended December
31, 1999, 1998 and 1997, respectively. The Company uses the specific
identification of costs and expenses. However, 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 also made based on their respective revenues.
The total assets of the automotive components business unit were $47,009,
$51,785 and $52,642 as of December 31, 1999, 1998 and 1997, respectively.
Depreciation expense associated with these assets was $5,087, $4,540 and $5,890
for the years ended December 31, 1999, 1998 and 1997, respectively. The total
capital expenditures for the automotive component business unit were $5,063,
$4,070 and $3,727 for the years ended December 31, 1999, 1998 and 1997.
Special charges of $8,900 were recorded in 1999 to increase reserves for
slow moving and obsolete inventory and our product warranty accrual. The special
charges effected the operating segments as follows: hearing aid components
$6,955, acoustic and infrared technology $537, and automotive components $1,408.
The increases in these reserves were primarily due to an increase in excess
inventory due to the introduction of non-competitive products, the support of
many old product models, a change in management's philosophy on disposal of slow
moving inventory and an increase in warranty claim experience due to extended
warranty periods.
F-19
<PAGE> 124
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following is a reconciliation of segment operating income and assets to
the Company's consolidated totals:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
PROFIT OR LOSS
Total operating income for reportable segments............. $ 38,247 $ 53,254 $ 51,720
Unallocated amount--Corporate overhead..................... (2,444) (3,487) (4,135)
Recapitalization expenses.................................. (10,674) -- --
-------- -------- --------
Total consolidated operating income........................ 25,129 49,767 47,585
Other expense.............................................. (22,434) (1,414) (1,281)
-------- -------- --------
Income from continuing operations before income taxes...... $ 2,695 $ 48,353 $ 46,304
======== ======== ========
ASSETS
Total assets for reportable segments....................... $163,186 $167,454 $147,616
Adjustment for actual foreign currency exchange rates and
other.................................................... 23,320 (4,089) (7,797)
Assets of discontinued operations.......................... -- 102,308 114,594
-------- -------- --------
Total consolidated assets.................................. $186,506 $265,673 $254,413
======== ======== ========
GEOGRAPHIC INFORMATION
Revenues (based on origination of product shipment)
United States............................................ $133,198 $136,743 $129,016
Germany.................................................. 29,539 36,973 36,584
Other geographic areas................................... 66,369 61,183 52,550
-------- -------- --------
$229,106 $234,899 $218,150
======== ======== ========
LONG-LIVED ASSETS
United States.............................................. $ 28,911 $ 28,599 $ 23,051
Germany.................................................... 4,519 6,291 6,616
Other geographic areas..................................... 27,215 27,484 24,179
-------- -------- --------
$ 60,645 $ 62,374 $ 53,846
======== ======== ========
</TABLE>
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 55%, 53%
and 52% of consolidated sales in 1999, 1998 and 1997, respectively. Revenues
from one customer of the hearing aid components business unit accounted for
approximately $25,804, $26,173 and $23,053 of consolidated revenues in 1999,
1998 and 1997, respectively.
9. DISCONTINUED OPERATIONS
On June 29, 1999, the day prior to the closing of the Recapitalization, the
Company distributed to certain preexisting stockholders the equipment financing
business of the Company and two pieces of real estate, with a net book value of
$74,759, in redemption of 10% of the stock owned by the stockholders (45,947
shares). This transaction was recorded at the net book value of the business
distributed with no gain recognized.
The net assets and operating results of the equipment financing business
have been reported separately as discontinued operations for all periods
presented. At December 31, 1998, net current and long-term assets of
discontinued operations consisted primarily of lending and finance assets.
F-20
<PAGE> 125
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Revenues, principally interest, loan fees, and lease income, were $3,053,
$8,232 and $8,037 in fiscal 1999, 1998 and 1997, respectively.
10. SUBSEQUENT EVENT
In March 2000, the Company approved a significant restructuring of its
operations which will entail the consolidation of worldwide operations by
outsourcing some activities currently performed in Itasca and Rolling Meadows,
Illinois. In addition, it will cease production at its United Kingdom, Taiwanese
and German manufacturing facilities. Production from those operations will be
moved to China, Malaysia and Hungary. Over the next twelve to eighteen months,
the Company expects to reduce its global workforce by about 20 percent. An
expense of $20 million related to these actions was recorded in March 2000.
F-21
<PAGE> 126
KNOWLES ELECTRONICS HOLDINGS, INC.
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30, 2000
--------------
(IN THOUSANDS)
<S> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 19,447
Accounts receivable....................................... 42,276
Inventories............................................... 45,323
Prepaid expenses and other................................ 6,027
---------
Total current assets........................................ 113,073
Property, plant and equipment, at cost:
Land...................................................... 6,968
Buildings and improvements................................ 27,055
Machinery and equipment................................... 68,648
Furniture and fixtures.................................... 22,527
Construction in progress.................................. 7,840
---------
Subtotal............................................. 133,038
Accumulated depreciation.................................. 74,383
---------
Net.................................................. 58,655
Other assets, net........................................... 1,947
Deferred finance costs, net................................. 10,541
---------
Total assets................................................ $ 184,216
=========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
Accounts payable.......................................... $ 8,405
Income taxes.............................................. 8,811
Deferred income tax....................................... 8,259
Accrued compensation and employee benefits................ 9,331
Accrued interest payable.................................. 18,276
Accrued warranty and rebates.............................. 2,748
Accrued restructuring costs............................... 3,282
Accrued recapitalization costs............................ 2,726
Other liabilities......................................... 2,399
Current portion of notes payable.......................... 6,500
---------
Total current liabilities................................... 70,737
Accrued pension liability................................... 11,115
Other noncurrent liabilities................................ 1,910
Notes payable............................................... 343,777
Preferred stock mandatorily redeemable in 2019, including
accumulating dividends of $18,500......................... 203,500
Stockholders' equity (deficit)
Common stock, Class A, $0.001 par value, 1,052,632 shares
authorized and
983,333 shares issued at June 30, 2000................. --
Common stock, Class B, $0.001 par value, 52,632 shares
authorized,
none ever issued....................................... --
Capital in excess of par value............................ 15,573
Retained earnings (accumulated deficit)................... (457,643)
Accumulated other comprehensive income -- translation
adjustment............................................. (4,753)
---------
Total stockholders' equity (deficit)........................ (446,823)
---------
Total liabilities and stockholders' equity (deficit)........ $ 184,216
=========
</TABLE>
See accompanying notes.
F-22
<PAGE> 127
KNOWLES ELECTRONICS HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------
2000 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Net sales................................................... $120,573 $114,112
Cost of sales............................................... 69,119 69,262
-------- --------
Gross margin................................................ 51,454 44,850
Selling expense............................................. 6,007 5,978
General and administrative expense.......................... 12,805 11,648
Research and development expense............................ 4,803 5,130
Recapitalization expenses................................... -- 10,674
Restructuring expense....................................... 20,094 --
-------- --------
Operating income............................................ 7,745 11,420
Other income (expense):
Interest income........................................... 546 496
Interest expense.......................................... (21,621) (29)
Miscellaneous, net........................................ -- (81)
-------- --------
Income (loss) from continuing operations before income
taxes..................................................... (13,330) 11,806
Income taxes................................................ (2,152) 1,985
-------- --------
Income (loss) from continuing operations.................... (15,482) 13,791
Income from discontinued operations less applicable income
taxes of $39.............................................. -- 2,556
-------- --------
Net income (loss)........................................... $(15,482) $ 16,347
======== ========
</TABLE>
See accompanying notes.
F-23
<PAGE> 128
KNOWLES ELECTRONICS HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------
2000 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
OPERATING ACTIVITIES
Income (loss) from continuing operations.................... $(15,482) $ 13,791
Adjustments to reconcile income (loss) from continuing
operations to
net cash provided by operating activities:
Depreciation and amortization.......................... 6,225 6,226
Restructuring costs.................................... 20,094 --
Amortization of deferred financing fees and debt
discount.............................................. 1,291 --
Inventory obsolescence provision....................... 416 2,956
Change in assets and liabilities:
Accounts receivable............................... 1,136 (2,223)
Inventories....................................... 167 (2,078)
Other current assets.............................. (2,504) 117
Deferred income taxes............................. (700) (2,205)
Accounts payable.................................. 168 (363)
Accrued restructuring costs....................... (1,818) --
Accrued interest payable.......................... (111) --
Other current liabilities......................... 1,692 7,334
Other noncurrent liabilities...................... 1,770 (7,668)
Income taxes payable.............................. 1,185 (1,686)
Net cash provided by discontinued operating activities...... -- 30,048
-------- --------
Net cash provided by operating activities................... 13,229 44,249
INVESTING ACTIVITIES
Purchases of property, plant, and equipment, net............ (7,448) (7,748)
-------- --------
Net cash used in investing activities....................... (7,448) (7,748)
FINANCING ACTIVITIES
Dividends paid.............................................. -- (24,811)
Issuance of preferred stock and common stock................ 700 190,594
Costs associated with equity transactions................... -- (11,628)
Debt proceeds............................................... -- 340,830
Purchase of common stock.................................... -- (508,315)
Price adjustment on previously purchased common stock....... (8,316) --
Costs associated with debt.................................. (892) --
Repurchase of common stock.................................. (350) --
-------- --------
Net cash used in financing activities....................... (8,858) (13,330)
Effect of exchange rate changes on cash..................... (108) (380)
-------- --------
Net increase (decrease) in cash and cash equivalents........ (2,885) 22,791
Cash and cash equivalents at beginning of year.............. 22,332 5,594
-------- --------
Cash and cash equivalents at end of period.................. $ 19,447 $ 28,385
======== ========
</TABLE>
See accompanying notes.
F-24
<PAGE> 129
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30, 2000 AND 1999
(UNAUDITED)
1. BASIS OF RECAPITALIZATION AND PRESENTATION
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 transaction (the
Recapitalization) closed on June 30, 1999.
On June 29, 1999, the Company distributed the equipment financing business
and certain real estate of the Company to certain preexisting stockholders in
exchange for 10% of the Common Stock. On June 30, 1999, the Company used the
proceeds from the sale of the preferred and common stock in addition to funds
obtained from a senior credit facility and bridge notes to finance the purchase
of 90% of the remaining 90% of the preexisting stockholders' common shares.
The Recapitalization has been 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.
The amount payable to the preexisting common stockholders for the
repurchase of their common stock in the Recapitalization was subject to a
post-closing adjustment. In June 2000, the arbitrator issued a ruling in the
dispute regarding the amount of the post-closing price adjustment payable by the
Company to the preexisting stockholders. As a result, the Company paid the
preexisting stockholders approximately $8.3 million of the $13.3 million price
adjustment originally proposed, plus $0.7 million in interest. The price
adjustment was recorded as a reduction to stockholders' equity.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of our management, all adjustments
(consisting of normal recurring accruals and an accrual for Restructuring
expenses described in Note 5) necessary for a fair presentation have been
included. The results for the six months ended June 30, 2000 do not necessarily
indicate the results that may be expected for the full year. For further
information, refer to the consolidated financial statements and footnotes
thereto included elsewhere herein for the year ended December 31, 1999.
During the six months ended June 30, 2000 and 1999, total comprehensive
income (loss) amounted to ($16,702) and $14,393, respectively.
F-25
<PAGE> 130
2. INVENTORY
Inventories are as follows:
<TABLE>
<CAPTION>
JUNE 30,
2000
-------------
<S> <C>
Raw materials............................................... $31,063
Work in process............................................. 13,136
Finished goods.............................................. 15,089
-------
59,288
Less allowances for:
Adjustment to LIFO..................................... 1,252
Obsolescence and net realizable value.................. 12,713
-------
$45,323
=======
</TABLE>
Approximately 51% of inventory is valued on the LIFO method at June 30,
2000.
3. NOTES PAYABLE
As part of the Recapitalization transaction, the Company entered into a
senior credit agreement, dated June 28, 1999 and amended and restated as of July
21, 1999 and amended on December 23, 1999 and April 10, 2000, with certain
lenders ("Senior Credit Agreement"). The credit agreement consists of $250,000,
which provides for revolving loans of $50,000 (Revolving Credit Facility) for a
period of seven years, a Term A Facility of $50,000 (Term A Facility), which has
a maturity of seven years, and a Term B Facility of $150,000 (Term B Facility),
which has a maturity of eight years. The Term A Facility and the Revolving
Credit facility bear interest, at the Company's option, at either (1) one-,
two-, three-, or six month LIBOR plus 2.50% or (2) the greater of the prime
rate, a base certificate of deposit rate plus 1.00%, or the federal funds
effective rate plus 0.50% (the Alternate Base Rate), in each case plus an
initial margin of 1.50%. The Term B Facility bears interest, at the Company's
option, at either (1) one-, two-, three-, or six-month LIBOR plus 3.00% or (2)
Alternate Base Rate plus an initial margin of 2.00%. The amendment to the Senior
Credit Agreement dated April 10, 2000, increased the interest rate spread for
each of the Term A Facility, Revolving Credit Facility and Term B Facility by
0.25%. At June 30, 2000, the weighted average interest rate was 9.0625% for the
Term A Facility and 9.75% for the Term B Facility.
The balance under the Term A Facility, Term B Facility and the Senior
Subordinated Notes as of June 30, 2000 is as follows:
<TABLE>
<S> <C>
Term A facility............................................. $ 50,000
Term B facility............................................. 150,000
Senior Subordinated Notes, net of discount of $2,923 150,277
--------
350,277
Less: Current portion....................................... 6,500
--------
Total Long-term notes payable............................... $343,777
========
</TABLE>
The 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 intends to subsequently exchange all of the privately
placed Notes for a like amount of identical Notes registered with the Securities
and Exchange Commission. The 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 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 April 10,
2000 ("the
F-26
<PAGE> 131
Amendment") whereby the Company is in compliance with all its debt covenants
through the date of the Amendment. As security for the obligations under the
Senior Credit Agreement the Company has pledged all of the shares of its U.S.
subsidiaries and 65% of the shares of its non-U.S. subsidiaries and has granted
the lenders a security interest in substantially all of its assets and the
assets of its U.S. subsidiaries.
The 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 June
30, 2000, and summarized income statement information for the six months ended
June 30, 2000 and 1999. The column labeled "Parent Company" represents the
holding company for each of the Company's direct subsidiaries which are
guarantors of the Notes, all of which are wholly owned by the parent company;
and the column labeled "Nonguarantors" represents wholly owned subsidiaries of
the Guarantors and the parent company which are not guarantors of the Notes.
Pursuant to a contribution agreement effective August 30, 1999, Knowles
Electronics, Inc., recognized in prior periods as the parent company,
contributed substantially all of its operating 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
Senior Credit Agreement and Subordinated Notes) to Knowles Electronics, LLC, a
newly created Delaware limited liability company. As a result of this
reorganization, Knowles Electronics, Inc., which changed its name to Knowles
Electronics Holdings, Inc., is now a holding company that does not conduct any
significant operations. Therefore, the June 30, 2000 presentation of summarized
income statement information reflects the current structure, which is not
comparable to the June 30, 1999 presentation as some of the amounts included in
the Parent Company column in 1999 are now included in the Guarantors column in
2000. 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 June 30, 2000 and for the six months ended
June 30, 2000 and 1999 is as follows:
<TABLE>
<CAPTION>
JUNE 30, 2000
--------------------------------------------------------------------
PARENT
COMPANY GUARANTORS NONGUARANTORS ELIMINATIONS CONSOLIDATED
------- ---------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Assets
Continuing operations:
Current assets................. $ 7,688 $ 63,352 $ 99,991 $ (57,958) $ 113,073
Investments in and advances to
subsidiaries................... 62,943 (12,126) 23 (50,840) --
Noncurrent assets.............. 10,842 27,174 33,858 (731) 71,143
--------- -------- -------- --------- ---------
$ 81,473 $ 78,400 $133,872 $(109,529) $ 184,216
========= ======== ======== ========= =========
Liabilities and equity
Current liabilities............ $ 17,645 $ 57,103 $ 50,836 $ (54,847) $ 70,737
Noncurrent liabilities......... 547,278 8,138 4,843 43 560,302
Investments by and advances
from parent.................... -- (5,318) 21,862 (16,544) --
Stockholders' equity
(deficit).................... (483,450) 18,477 56,331 (38,181) (446,823)
--------- -------- -------- --------- ---------
$ 81,473 $ 78,400 $133,872 $(109,529) $ 184,216
========= ======== ======== ========= =========
</TABLE>
F-27
<PAGE> 132
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 2000
-------------------------------------------------------------------
PARENT
COMPANY GUARANTORS NONGUARANTORS ELIMINATIONS CONSOLIDATED
------- ---------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Net sales............................ $ -- $87,502 $ 97,280 $(64,209) $120,573
Cost and expenses.................... (102) (79,484) (98,299) 62,905 (114,980)
Net interest (expense) income........ (21,459) 948 (482) (82) (21,075)
-------- ------- -------- -------- --------
Net income (loss).................... $(21,561) $ 8,966 $ (1,501) $ (1,386) $(15,482)
======== ======= ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1999
-------------------------------------------------------------------
PARENT
COMPANY GUARANTORS NONGUARANTORS ELIMINATIONS CONSOLIDATED
------- ---------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Net sales............................ $ 70,242 $17,024 $ 85,577 $(58,731) $114,112
Cost and expenses.................... (62,238) (16,717) (79,484) 57,651 (100,788)
Net interest (expense) income........ 1,048 (133) (418) (30) 467
-------- ------- -------- -------- --------
Income (loss) from continuing
operations......................... 9,052 174 5,675 (1,110) 13,791
Income from discontinued
operations......................... 2,556 -- -- -- 2,556
-------- ------- -------- -------- --------
Net income (loss).................... $ 11,608 $ 174 $ 5,675 $ (1,110) $ 16,347
======== ======= ======== ======== ========
</TABLE>
4. 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.
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 computer telephony integration,
automotive communications and multi-media. 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:
<TABLE>
<CAPTION>
ACOUSTIC AND
HEARING AID INFRARED AUTOMOTIVE
COMPONENTS TECHNOLOGY COMPONENTS TOTAL
----------- ------------ ---------- -----
<S> <C> <C> <C> <C>
SIX MONTHS ENDING JUNE 30, 2000
Revenues from external customers......... $71,880 $15,645 $33,048 $120,573
Operating income (loss).................. 16,228 920 (3,538) 13,610
Operating income excluding restructuring
expenses............................... 26,215 1,039 3,016 30,270
SIX MONTHS ENDING JUNE 30, 1999
Revenues from external customers......... $66,845 $14,686 $32,581 $114,112
Operating income......................... 22,218 576 848 23,642
</TABLE>
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 June 30, 2000 were $115,441. The Company uses
the specific identification of costs and expenses. However, due to the joint use
of assets by 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 also made based on their respective revenues. The
total assets of the automotive components business unit were $49,936 at June 30,
2000.
F-28
<PAGE> 133
The following is a reconciliation of segment operating income to the
Company's consolidated totals:
<TABLE>
<CAPTION>
SIX MONTHS ENDING
JUNE 30,
-----------------
2000 1999
---- ----
<S> <C> <C>
PROFIT OR LOSS
Total operating income for reportable segments.............. $ 13,610 $ 23,642
Unallocated amount -- corporate overhead.................... (5,865) (1,548)
Recapitalization expenses................................... -- (10,674)
-------- --------
Total consolidated operating income......................... 7,745 11,420
Other income (expense), primarily interest.................. (21,075) 386
-------- --------
Income (loss) from continuing operations before income
taxes..................................................... $(13,330) $ 11,806
======== ========
GEOGRAPHIC INFORMATION
Revenues (based on origination of product shipment)
United States............................................. $ 67,882 $ 67,728
Germany................................................... 13,635 16,175
Other geographic areas.................................... 39,056 30,209
-------- --------
$120,573 $114,112
======== ========
</TABLE>
5. RESTRUCTURING EXPENSES
The Company announced a major restructuring in March 2000, resulting in a
first quarter charge of $20.1 million. Under the restructuring plan, the Company
is consolidating 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.
The restructuring charge consists almost entirely of severance payments to
terminated employees and outplacements expenses. Through June 30, 2000, 325
positions have been eliminated of the 1,047 total positions that will be
eliminated in the restructuring and $1.8 million has been spent on severance and
outplacement costs of the $20.1 million that was accrued.
At the five facilities where production is being eliminated, the number of
positions being eliminated at each facility and the final production dates at
each facility are as follows: (1) Burgess Hill, United Kingdom; 148 positions;
June 2000, (2) Itasca, Illinois; 248 positions; September 2000, (3) Taipai,
Taiwan; 216 positions; March, 2001, (4) Rolling Meadows, Illinois; 26 positions;
March 2001, and (5) Hoenkirchen, Germany; 270 positions; September 2001. Over
the next 12 to 18 months these actions will reduce our global workforce by about
20%.
6. RECENTLY ISSUED ACCOUNTING GUIDANCE
In December 1999 the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements," which among other guidance clarifies certain conditions to be met
in order to recognize revenue. The Company does not expect the impact of this
new pronouncement to be material. The effect of any change will be reflected by
a cumulative effect of an accounting change as of January 1, 2000. In May 2000,
the SEC deferred the required effective date for implementation of SAB No. 101
until the fourth quarter of 2000.
F-29
<PAGE> 134
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER PERSON IS AUTHORIZED TO GIVE ANY INFORMATION OR
TO REPRESENT ANYTHING NOT CONTAINED IN THIS PROSPECTUS OR IN THE ACCOMPANYING
LETTER OF TRANSMITTAL. YOU MUST NOT RELY ON ANY UNAUTHORIZED INFORMATION OR
REPRESENTATIONS. THIS PROSPECTUS AND THE ACCOMPANYING LETTER OF TRANSMITTAL ARE
AN OFFER TO SELL OR TO BUY ONLY THE SECURITIES OFFERED HEREBY, BUT ONLY UNDER
CIRCUMSTANCES AND IN JURISDICTIONS WHERE IT IS LAWFUL TO DO SO. THE INFORMATION
CONTAINED IN THIS PROSPECTUS AND IN THE ACCOMPANYING LETTER OF TRANSMITTAL ARE
CURRENT ONLY AS OF THEIR RESPECTIVE DATES.
[KNOWLES LOGO]
UNTIL JANUARY 17, 2001 (THE 90TH DAY AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS THAT EFFECT TRANSACTIONS IN THESE SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS
IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
