SECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549

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FORM 10-K

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
COMMISSION FILE NUMBER: 333-48299

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SAUER-DANFOSS INC.(Exact name of registrant as specified in its charter)

|Delaware(State or other jurisdiction of incorporation or organization)                       |  | 36-3482074(I.R.S. Employer Identification No.)
|-------------------------------------------------------------------------------------------- |  | ----------------------------------------------
|250 Parkway Drive, Suite 270, Lincolnshire, Illinois(Address of principal executive offices) |  | 60069(Zip Code)                               

(515) 239-6000(Registrant's telephone number, including Area Code)

Securities
registered pursuant to Section 12(b) of the Act:

Common Stock, par value $0.01 per share
(Title of each class)

New York Stock ExchangeFrankfurt (Germany) Stock Exchange
(Name of each exchange on which registered)


Securities registered pursuant to Section 12(g) of the Act: None(Title of class)

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act):
Yes ý No o

The aggregate market value of the voting stock of the Registrant held by nonaffiliates at February 17, 2004, was $152,438,818. As of February 17,
2004, there were 47,432,268 shares of common stock, $0.01 par value, of the Registrant outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the annual meeting of stockholders to be held May 5, 2004 are incorporated by reference into Parts II and III.



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PART I

Item 1.    Business.



Sauer-Danfoss Inc., a U.S. Delaware corporation, and its predecessor organizations have been active in the mobile hydraulics industry since the 1960s.
Sauer-Danfoss is a global manufacturer of components and integrated hydraulic, electric, and electronic systems that generate, transmit, and control power in mobile equipment. Principal products are
hydrostatic transmissions, gear pumps and motors, orbital motors, hydrostatic steering units, proportional load-sensing valves, microprocessor controls, electric drives, and
electrohydraulics. The Company sells its products to original equipment manufacturers (OEMs) who use Sauer-Danfoss products to provide the hydraulic and electronic power for the propel, work, and
control functions of their vehicles. The Company's products are sold primarily to the construction, road building, agriculture, turf care, and specialty vehicle markets. The Company conducts its
business globally under the Sauer-Danfoss name.

The
Company exercised its option to acquire an additional 40 percent of the outstanding shares of Comatrol S.p.A during the second quarter 2003 for approximately
$10.3 million. With this purchase, the Company now owns 85 percent of Comatrol and has consolidated the financial results of the business for the last three quarters of 2003. Prior to
purchasing its controlling interest in Comatrol, the Company accounted for the results of its ownership interest under the equity method of accounting. The Company has the option to acquire the
remaining ownership interest (15 percent) in Comatrol for approximately 3.7 million euros, which equates to $4.7 million at December 31, 2003, using an exchange rate of
0.795 euros to the U.S. dollar. The option period runs from April 1, 2004 through April 30, 2004. Should the Company not elect to exercise this option, the minority owners of Comatrol
could exercise their option requiring the Company to acquire the remaining 15 percent of Comatrol for the amount
disclosed above. This put option period runs from May 1, 2004 through May 31, 2004. Should neither party exercise their respective options, all such options expire after May 31,
2004.

In
2003 the Company relocated the operations of its Sturtevant, Wisconsin, and West Branch, Iowa, locations to other existing facilities and outsourced certain processes to reduce costs
and increase efficiencies. The Company has also undertaken projects to reorganize its European sales and distribution operations, and to implement a common business system. See further discussion of
these projects in Management's Discussion and Analysis presented in Item 7.

In
connection with the closing of the West Branch location, accounting errors were identified which resulted in restating the 2002, 2001 and 2000 financial statement amounts. The errors
relate to an unreconciled account and unrecognized depreciation associated with a purchase accounting fair value adjustment related to fixed assets. Both originated in 2000 in connection with the
closing of the Racine, Wisconsin, facility and relocation of its operations to the West Branch location. The total impact of the restatement, net of tax, over the three-year period is
$1.6 million, or $0.04 per share. The restatement is not material to any one year. See Note 17 in the Notes to Consolidated Financial Statements for further discussion. The Company will
file an amended Form 10-Q for the third quarter of 2003 to reflect the restatement of the financial information for such period. The Company does not plan to file amended Forms 10-Q for the
first and second quarters of 2003 and does not plan to file amended Form 10-Ks or Form 10-Qs for 2002, 2001 and 2000.



The Company reports its operating segments based on its various product lines of Propel, Work Function and Controls. Propel products include hydrostatic
transmissions and related products that transmit the power from the engine to the wheel to propel a vehicle. Work Function products include steering motors as well as gear pumps and motors that
transmit power for the work functions of the

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vehicle.
Controls products include electrohydraulic controls, microprocessors, and valves that control and direct the power of a vehicle. Information about the Company's reportable segments defined by
product lines is set forth in Note 16 in the Notes to Consolidated Financial Statements on pages 69-71 of this report, and is incorporated herein by reference.



Information regarding the Company's principal products, by segment, and the business in general is presented below. Information regarding sales by the Company's
segments and geographic regions is set forth in Note 16 in the Notes to Consolidated Financial Statements on pages 69-71, and is incorporated herein by reference. No individual customer,
OEM or other, accounted for 10 percent or more of the Company's overall net sales for 2003.

Propel Segment

Hydrostatic Transmissions

Sauer-Danfoss designs, manufactures, and markets a range of closed circuit axial piston hydrostatic transmissions for the propulsion of mobile equipment in the
Americas, Europe, and Asia-Pacific region. High-power (typically over 50 HP) and medium-power (typically 25 to 50 HP) applications for hydrostatic transmissions manufactured by
the Company include construction and agricultural mobile equipment. Light-power (typically 15 to 25 HP) and bantam-power (typically under 15 HP) applications for hydrostatic transmissions manufactured
by the Company include light agricultural and turf care mobile equipment. The Company manufactures these hydrostatic transmissions at its facilities in Ames, Iowa; Lawrence, Kansas; Sullivan,
Illinois; Neumunster, Germany; Dubnica nad Vahom, Slovakia; Povazská Bystrica, Slovakia; Shanghai, China; and Osaka, Japan.

Work Function Segment

Gear Pumps and Motors

Sauer-Danfoss designs, manufactures, and markets custom-designed gear pumps, as well as a broad range of high-performance standard gear pumps and
motors. Gear pumps and motors are the most widely used type of mobile hydraulic pumps and motors in the industry. The Company manufactures gear pumps and motors at its Swindon, England; Lawrence,
Kansas; Bologna, Italy; and Povazská Bystrica, Slovakia facilities.

Open Circuit Piston Pumps

Sauer-Danfoss designs, manufactures, and markets custom-designed open circuit piston pumps used to transform mechanical power from the engine to hydraulic power
for the work function of the vehicle. The advantages of open circuit piston pumps compared to other types of pumps, such as vane or gear pumps, are the high degree of control within the work function
hydraulic system and the more efficient use of engine power. These products are designed and manufactured at facilities in Ames, Iowa, and Povazská Bystrica, Slovakia.

Low Speed High Torque Motors

Sauer-Danfoss designs, manufactures, and markets a complete line of geroller and gerotor motors at its Nordborg, Denmark, facility. These motors are used for both
the propel and work functions in all served markets.

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Steering Units

Sauer-Danfoss designs, manufactures, and markets hydrostatic steering units to customers throughout the world. The Company manufactures steering units in
Nordborg, Denmark, and Wroclaw, Poland. These steering units convert steering wheel motion into hydraulic flow and pressure to provide steering motion for agriculture tractors, combines, turf care,
and earthmoving equipment.

Controls Segment

Mobile Electronics

Sauer-Danfoss designs, manufactures, and markets electrohydraulic valves and electronic controls, including microprocessor-based controls and electronic sensors
through its electrohydraulics operations in the United States and Sweden and also designs electrohydraulic products in Germany, the United Kingdom, Italy, and Denmark. Electrohydraulic controls and
sensors integrate hydraulics, hydrostatic transmissions, and mechanical components with electronic controls and are used by OEMs of mobile equipment to control the Company's hydraulic systems,
as well as the hydraulic systems of other manufacturers. The electrohydraulic products bring together the propulsion and work functions by providing standard or custom-designed controls.

Additionally,
the Company designs and manufactures both alternating current (AC) and direct current (DC) electric motors, electronic motor controllers, inverters, and power units through
its Electric Drives operations in Denmark and Germany.

Control Valves

Sauer-Danfoss designs, manufactures and markets a variety of spool type control valves to meet its customers' needs, ranging from very sophisticated
electrohydraulic valves for highly sophisticated forestry and agricultural harvesting equipment, to very simple low cost valves for high volume agricultural tractors. These products are manufactured
in facilities located in Caxias do Sul, Brazil; Nordborg, Denmark; and Easley, South Carolina.

The
Company also designs, manufactures and markets a complete line of cartridge valves and hydraulic integrated circuits in facilities located in Reggio Emilia, Italy; Hillsboro, Oregon;
and Easley, South Carolina. Aerial lift platforms and road building equipment are examples of significant users of cartridge valves.

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Major Markets and Applications

|Construction and Road
Building                                                                                                                                                                                                                 |  | Agriculture                                                              |  | Turf Care                                                                                                                   |  | Specialty Vehicles                                                                                                                                                                                                                                                                         
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------ |  | --------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Chip spreaders
Concrete pumps
Concrete saws
Crawler dozers
Crawler loaders
Ditchers/trenchers
Excavators
Grinders
Landfill compactors
Oil distributors
Pavers
Planers
Rollers
Skid steer loaders
Transit mixers
Utility tractors
Wheel loaders |  | Combines
Cotton pickers
Detasselers
Seeders
Sprayers
Tractors
Windrowers |  | Commercial-wide area, walk-
    behind mowers
Commercial zero-turn mowers
General turf maintenance
Lawn and garden tractors |  | Fruit pickers
Industrial lift trucks
Logging equipment
Marine equipment
Mining equipment
Oil field equipment
Railway maintenance
Rough terrain fork lifts
Self-propelled boom aerial lifts
Self-propelled scissor aerial lifts
Snow groomers
Sweepers
Tree shakers
Truck and bus fan drives

General Characteristics

Sauer-Danfoss sells both standard and customized products, with most products being built to order. With respect to some of the most technologically demanding
vehicles, such as those used in forestry, construction, and road building, Sauer-Danfoss' engineers work closely with customers from design through manufacture of the final product, a cycle that can
take as long as four to six years for a major new machine.

Sauer-Danfoss
operates 25 manufacturing facilities in the Americas, Europe, and the Asia-Pacific region. The Company's decentralized manufacturing capabilities allow it to
adapt its products to local market needs and to provide flexibility to meet customer delivery requirements. In North America, the Company sells and distributes its products directly to large
OEMs and through independent distributors to smaller OEMs. In Europe, South America, and the Asia-Pacific region, the Company sells and distributes its products either
directly or through subsidiaries.

In
accordance with standard industry practice for the mobile equipment industry, the Company warrants its products to be free from defects in material and workmanship. The warranty
period varies from one to three years from the date of first use or date of manufacture, depending on the type of product or, in some cases, the application. The Company's warranty expense has been
less than 1.5 percent of net sales in each of the past three years.

Because
many of its products are designed and developed in conjunction with its customers' design teams to fit their specific needs and to minimize inventory levels, the Company
primarily manufactures products to order. The Company typically machines components with long lead times according to a sales forecast and machines certain unique components for specific customers
according to firm orders. Inventories at the Company's manufacturing sites consist primarily of raw materials and machined iron housings and components. Only small amounts of assembled finished units
are maintained in inventory at the manufacturing sites. Historically, inventories at the Company's sales locations consisted mainly of finished units manufactured specifically for distribution to
customers in those locations. As discussed in Management's Discussion and Analysis on page 15 of this report, the Company has begun the process to streamline its sales and distribution operations in
Europe to reduce expenses and improve customer

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service
and delivery. One result of this process will be to reduce the amount of inventory held at the sales and distribution operations.

The
Company does not normally accept orders subject to late delivery penalties. On occasion, the Company sells its products to government agencies, including those used for military
applications, but it does not design its products to meet specific government standards and usually only enters into contracts for the supply of commercial products. There are no government contracts
of material value to the Company.

Raw Materials

The Company purchases iron housings and components from various U.S., European, and Asian foundries. The principal materials used by the Company are iron, steel,
brass, and aluminum. All materials used by the Company are generally available from a number of sources in quantities sufficient to meet current requirements. The Company has in place a Global
Supplier Quality Program called "Partners in Quality" (PIQ) that is the primary program used by the Company to ensure that all suppliers meet the Company's quality expectations.

Patents, Trademarks, and Licenses

The Company owns or licenses rights to approximately 610 patents and trademarks relating to its business. While the Company considers its patents and trademarks
important in the operation of its business and in protecting its technology from being used by competitors, its business is not dependent on any single patent or trademark or group of related patents
or trademarks.

To
ensure worldwide availability of the Company's design of products, the Company has, in the past, licensed its technology to companies in certain countries. The Company currently has
one license agreement in place to manufacture or distribute its technology with the Sauer-Danfoss-Daikin LTD. joint venture in Japan.

Backlog

The amount of the Company's backlog is significant because, among other factors, customer orders have historically involved long lead times and specific model
types. At December 31, 2003 the Company's backlog (consisting of accepted but unfilled customer orders primarily scheduled for delivery during 2004) was $409 million as compared with
$383 million at December 31, 2002. However, orders can be canceled or rescheduled by customers. Thus, the level of orders currently in backlog could decline because of cancellation or
rescheduling. Additionally, the level of reported backlog can be impacted by currency translation fluctuations and acquisitions. Excluding the impact of currency and acquisition, backlog at
December 31, 2003 was $379 million. Customers' ordering patterns can also impact the level of reported backlog. For example, the Company's U.S. distributor customers are placing orders
with shorter lead times due to the Company's ability to fulfill such orders.

Competition

The mobile hydraulics industry is very competitive. Sauer-Danfoss competes based on technological product innovation, quality, and customer service. The Company
believes that long-term successful suppliers to mobile equipment manufacturers will be those companies that have the ability to capitalize on the changing needs of the industry by
providing technological innovation, shorter product development times, and reduced manufacturing lead times at globally competitive price levels.

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The closed circuit hydrostatic transmission market is highly concentrated and intensely competitive. There are a small number of manufacturers of hydrostatic
transmissions with which the Company competes worldwide that are not captive suppliers of OEMs. These include Bosch Rexroth AG, Eaton
Corporation, and Linde AG. In addition, the Company competes with alternative products, such as mechanical transmissions of other manufacturers.

The
Company competes with a number of smaller companies that typically offer a single, specialized product on a more limited geographic basis as a component of a closed circuit
hydrostatic transmission system.

In
terms of global supply of closed circuit hydrostatic transmissions, the Company believes it is the world leader in terms of product range, market share, and geographic coverage. Only
Bosch Rexroth AG offers similar geographic coverage.



The open circuit work function market is fragmented with a large number of suppliers of all types of products, including open circuit piston pumps, gear pumps and
motors, and with intensive competition on pricing at the component level. There are approximately ten major companies that compete on a global basis, including Bosch Rexroth AG, Parker Hannifin
Corporation, and Eaton Corporation, and in Japan, Kayaba and Kawasaki. The supply of standard gear pumps and motors is particularly fragmented with more than 50 companies worldwide in each respective
area. Most of these competitors have a limited product range and operate in a limited geographic market.



There are a limited number of competitors who can provide a complete line of low speed, high torque motors (LSHT). Competitors include Eaton Corporation, Bosch
Rexroth AG, White Hydraulics, Parker-Hannifin Corporation, and M&S Hydraulics. This market is extremely price-competitive, and is growing, providing Sauer-Danfoss opportunity to develop new products
to increase market share.



Hydrostatic steering units are provided to the market from the same competitors as LSHT motors (above) plus Ognibene. Sauer-Danfoss has the largest European
market share and a growing share
globally. As steering systems grow and needs expand, Sauer-Danfoss is providing electronic control of steering and complete electrical steering solutions to meet the growing demands of the steering
market. Today, Sauer-Danfoss believes that it leads the industry in this direction for steering technology.



In the mobile electronics market, which covers both propulsion and work function systems, there are few suppliers of propulsion system controls and only three are
worldwide competitors. The main competition in this area comes from major OEMs, who produce controls for their own use. In work function electrohydraulic valves, electronic sensors, and controls,
there is a wide range of niche suppliers in limited geographic markets. In recent years, larger companies have increasingly acquired these niche or regional suppliers and thereby have improved their
ability to offer integrated systems. The Company has closely watched the needs for electric drives grow in the low power market segments. With the Company's addition of alternating current (AC) and
direct current (DC) motors and controls it is now well equipped to serve our customers in these segments with either a hydraulic solution or an electric solution for their propel and work function
needs. The Company believes it is well positioned to establish itself as a

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technology
leader in the work function and propel segments, as there is no clearly established technology in this sector that is deemed to be an industry standard.



The control valve marketplace is fragmented with a large number of suppliers who are primarily focused on limited valve types or flow ranges. Sauer-Danfoss
provides a comprehensive line of both spool valves and cartridge valves to meet the specific needs of its customers. Competitors who provide partial lines include Eaton Corporation, Hydra-Force,
Sterling Hydraulics, Husco, Sun Hydraulics, Integrated Hydraulics, Walvoil, and Oil Control, plus many others. Complete global control valve line competitors are limited to Parker-Hannifin and Bosch
Rexroth AG.

Research and Development

The Company's research and development expenditures during 2003, 2002, and 2001 were approximately $43.5 million, $37.8 million, and
$38.1 million, respectively.

Environmental Matters

In all countries in which it operates, the Company is subject to environmental laws and regulations concerning emissions to air, discharge to waterways, and the
generation, handling, storage, transportation, treatment, and disposal of waste materials. These laws and regulations are constantly evolving, and it is impossible to predict accurately the effect
they will have on the Company in the future. The regulations are subject to varying and conflicting interpretations and implementation. In some cases, compliance can only be achieved by additional
capital expenditures. The Company cannot accurately predict what capital expenditures, if any, may be required to comply with applicable environmental laws and regulations in the future; however, the
Company does not currently estimate that any future capital expenditures for environmental control facilities will be material. The Company is not currently subject to any governmental remediation
order, nor is the Company aware of any environmental problems that would have a materially adverse effect on the Company.

Employees

As of December 31, 2003, 2002, and 2001 the Company had 7,200, 7,207, and 6,790 employees, respectively. Of its full time employees at December 31,
2003, approximately 2,300 were located in the Americas with the remaining located in Europe and Asia. From time to time, the Company also retains consultants, independent contractors, and temporary
and part-time workers.

Financial Information about Geographic Areas

Information regarding the Company's net sales and long-lived assets by geographic area is set forth in Note 16 in the Notes to Consolidated
Financial Statements on pages 69-71 of this report, and is incorporated herein by reference.

Available Information

The Company maintains an Internet Website and the address of that site is http://www.sauer-danfoss.com. The Company provides access to its annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to
Section 13(a) of the Securities Exchange Act of 1934 on its Internet website as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the
Securities and Exchange Commission.

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Item 2.    Properties.

Sauer-Danfoss Inc. conducts its manufacturing operations at 25 locations; eight in the United States, three each in Italy and Germany, two each in the
United Kingdom, Denmark, and Slovakia, and one each in Brazil, China, Japan, Poland, and Sweden. The Company leases approximately 15,000 square feet of office space in Lincolnshire, Illinois, where
its principal executive offices are located. The following table sets forth certain information relating to the Company's principal manufacturing facilities:

|Location      |                              | Segment that Uses the Facility |                            | Approx.
Area in
Sq. Ft. |           | Owned/Leased
|------------- | ---------------------------- | ------------------------------ | -------------------------- | ----------------------- | --------- | ------------
|United States |                              |                                |                            |                         |           |             
|              | Ames, Iowa                   |                                | Propel and Work Function   |                         | 330,000   |             
|              | LaSalle, Illinois            |                                | Propel                     |                         | 325,000   |             
|              | Freeport, Illinois           |                                | Propel                     |                         | 183,000   |             
|              | Lawrence, Kansas             |                                | Propel and Work Function   |                         | 162,000   |             
|              | Easley, South Carolina       |                                | Controls                   |                         | 184,000   |             
|              | Hillsboro, Oregon            |                                | Controls                   |                         | 60,000    |             
|              | Minneapolis, Minnesota       |                                | Controls                   |                         | 75,000    |             
|              | Sullivan, Illinois           |                                | Propel                     |                         | 176,000   |             
|South America |                              |                                |                            |                         |           |             
|              | Caxias do Sul, Brazil        |                                | Controls                   |                         | 29,000    |             
|Europe        |                              |                                |                            |                         |           |             
|              | Neumünster, Germany          |                                | Propel and Controls        |                         | 463,000   |             
|              | Berching, Germany            |                                | Controls                   |                         | 131,000   |             
|              | Kaiserslautern, Germany      |                                | Controls                   |                         | 8,500     |             
|              | Nordborg, Denmark            |                                | Work Function and Controls |                         | 680,000   |             
|              | Odense, Denmark              |                                | Controls                   |                         | 121,500   |             
|              | Wroclaw, Poland              |                                | Work Function              |                         | 41,000    |             
|              | Povazská Bystrica, Slovakia  |                                | Propel and Work Function   |                         | 351,500   |             
|              | Dubnica nad Váhom, Slovakia  |                                | Propel                     |                         | 236,000   |             
|              | Swindon, England             |                                | Work Function              |                         | 229,000   |             
|              | Stratford-upon-Avon, England |                                | Controls                   |                         | 5,000     |             
|              | Bologna, Italy               |                                | Work Function              |                         | 246,000   |             
|              | Cento, Italy                 |                                | Controls                   |                         | 3,500     |             
|              | Reggio Emilia, Italy         |                                | Controls                   |                         | 53,000    |             
|              | Älmhult, Sweden              |                                | Controls                   |                         | 20,000    |             
|Asia          |                              |                                |                            |                         |           |             
|              | Shanghai/Pudong, China       |                                | Propel                     |                         | 105,000   |             
|              | Osaka, Japan                 |                                | Propel                     |                         | 94,000    |             
|              |                              |                                |                            |                         |           |             
|              | Total                        |                                |                            |                         | 4,312,000 |             
|              |                              |                                |                            |                         |           |             

Item 3.    Legal Proceedings.

From time to time, the Company is involved in various legal matters considered normal in the course of its business. The Company intends to vigorously defend
against all such claims. It is the Company's policy to accrue for amounts related to these matters if it is probable that a liability has been incurred and an amount can be reasonably estimated.
Although the outcome of such matters cannot be predicted with certainty and no assurances can be given with respect to such matters, the Company believes that the outcome of these matters in which it
is currently involved will not have a materially adverse effect on its results of operations, liquidity, or financial position.

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

The Company did not submit any matter to a vote of security holders, through a solicitation of proxies or otherwise, during the fourth quarter of 2003.

EXECUTIVE OFFICERS OF THE COMPANY

The following table sets forth certain information regarding the executive officers of the Company:

|Name                    |  | Age |  | Position                                                        |  | Year
Appointed
|----------------------- |  | --- |  | --------------------------------------------------------------- |  | --------------
|Klaus H. Murmann (1)(2) |  | 72  |  | Chairman                                                        |  | 1989          
|Joergen M. Clausen (3)  |  | 55  |  | Vice Chairman                                                   |  | 2000          
|David J. Anderson (1)   |  | 56  |  | President and Chief Executive Officer                           |  | 2000          
|Hans J. Cornett (4)     |  | 53  |  | Executive Vice President  Sales and Marketing                  |  | 2000          
|Karl J. Schmidt (5)     |  | 50  |  | Executive Vice President and Chief Financial Officer, Treasurer |  | 2002          
|James R. Wilcox (6)     |  | 58  |  | Executive Vice President and Chief Operating Officer            |  | 2000          
|Ron Hanson (7)          |  | 41  |  | Vice President  Human Resources                                |  | 2003          
|Thomas K. Kittel (1)    |  | 55  |  | Vice President  Propel Products                                |  | 2000          
|Henrik Krabsen (4)      |  | 42  |  | Vice President  Valves                                         |  | 2000          
|Finn Lyhne (4)          |  | 49  |  | Vice President  Work Function Products                         |  | 2000          
|Kenneth D. McCuskey (1) |  | 49  |  | Vice President and Chief Accounting Officer, Secretary          |  | 2000          
|Albert Zahalka (8)      |  | 52  |  | Vice President  Mobile Electronics                             |  | 2000          

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PART II

Item 5.    Market for the Company's Common Stock and Related Stockholder Matters.



The Company's Common Stock is traded on the New York Stock Exchange and the Frankfurt (Germany) Stock Exchange. As of February 25, 2004, there were
approximately 220 stockholders of record.

The
Company is currently paying a quarterly dividend of $0.07 per share, which is subject to Board of Directors approval.

The
following table sets forth the high and low prices on the New York Stock Exchange for the Company's Common Stock since January 1, 2002, and the quarterly cash dividends paid
in 2003 and 2002:

1st

2nd

3rd

4th

Full
Year2003High

$
9.58

$
11.90

$
15.16

$
16.97

$
16.97Low

$
7.44

$
7.55

$
10.18

$
13.40

$
7.44Dividends

$
0.07

$
0.07

$
0.07

$
0.07

$
0.282002High

$
11.72

$
12.75

$
11.16

$
9.45

$
12.75Low

$
7.55

$
9.58

$
8.79

$
7.25

$
7.25Dividends

$
0.07

$
0.07

$
0.07

$
0.07

$
0.28


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Item 6.    Selected Financial Data.

SELECTED FINANCIAL DATA

|                                            |                      | 2003 |         | 2002 (1) |   | 2001 (1) |       | 2000 (1)(2) |       | 1999   |  
|------------------------------------------- | -------------------- | ---- | ------- | -------- | - | -------- | ----- | ----------- | ----- | ------ | -
|
|Operating Data:                             |                      |      |         |          |   |          |       |             |       |        |  
|Net sales                                   |                      | $    | 1,126.8 |          | $ | 952.3    |       | $           | 855.3 |        | $
|Gross profit                                |                      |      | 252.4   |          |   | 219.0    |       |             | 192.6 |        |  
|Selling, general and administrative         |                      |      | 156.7   |          |   | 128.6    |       |             | 122.8 |        |  
|Research and development                    |                      |      | 43.4    |          |   | 37.8     |       |             | 38.1  |        |  
|Loss on disposal of fixed assets            |                      |      | 5.3     |          |   | 0.4      |       |             | 0.6   |        |  
|Total operating expenses                    |                      |      | 205.4   |          |   | 166.8    |       |             | 161.5 |        |  
|Total interest expense, net                 |                      |      | 17.4    |          |   | 17.2     |       |             | 17.4  |        |  
|Net income                                  |                      |      | 11.2    |          |   | 13.7     |       |             | 4.3   |        |  
|Per Share Data:                             |                      |      |         |          |   |          |       |             |       |        |  
|Income per common share, basic and diluted  |                      | $    | 0.24    |          | $ | 0.29     |       | $           | 0.09  |        | $
|Cash dividends per share                    |                      | $    | 0.28    |          | $ | 0.28     |       | $           | 0.28  |        | $
|Weighted average basic shares outstanding   |                      |      | 47.4    |          |   | 47.4     |       |             | 47.0  |        |  
|Weighted average diluted shares outstanding |                      |      | 47.5    |          |   | 47.4     |       |             | 47.0  |        |  
|Balance Sheet Data:                         |                      |      |         |          |   |          |       |             |       |        |  
|Inventories                                 |                      | $    | 198.9   |          | $ | 164.7    |       | $           | 141.7 |        | $
|Property, plant and equipment, net          |                      |      | 452.9   |          |   | 435.1    |       |             | 422.5 |        |  
|Total assets                                |                      |      | 1,101.8 |          |   | 970.5    |       |             | 884.3 |        |  
|Total debt                                  |                      |      | 355.5   |          |   | 318.3    |       |             | 298.8 |        |  
|Stockholder's equity                        |                      |      | 397.2   |          |   | 367.3    |       |             | 345.8 |        |  
|Debt to debt plus equity (3)                |                      |      | 45.3    | %        |   | 44.7     | %     |             | 44.6  | %      |  
|Other Data:                                 |                      |      |         |          |   |          |       |             |       |        |  
|Backlog (at year-end)                       |                      | $    | 408.6   |          | $ | 382.8    |       | $           | 319.9 |        | $
|Depreciation and amortization               |                      |      | 80.4    |          |   | 72.6     |       |             | 69.9  |        |  
|Capital expenditures                        |                      |      | 60.0    |          |   | 42.3     |       |             | 69.7  |        |  
|EBITDA (4)                                  |                      |      | 108.6   |          |   | 110.7    |       |             | 94.2  |        |  
|Cash flows from (used in):                  |                      |      |         |          |   |          |       |             |       |        |  
|                                            | Operating activities |      |         | 95.6     |   |          | 98.3  |             |       | 67.3   |  
|                                            | Investing activities |      |         | (65.0    | ) |          | (66.3 | )           |       | (110.1 | )
|                                            | Financing activities |      |         | (28.8    | ) |          | (34.4 | )           |       | 33.5   |  
|Number of employees (at year-end)           |                      |      | 7,200   |          |   | 7,207    |       |             | 6,790 |        |  

---

11

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Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations.

Safe Harbor Statement

This Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as other portions of this annual
report on Form 10-K, contain statements that constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking
statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. All statements
regarding future performance, growth, sales and earnings projections, conditions or developments are forward-looking statements. Words such as "anticipates," "in the opinion," "believes," "intends,"
"expects," "may," "will," "should," "could," "plans," "forecasts," "estimates," "predicts," "potential," "continue," and similar expressions may be intended to identify forward-looking
statements.

Actual future results may differ materially from those described in the forward-looking statements due to a variety of factors, including the fact that the
economy generally, and the agriculture, construction, road building, turf care and specialty vehicle markets specifically, have recently been in varying states of uncertainty, making it difficult to
determine if past experiences are a good guide to the future. A continuing downturn in the Company's business segments could adversely affect the Company's revenues and results of operations. Other
factors affecting forward-looking statements include, but are not limited to, the following: specific economic conditions in the agriculture, construction, road building, turf care and specialty
vehicle markets and the impact of such conditions on the Company's customers in such markets; the cyclical nature of some of the Company's businesses; the ability of the Company to win new programs
and maintain
existing programs with its original equipment manufacturer (OEM) customers; the highly competitive nature of the markets for the Company's products as well as pricing pressures that may result from
such competitive conditions; the continued operation and viability of the Company's major customers; the Company's execution of internal performance plans; difficulties or delays in manufacturing;
cost-reduction and productivity efforts; competing technologies and difficulties entering new markets, both domestic and foreign; changes in the Company's product mix; future levels of
indebtedness and capital spending; claims, including, without limitation, warranty claims, charges or dispute resolutions; ability of suppliers to provide materials as needed and the Company's ability
to recover any price increases for materials and product pricing; the Company's ability to attract and retain key technical and other personnel; labor relations; the failure of customers to make
timely payment; any inadequacy of the Company's intellectual property protection or the potential for third-party claims of infringement; global economic factors, including currency exchange rates;
general economic conditions, including interest rates, the rate of inflation, and commercial and consumer confidence; energy prices; governmental laws and regulations affecting domestic and foreign
operation, including tax obligations; changes in accounting standards; worldwide political stability; the effects of terrorist activities and resulting political or economic instability; U.S. military
action overseas; and the effect of acquisitions, divestitures, restructurings, product withdrawals, and other unusual events.

The Company cautions the reader that these lists of cautionary statements and risk factors may not be exhaustive. The Company expressly disclaims any obligation
or undertaking to release publicly any updates or changes to these forward-looking statements that may be made to reflect any future events or circumstances.

About the Company

Sauer-Danfoss Inc. and subsidiaries (the Company) is a leading international supplier of components and systems that generate, transmit and control fluid
power in mobile equipment. The Company's products are used by original equipment manufacturers (OEMs) of mobile equipment, including construction, road building, agricultural, turf care and specialty
equipment. The Company designs, manufactures and markets its products in the Americas, Europe and the Asia-Pacific region, and markets its products throughout the rest of the world either
directly or through distributors.

12

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About Management's Discussion

In December 2003 the SEC released guidance regarding management's discussion and analysis of financial condition and results of operations. The following
discussion has been prepared on the basis
of the guidelines in the SEC release. Management's discussion and analysis is designed to provide the reader of the financial statements with information that is transparent and necessary to
understand the Company's results of operations, financial condition and changes in financial condition. The format of this discussion for comparing the 2003 results from operations and financial
condition to 2002 has been enhanced from the format used in prior years in order to accomplish the following objectives:



The
discussion comparing 2002 results from operations to 2001 has not been reformatted.

Prior Period Restatement

The 2002 and 2001 financial statement amounts have been restated due to accounting errors identified during the closing of the West Branch, Iowa, operations. The
errors relate to an unreconciled account and unrecognized depreciation associated with a purchase accounting fair value adjustment related to fixed assets. Both originated in 2000 in connection with
the closing of the Racine, Wisconsin, facility and relocation of its operations to the West Branch location. The total impact of the restatement, net of tax, over the three-year period is
$1.6 million, or $0.04 per share. The restatement is not material to any one year and impacted only the Work Function segment. Refer to Note 17 in the Notes to Consolidated Financial
Statements for further discussion.

Executive Summary of 2003 Compared to 2002

The nature of the Company's operations as a global producer and supplier in the fluid power industry means the Company is impacted by changes in the local
economies, including currency exchange rate fluctuations. In order to gain a better understanding of the Company's base results, a financial statement user needs to understand the impact of those
currency exchange rate fluctuations as well as changes resulting from strategic acquisitions. The following table summarizes the Company's 2003 and 2002 results

13

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from
operations on a comparable basis, by excluding acquisitions and the impact of currency fluctuations. This analysis is more consistent with how the Company internally evaluates its results.

|(in millions)                             |                              | 2003
as reported |         | 2003 
comparable
basis (1) |      | 2002 as
reported (2) |       | Constant
dollar
change |       | Percent
change |     
|----------------------------------------- | ---------------------------- | ---------------- | ------- | --------------------------- | ---- | -------------------- | ----- | ---------------------- | ----- | -------------- | ----
|Net sales                                 |                              | $                | 1,126.8 |                             | $    | 1,008.8              |       | $                      | 952.3 |                | $   
|                                          | Gross profit                 |                  |         | 252.4                       |      |                      | 224.1 |                        |       | 219.0          |     
|                                          | % of Sales                   |                  |         | 22.4                        | %    |                      | 22.2  | %                      |       | 23.0           | %   
|Selling, general and administrative       |                              |                  | 156.7   |                             |      | 142.0                |       |                        | 128.7 |                |     
|Research & development                    |                              |                  | 43.5    |                             |      | 39.0                 |       |                        | 37.8  |                |     
|Loss on disposal of fixed assets          |                              |                  | 5.3     |                             |      | 5.2                  |       |                        | 0.4   |                |     
|                                          |                              |                  |         |                             |      |                      |       |                        |       |                |     
|                                          | Total operating costs        |                  |         | 205.5                       |      |                      | 186.2 |                        |       | 166.9          |     
|                                          |                              |                  |         |                             |      |                      |       |                        |       |                |     
|                                          |                              | Operating income |         |                             | 46.9 |                      |       | 37.9                   |       |                | 52.1
|                                          | % of Sales                   |                  |         | 4.2                         | %    |                      | 3.8   | %                      |       | 5.5            | %   
|Net interest expense                      |                              |                  | (17.4   | )                           |      | (15.7                | )     |                        | (17.2 | )              |     
|Other expense, net                        |                              |                  | (3.4    | )                           |      | (1.5                 | )     |                        | (2.9  | )              |     
|                                          |                              |                  |         |                             |      |                      |       |                        |       |                |     
|Income before taxes and minority interest |                              |                  | 26.1    |                             |      | 20.7                 |       |                        | 32.0  |                |     
|Minority interest and equity income, net  |                              |                  | (15.4   | )                           |      | (15.8                | )     |                        | (11.6 | )              |     
|                                          |                              |                  |         |                             |      |                      |       |                        |       |                |     
|                                          | Earnings before taxes        |                  |         | 10.7                        |      |                      | 4.9   |                        |       | 20.4           |     
|                                          |                              | % of Sales       |         |                             | 1.0  | %                    |       | 0.5                    | %     |                | 2.1 
|                                          | Income tax benefit (expense) |                  |         | 0.5                         |      |                      | 1.9   |                        |       | (7.2           | )   
|                                          |                              |                  |         |                             |      |                      |       |                        |       |                |     
|Net income                                |                              |                  | 11.2    |                             |      | 6.8                  |       |                        | 13.2  |                |     
|                                          |                              |                  |         |                             |      |                      |       |                        |       |                |     

---

NM
 Percentage is not meaningful

The
Company exceeded its own expectations in terms of sales growth by posting a 6 percent sales growth (in constant dollar terms) in 2003 over 2002. This sales increase exceeded
the market growth of approximately 2 percent, which the Company determined based on the volume of units sold in the regions in which the Company distributes its products. However, the margin
returns on the increased sales levels in 2003 did not meet the Company's expectations. Operating margins and net income
margins were all lower in 2003 than in 2002, due in part to some strategic business decisions that the Company made during the year that were not originally planned, but also due to unexpected costs.
These items are discussed in more detail below.

The
most significant item to impact the Company's financial performance in 2003 was the decision to close and relocate two of its manufacturing locations in the U.S. These facilities
were located in Sturtevant, Wisconsin, and West Branch, Iowa. The total costs incurred in 2003 related to the closure of these facilities amounted to $7.6 million on a pretax basis. These costs
included impairment charges on property, plant and equipment, accelerated depreciation, employee severance costs, inventory disposal costs, costs to move people and equipment to other facilities, and
manufacturing inefficiencies during the shut down and move of operations from these two facilities. Approximately $3.9 million was recorded as loss on fixed assets. The remaining $3.3 and
$0.4 million affected the cost of sales and selling, general and administrative lines, respectively, of the income statement. The Company did not incur any restructuring costs in 2002 and
expects to incur only $0.7 million of costs related to the West Branch restructuring in 2004.

14

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The
Company's 2003 financial results were also significantly impacted by several large field recall issues. The field recalls amounted to a total of $6.2 million on a pretax basis
and impacted the gross profit line of both the Propel and Work Function segments. While the Company was not pleased to have incurred these field recalls, they related to five individual defects that
were not interrelated. The Company is diligently working to understand the root cause of these defects and to enhance its processes in order to prevent this order of magnitude of field recall costs
from occurring in the future. However, as the Company has identified under its Critical Accounting Estimates, warranty and field recall costs can be a recurring part of its business due to the
high-precision and technical nature of its products and processes. There can be no assurances as to the frequency or significance of these costs in the future.

In
addition to the above items, the Company incurred $1.3 million of expense to begin the restructuring of its sales and distribution operations in Europe, which will reduce
future operating costs by streamlining delivery directly from the manufacturing locations to the customer. The Company incurred $2.2 million of expense to begin the implementation of a common
business system to standardize business processes and provide a single interface to direct OEM customers and suppliers. The investment in the common business system will drive improved operational
efficiency, customer service, and financial performance in future years. In 2003, the Company also incurred $0.5 million of outside consulting fees related to the initial work to comply with
Section 404 of the Sarbanes-Oxley Act of 2002. These costs are all reflected in the selling, general and administrative expenses line on the Consolidated Statement of Income and are anticipated
to continue in 2004 at varying degrees.

The
items discussed above negatively impacted income from operations by $17.8 million. Excluding these items, the Company would have experienced a $3.6 million real
increase in operating income on the real sales increase of $56.5 million, or approximately 6 percent of the incremental sales growth. The
Company generally targets overall margin improvement of 20 to 25 percent on each dollar of incremental sales based on the cost structure it has in place and the intent of reinvesting in the
business for future growth. Additionally, the Company experienced deterioration in gross profit margins due to the impact of the weakening U.S. currency on product sold in the U.S. that was
manufactured outside the U.S. (See further discussion of currency risk below under Market Risk.) Based on the 2003 ongoing operational performance, the Company is not meeting these internal targets.

The
Company's focus going into 2004 is to deliver both top line and bottom line growth. The Company has demonstrated that it can deliver top line sales growth exceeding the market growth
in the markets that it serves by achieving a 14 percent compound annual growth rate in reported sales over the past ten years. This growth has been achieved based on the Company's strategic
initiatives to grow sales through core market growth, increased product content per customer vehicle, and selective acquisitions. Going forward, more emphasis will be placed on improving profitability
margins through the following strategies:



Following
is a discussion of the Company's sales growth broken down between the various markets that the Company serves and by each major region of the world.

15

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Operating Results  2003 Compared to 2002

Sales Growth by Market

The following table summarizes the Company's sales growth by market. The table and following discussion is on a comparable basis, which excludes acquisitions and
currency fluctuations.

|              |  | Americas |   | Asia-Pacific |   | Europe |   | Total |  
|------------- |  | -------- | - | ------------ | - | ------ | - | ----- | -
|Agriculture   |  | 9        | % | 76           | % | 6      | % | 8     | %
|Construction  |  | 8        |   | 41           |   | 4      |   | 9     |  
|Road building |  | (7       | ) | 65           |   | (6     | ) | 1     |  
|Turf care     |  | 15       |   | (9           | ) | (16    | ) | 14    |  
|Specialty     |  | (7       | ) | (8           | ) | (1     | ) | (3    | )
|Distribution  |  | 4        |   | 17           |   | 8      |   | 7     |  

Agriculture 

The agriculture market increased in all regions of the world during 2003 after several years of very depressed sales volumes. The Asia-Pacific region,
while up significantly, is off of a relatively small base compared to the rest of the world that the Company serves. Of particular note is that the increase in Europe was driven primarily by new
projects with several large customers that began production during 2003. In the Americas, the Company had increased business from all of its major OEMs in the fourth quarter of 2003 compared to 2002.

Construction 

In the construction market, the Company also experienced sales gains in all regions of the world. The Americas' construction market was moderately up over 2002,
with the fourth quarter showing continued strengthening. In Europe, the increase in shipments was led by the smaller and mid-sized manufacturers in this market. In general, the outlook for
this market in Europe is positive for many of the Company's major customers. The Asia-Pacific region was led by the strong transit mixer business in Australia, which is expected to
continue into the first half of 2004.

Road Building 

The road building market was weak in the Americas and Europe with both being down from 2002. In the Americas, this was driven primarily by a generally soft market
and also by the lack of funding by state governments for highway projects. While the market in Europe was down, the outlook for 2004 is generally positive. Road building in the
Asia-Pacific region was led by many large projects in China such as preparation for the 2008 Olympics in Beijing, installing infrastructure for water transfer from the south of China to
the north, and for national highway projects. This increase offset the declines in both the Americas and Europe.

Turf Care 

The Company's primary business within this market comes from products produced for the consumer and commercial turf care markets in the Americas region. Consumers
continue to move away from mechanical transmissions on these machines and the introduction of zero-turn radius machines being sold through retail outlets is helping to continue to fuel
growth in this market.

Specialty Vehicles 

Sales into the specialty vehicle markets were down across all regions. This is a trend that has been occurring for the past couple of years, primarily in the
aerial lift and forklift markets. Management believes

16

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that
the aerial lift market has finally stabilized in the Americas and that the outlook in Europe is for an upturn in the forklift market in 2004.

Order Backlog

The following table shows the Company's order backlog and orders written activity, on a comparable basis, excluding acquisitions and currency fluctuations. Order
backlog represents the amount of customer orders that have been received into the Company's system for future shipment.

|(in millions)  |  | 2003 |         | 2003-
Comparable
Basis |   | 2002    |  | Constant
dollar
percent
change |      
|-------------- |  | ---- | ------- | ---------------------- | - | ------- |  | ------------------------------ | -----
|Americas       |  |      |         |                        |   |         |  |                                |      
|Backlog        |  | $    | 224.4   |                        | $ | 223.8   |  | $                              | 224.0
|Orders Written |  |      | 481.9   |                        |   | 482.9   |  |                                | 472.9
|Asia-Pacific   |  |      |         |                        |   |         |  |                                |      
|Backlog        |  |      | 21.5    |                        |   | 20.8    |  |                                | 19.3 
|Orders Written |  |      | 85.2    |                        |   | 80.0    |  |                                | 72.8 
|Europe         |  |      |         |                        |   |         |  |                                |      
|Backlog        |  |      | 159.3   |                        |   | 134.7   |  |                                | 139.5
|Orders Written |  |      | 527.5   |                        |   | 445.1   |  |                                | 451.0
|Total          |  |      |         |                        |   |         |  |                                |      
|Backlog        |  |      | 405.2   |                        |   | 379.3   |  |                                | 382.8
|Orders Written |  |      | 1,094.6 |                        |   | 1,008.0 |  |                                | 996.7

Total
order backlog at the end of 2003 was $408.6 million, compared to $382.8 million at the end of 2002, an increase of 6.7 percent. On a comparable basis,
excluding the impact of currency exchange fluctuation and acquisitions, order backlog remained flat with year-end 2002 levels. New sales orders written for 2003 were
$1,125.8 million, an increase of 13.0 percent from 2002. Excluding the impact of currencies and acquisitions, total orders written in 2003 were only 1 percent above the 2002
levels. As the Company has noted in earlier communications, customers continue to adjust orders closer to the scheduled production dates, often within the scheduled shipping month. In some cases, this
is a result of the customer's uncertainty with respect to the outlook of their own markets, but it is also a sign that customers are taking advantage of reduced production cycles within the Company's
facilities. In either case, the Company's order and backlog information has become less reliable as an indicator of future expectations.

Overall,
the Company has been able to achieve solid sales growth through its strategies to continue to develop new vehicle applications and to expand the content supplied for each
vehicle by selling system solutions and integrating electronics with hydraulics.

Business Segment Results

The following discussion of operating results by reportable segment relates to information as presented in Note 16 in the Notes to Consolidated Financial
Statements. Segment income is defined as the respective segment's portion of the total Company's net income, excluding net interest, income taxes, minority interest, equity in net earnings of
affiliates, and corporate expenses. Propel products include hydrostatic transmissions and related products that transmit the power from the engine to the wheel to propel a vehicle. Work Function
products include steering motors as well as gear pumps and motors that transmit power for the work functions of the vehicle. Controls products include electrohydraulic controls, microprocessors, and
valves that control and direct the power of a vehicle. The following table provides a

17

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summary
of each segment's sales and segment income on a comparable basis, excluding acquisitions and currency fluctuations.

|(in millions)         |                                         | 2003 |   | 2002  |   | Change |       | Percent
change |  
|--------------------- | --------------------------------------- | ---- | - | ----- | - | ------ | ----- | -------------- | -
|Net sales             |                                         |      |   |       |   |        |       |                |  
|                      | Propel                                  |      | $ | 479.1 |   | $      | 440.2 |                | $
|                      | Work Function                           |      |   | 307.9 |   |        | 295.0 |                |  
|                      | Controls                                |      |   | 221.8 |   |        | 217.1 |                |  
|Segment income (loss) |                                         |      |   |       |   |        |       |                |  
|                      | Propel                                  |      | $ | 48.1  |   | $      | 47.3  |                | $
|                      | Work Function                           |      |   | 6.9   |   |        | 19.0  |                |  
|                      | Controls                                |      |   | 9.0   |   |        | 5.8   |                |  
|                      | Global Services and other expenses, net |      |   | (27.7 | ) |        | (22.9 | )              |  

Propel Segment

There are two primary reasons for the increase in the Propel segments net sales in 2003. The first reason is the continued growth in the turf care market in the
Americas. As mentioned in the preceding Sales Growth by Market section, the move away from mechanical transmissions to hydrostatic transmissions and the zero-turn radius mowers are leading
the way for this growth. The other factor of growth in the Propel segment during 2003 came from the increased sales volume in the Asia-Pacific region as China and Japan experienced
increased sales, primarily in the construction and road building markets as mentioned above.

The
Propel segment income generated on the increased sales only amounted to 2 percent of the incremental sales over 2002, which is considered very substandard by the Company's
internal standards. During 2003, the Propel segment incurred $5.2 million of field recall costs as a result of four separate quality issues at several large OEM customers. Each of these
instances had its own unique root cause and the Company is working diligently to put the proper processes and tools in place to ensure that these types of recalls do not occur in the future. Without
these field recall costs, Propel segment income would have increased $7.0 million, or 18 percent of the incremental sales increase. This is more in line with the Company's internal
expectations. The Propel segment income has also been impacted by increased price pressures which the Company has experienced in recent years. The Propel segment is predominantly a mature product line
with enhancements coming primarily from the addition of electronic controls. Consequently, customers in this market have been very aggressive in demanding price concessions. To the extent the Company
concedes price reductions without offsetting these concessions with cost reductions, the price reduction negatively impacts the segment profitability. In
order to combat this impact, the Propel segment is focused on utilizing global purchasing initiatives to lower part costs through sourcing components to more cost effective global suppliers and to
outsource components where the Company does not believe there is a manufacturing advantage.

Work Function Segment

While the Work Function segment experienced net sales growth over the prior year of almost $13.0 million, segment income declined by $12.1 million
from 2002. Of this decline, approximately $7.4 million was a result of the Company's decision during 2003 to shutdown and relocate two of its manufacturing plants in North America. In the
second and third quarters of 2003, the Company shut down its steering unit manufacturing operation in Sturtevant, Wisconsin, and relocated the operations to its facilities in Nordborg, Denmark, and
Wroclaw, Poland. The costs incurred for this closure, (net of savings realized already during 2003) was approximately $1.4 million. During the third quarter of 2003, the Company made the
decision to shut down and relocate its West Branch, Iowa, plant. The majority of the

18

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costs
to close and relocate this facility were incurred in 2003 and amounted to approximately $6.0 million. The majority of the manufacturing operations at West Branch were transferred to the
Company's Freeport, Illinois, and Lawrence, Kansas, facilities. In addition, the Company successfully rationalized and outsourced certain low-volume product lines that will also help to
improve profitability in this segment in future periods. The Work Function segment also incurred $1.0 million of field recall costs due to a quality problem with one particular product at one
customer. This segment is also working to implement the proper processes and tools to prevent costs of this magnitude in the future.

Controls Segment

The Controls segment experienced sales growth that was in line with the general market trend in which the Company operates. On the positive side, the Controls
segment income was a very strong 67 percent of the incremental sales growth, much higher than even the Company's internal expectations. However, the Controls segment income in 2002 was
negatively impacted by a $1.2 million product rationalization charge. Excluding this item, the Controls segment income increased 41 percent of the incremental sales growth which still
exceeded the Company's internal expectations.

Global Services and other expenses, net

The Company's Global Services and other expenses, net segment incurs costs related to internal global service departments, along with the operating costs of the
Company's executive offices which were established in 2002 in Lincolnshire, Illinois. Worldwide services such as tax and accounting fees paid to outside third parties, certain insurance premiums, and
the amortization of intangible assets from certain business combinations are also included in this classification. The majority of the increase in this area relates to three items: initial costs
incurred to begin implementation of a common business system for all of the Company's worldwide operations, outside service costs to assist in meeting the new requirements regarding internal controls
under the Sarbanes-Oxley Act of 2002, and the additional costs related to the Company's executive office in place for the full year of 2003 compared to only six months of 2002.

Income Taxes

The Company has a tax benefit of $0.5 million in 2003 even though it reported pre-tax net income of $10.7 million. The tax benefit is
due to two primary factors. First, the majority of the restructuring costs were incurred in the U.S., which are benefited at an effective corporate tax rate of 39 percent; whereas, the majority
of the earnings, primarily European based, are taxed at various statutory rates averaging approximately 30 percent. Second, the Company's operations in China and Slovakia generated income in
2003 but there is no tax expense on these amounts as both countries have tax loss carryforwards with no previously recorded tax benefit. The Company expects its overall tax rate to return to a rate
closer to the statutory rate in 2004.

19

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2002 Compared to 2001

Consolidated Results

Net income in 2002 was $13.7 million, or $0.29 per diluted share, compared with net income per diluted share of $0.09 in 2001. Special pretax charges of
$1.9 million in 2002 and $9.7 million in 2001 had a negative impact on the results for the respective years. The special charges for 2002 were $1.2 million related to
rationalizing overlapping product lines within the Controls segment relating to the acquisition of the low voltage motor business (TE) and a one-time noncash after-tax charge
of $0.7 million for goodwill impairment. The special charges in 2001 related to plant closing costs of $8.3 million and a bad debt write-off of $1.4 million relating
to a customer in the aerial lift market filing for bankruptcy. The following table, although not a U.S. GAAP disclosure, shows net income for the two years adjusted for these special charges in order
to provide a more comparable picture of the Company's net operating results:

(in millions)

2002

2001Net income as reported

$
13.7

$
4.3Product rationalization charge after tax


0.8


Goodwill impairment charge


0.7


Plant closing costs after tax





5.4Bad debt write-off after tax





0.9Net income on comparable basis

$
15.2

$
10.6Net income per share

$
0.32

$
0.23


Excluding the special charges in both years, net income in 2002 increased by 43 percent over 2001. The primary factor for this improvement was the
Company's broad-based cost control initiatives, particularly in the areas of fixed production costs, selling, general and administrative expenses, and research and development expenses. In addition,
the Company focused significant attention on working capital management that resulted in a $13.2 million reduction in trade receivables. These factors helped generate a record operating cash
flow of $98.3 million, or an increase of 45 percent over 2001.

Net
sales in 2002 of $952.3 million increased by $97.0 million, or 11.4 percent, over the 2001 sales of $855.3 million. Excluding the impact of currency
exchange fluctuations, net sales increased 8.6 percent (i.e. net sales of businesses outside the United States measured in U.S. dollars would have been lower had currency exchange/translation
rates remained at the same levels as the rates that prevailed during 2001.) Excluding the impact of currency exchange fluctuations and acquisitions, net sales increased 1.6 percent over 2001.

Gross
profit in 2002 of $219.0 million increased $26.4 million or 13.7 percent from 2001 gross profit of $192.6 million. The majority of the reported increase
is a result of acquisitions completed in 2002 or those completed in 2001 and included for a full year in 2002. Gross profit as a percentage of sales for 2002 was 23.0 percent, compared to
22.5 percent for 2001. While fixed production costs were reported to be $5.2 million higher in 2002 compared to 2001, the Company successfully reduced overall fixed production costs by
$4.1 million compared to 2001 when the impact of currency exchange fluctuations and acquisitions are excluded.. Had the Company not achieved this cost reduction, gross profit as a percentage of
sales would have declined slightly from 2001. Pricing pressures within the markets the Company serves continue to challenge the Company to maintain profitability levels. While the Company was
successful in reducing fixed costs in 2002, it is not feasible to believe that the Company can attain this same year-over-year reduction in this area. Therefore, the Company
has embarked on a global procurement initiative by establishing a global procurement office with resources in the U.S., Europe, South America, and Asia-Pacific. The focus of this global
procurement will be to leverage the Company's global purchasing power to help reduce both direct and indirect material costs with a goal to obtain a 1 to 2 percent margin improvement over the
next 12 months. In addition, significant focus will be placed on the procurement of

20

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nonproductive
materials, supplies and services in order to achieve additional cost reductions to offset the ongoing pricing pressures.

The
Company's selling, general and administrative expenses increased $5.8 million, or 4.7 percent, over the 2001 reported amount of $122.8 million. Excluding the
impact of currency exchange fluctuations, selling, general and administrative expenses increased $2.7 million, and excluding acquisitions, these expenses actually declined from the 2001 levels
by $7.9 million, reflecting the Company's focus on reducing fixed costs during 2002.

Research
and development activities in 2002 were essentially flat with the 2001 levels in terms of reported amounts. Excluding the impact of currency exchange fluctuations and
acquisitions, these expenses were $3.1 million less than the 2001 levels. While the Company was focused on reducing fixed costs in all areas of the business, the Company remains committed to
investing in new technology and product development. Much of the Company's product development activities continue to be driven by ongoing customer inquiries.

Net
nonoperating expenses increased by $3.2 million over 2001 due primarily to foreign currency exchange losses and to the fact that the Company no longer receives royalty income
from its former Japanese licensee as a result of forming a joint venture in the fourth quarter of 2001. This accounts for a $3.1 million increase, which was offset by slightly lower net
interest expense for 2002.

The
Company's effective tax rate for 2002 of 34.5 percent was lower than the 2001 effective tax rate of 37.6 percent. The primary factor for the lower effective rate in
2002 is related to the mix of the Company's net income with a higher portion of the Company's net income being generated in countries with lower effective tax rates.

Business Segment Results

The following discussion of operating results by reportable segment relates to information as presented in Note 16in the Notes to Consolidated Financial
Statements. Segment income is defined as the respective segment's portion of the total Company's net income, excluding net interest, income taxes, minority interest, equity in net earnings of
affiliates, and corporate expenses. The format of this discussion for comparing the 2002 results from operations to 2001 is different from prior years due to the Company changing its reportable
segments beginning in 2002 to reflect the changes in organizational structure of the Company around its various product lines of Propel, Work Function and Controls. Propel products include hydrostatic
transmissions and related products that transmit the power from the engine to the wheel to propel a vehicle. Work Function products include steering motors as well as gear pumps and motors that
transmit power for the work functions of the vehicle. Controls products include electrohydraulic controls, microprocessors, and valves that control and direct the power of a vehicle.

Propel Segment

Net sales for the Propel segment of $440.2 million increased $40.7 million, or 10.2 percent, from 2001 net sales of $399.5 million.
All geographic regions in which the Propel segment operates experienced net sales growth. Excluding the impact of currency fluctuations, net sales increased $35.2 million. Additionally,
excluding the impact of acquisitions, net sales increased $11.0 million from 2001. Approximately $10.0 million of the increase in net sales was driven by a new product introduction for
compact utility tractors in the U.S. and from the infinitely variable transmission developed for agriculture tractors. An additional $14.0 million of increased sales were generated from the
turf care market in the Americas. However, these increases in the U.S. were partially offset by declines in the agriculture, construction, specialty and distribution markets. In Europe, both the
agriculture and road building markets experienced growth over 2001. The agriculture market in Europe recovered somewhat in 2002 after several difficult years caused by the foot and mouth disease
scare. These increases in Europe were offset be declines in the construction, turf care, and specialty markets.

21

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Propel
segment income in 2002 of $47.3 million increased $10.4 million, or 28 percent, over segment income of $36.9 million in 2001. Excluding the impact of
currency exchange fluctuations and acquisitions, Propel segment income increased $6.7 million, with all of this increase being driven by the turf care market.

Work Function Segment

Net sales in the Work Function segment of $295.0 million in 2002 increased by $26.6 million, or 9.9 percent, over 2001 net sales of
$268.4 million. Excluding the impact of currency exchange fluctuations and acquisitions, net sales increased $15.9 million, or 5.9 percent, from 2001. While sales of steering
units and low speed high torque motors increased $12.4 million over 2001, this was partially offset by a decline of gear pump and motor sales of $4.4 million.

Work
Function segment income in 2002 of $19.0 million increased $10.1 million, or 113.5 percent, over 2001 segment income of $8.9 million. Excluding the
impact of currency exchange fluctuations, Work Function segment income increased $9.1 million from 2001. The Work Function segment was impacted by a one-time special charge of
$0.7 million in 2002 related to goodwill impairment. The 2001 segment income was negatively impacted by a one-time pretax charge of $8.3 million related to plant closing
costs. Excluding these special charges and the impact of currencies, segment income for the Work Function segment increased $1.5 million, or 16.9 percent, over 2001, driven by the
overall higher sales levels within this segment.

Controls Segment

Net sales in the Controls segment in 2002 of $217.1 million increased $29.7 million, or 15.8 percent, over 2001 segment net sales of
$187.4 million. During 2002, the Company completed the acquisition of TE. The addition of this business added $34.2 million of sales to this segment. Excluding this acquisition and the
impact of currency exchange fluctuations, net sales for 2002 would have declined by $11.8 million from the comparable 2001 levels. The majority of this decrease comes from the aerial lift
market in the U.S. that continues to be depressed.

Controls
segment income for 2002 of $5.8 million decreased $0.8 million, or 12 percent, from 2001 segment income of $6.6 million. The TE business added
$1.3 million to the Controls segment income. Excluding the impact of acquisitions and currency exchange fluctuations, the Controls segment income declined $2.3 million from 2001.
However, in 2002, the Controls segment was negatively impacted by a special pretax charge of $1.2 million relating to product line rationalization as a result of overlapping product lines
within this segment relating to the acquisition of the TE business. On a comparable basis to 2001, Controls segment income declined $1.1 million, or 16.7 percent, from 2001.

Global Services and Other Expenses, net

The Company's Corporate Function incurs costs that relate to worldwide services such as worldwide tax and accounting fees paid to outside third parties, certain
insurance premiums, the amortization of intangible assets from certain business combinations, and internal global services departments, along with the operating costs of the Company's executive
offices which were established in 2002 located in Lincolnshire, Illinois. For 2002, total corporate charges amounted to $22.9 million, or an increase of $2.7 million from the 2001
charges of $20.2 million.

Order Backlog

Total order backlog at the end of 2002 was $382.8 million, compared to $319.9 million at the end of 2001, an increase of 19.7 percent. On a
comparable basis, excluding the effects of acquisitions, order backlog increased 15.7 percent from the year-end 2001 levels, or 10.2 percent excluding the additional impact
of currency fluctuations. During the fourth quarter of 2002, $249.7 million in new orders were

22

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written,
an increase of 8.1 percent compared to the fourth quarter of 2001. Excluding the impact of acquisitions, orders written in the fourth quarter were $239.1 million, which was
3.5 percent more than the orders written in the fourth quarter of 2001, but a decrease of 1.6 percent excluding the additional impact of currency fluctuation.

Market Risk

The Company is naturally exposed to various market risks, including changes in foreign currency exchange rates, interest rates, and prices.

Impact of Foreign Currency

The Company has historically not entered into any type of foreign currency hedging or derivative arrangements to manage its exposure to fluctuations in the
foreign currency markets. However, during 2002, the Company entered into a foreign currency hedge contract to protect against the effects of
foreign currency fluctuations for a loan to the U. S. holding company from a Danish bank denominated in euros. The hedge resulted in offsetting approximately $5.5 million of foreign currency
loss which would have resulted from the dollar weakening against the euro during 2003. In addition, the Company assumed a foreign currency exchange contract through its acquisition of the Thrige
Electric business in Denmark. This contract expires in 2004.

The
Company has operations and sells its products in many different countries of the world and therefore, conducts its business in various currencies. The Company's financial statements,
which are presented in U.S. dollars, can be impacted by foreign exchange fluctuations through both translation risk and transaction risk. Translation risk is the risk that the financial statements of
the Company, for a particular period or as of a certain date, may be affected by changes in the exchange rates that are used to translate the financial statements of the Company's operations from
foreign currencies into U.S. dollars. Transaction risk is the risk from the Company receiving its sale proceeds or holding its assets in a currency different from that in which it pays its expenses
and holds its liabilities.

With
respect to transaction risk, the impact on the Company's operating results has not historically been significant. In previous years, the Company had been well balanced between its
U.S. and European operations because the Company generated its sales in the same country in which it incurred its expenses, or shipped products between geographic regions on a balanced basis. However,
the Company is no longer as equally balanced in terms of where it generates its sales compared to the currency in which the production costs are incurred. In 2003 the Company sold a total of
$83.4 million into the U.S. of product that had been produced in European based currencies compared to sales into Europe of $37.5 million of product produced in U.S. dollars. This
imbalance had a significant impact on the bottom line results of the Company in 2003. The Company is currently taking steps to analyze and understand this impact globally. Based on its analysis, the
Company may decide to re-source certain operations or use hedging instruments in the future in order to protect against this margin erosion.

Additionally,
the Company is impacted by translation risk in terms of comparing results from period to period.

Fluctuations
of currencies against the U.S. dollar can be substantial and therefore significantly impact comparisons with prior periods. The translation impact on making prior period
comparisons with respect

23

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to
the Company's net sales can be material. As shown in the table below, historically the translation impact on net sales had not been significant, however, in 2003 this difference has become quite
substantial.

Percentage Sales Growth/(Decline)
Over Prior Year2003

2002

2001 (1)As Reported

18.3
%
11.4
%
(9.5
)%Without Currency Translation Impact

8.7

8.6

(7.9
)


---

During
2003, the U.S. dollar continued to weaken substantially against most foreign currencies, especially the euro. Between December 31, 2002 and December 31, 2003, the
U.S. dollar weakened by 20 percent against the euro, which followed a 15 percent weakening between 2001 and 2002. This has resulted in approximately one-third of the
Company's total balance sheet being stated 20 percent higher than the prior year since roughly one-third of the Company's total assets and liabilities are denominated in the euro.
As shown above, translation does affect comparisons between periods.

Interest Rates

The Company does not currently manage its interest rate change exposure by entering into any type of interest rate hedging or derivative arrangement. The
following table summarizes the maturity of the Company's debt obligations for fixed and variable rate debt (amounts in millions):

Fixed Rate
Debt

Variable Rate
Debt2004

$
92.7

$
132.32005


57.1


1.12006


12.4


2007


5.2


6.02008


17.2


Thereafter


31.4


Total

$
216.0

$
139.4


Liquidity and Capital Resources

The following table shows condensed balance sheet information for the Company as of December 31, 2003 compared to December 31, 2002. The 2003
information has been translated using the same exchange rates as were used for the 2002 balance sheet to make the U.S. dollar amounts comparable. In addition, the acquisition completed during 2003
that was not included in the 2002 amounts has been excluded for

24

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comparison
purposes. This table shows only the change in balances on a comparable basis; it does not show the actual cash flow impact to the Company.

|(in millions)                               |                                            | 2003
As Reported |       | 2003-
Comparable
Basis |   | 2002 As
Reported |       | Constant dollar Change |       | Percent
change |  
|------------------------------------------- | ------------------------------------------ | ---------------- | ----- | ---------------------- | - | ---------------- | ----- | ---------------------- | ----- | -------------- | -
|Cash                                        |                                            | $                | 15.1  |                        | $ | 12.7             |       | $                      | 12.4  |                | $
|Accounts receivable                         |                                            |                  | 186.3 |                        |   | 156.9            |       |                        | 153.6 |                |  
|Inventories                                 |                                            |                  | 198.9 |                        |   | 173.1            |       |                        | 164.7 |                |  
|Other current assets                        |                                            |                  | 33.0  |                        |   | 32.6             |       |                        | 30.5  |                |  
|                                            |                                            |                  |       |                        |   |                  |       |                        |       |                |  
|                                            | Total current assets                       |                  |       | 433.3                  |   |                  | 375.3 |                        |       | 361.2          |  
|                                            |                                            |                  |       |                        |   |                  |       |                        |       |                |  
|Net property, plant and equipment           |                                            |                  | 452.9 |                        |   | 405.3            |       |                        | 435.1 |                |  
|Goodwill and other intangibles              |                                            |                  | 154.9 |                        |   | 132.4            |       |                        | 133.6 |                |  
|Other long-term assets (1)                  |                                            |                  | 60.7  |                        |   | 57.3             |       |                        | 40.6  |                |  
|                                            |                                            |                  |       |                        |   |                  |       |                        |       |                |  
|                                            | Total assets                               |                  | $     | 1,101.8                |   | $                | 970.3 |                        | $     | 970.5          |  
|                                            |                                            |                  |       |                        |   |                  |       |                        |       |                |  
|Short-term debt and notes payable           |                                            | $                | 225.0 |                        | $ | 197.7            |       | $                      | 83.1  |                | $
|Accounts payable                            |                                            |                  | 93.8  |                        |   | 78.2             |       |                        | 71.0  |                |  
|Accrued liabilities                         |                                            |                  | 82.0  |                        |   | 74.9             |       |                        | 62.3  |                |  
|                                            |                                            |                  |       |                        |   |                  |       |                        |       |                |  
|                                            | Total current liabilities                  |                  |       | 400.8                  |   |                  | 350.8 |                        |       | 216.4          |  
|Long term debt                              |                                            |                  | 130.4 |                        |   | 123.0            |       |                        | 235.2 |                |  
|Pension liability                           |                                            |                  | 41.9  |                        |   | 36.3             |       |                        | 42.7  |                |  
|Deferred taxes                              |                                            |                  | 56.1  |                        |   | 50.1             |       |                        | 44.3  |                |  
|Other long-term liabilities                 |                                            |                  | 43.0  |                        |   | 38.6             |       |                        | 37.5  |                |  
|Minority interest in consolidated companies |                                            |                  | 32.4  |                        |   | 30.4             |       |                        | 27.1  |                |  
|Total stockholders' equity                  |                                            |                  | 397.2 |                        |   | 341.1            |       |                        | 367.3 |                |  
|                                            |                                            |                  |       |                        |   |                  |       |                        |       |                |  
|                                            | Total liabilities and stockholders' equity |                  | $     | 1,101.8                |   | $                | 970.3 |                        | $     | 970.5          |  
|                                            |                                            |                  |       |                        |   |                  |       |                        |       |                |  

---

The
Company's principal sources of liquidity have been from internally generated funds from operations and from borrowings under its committed and uncommitted, unsecured, credit
facilities. Because of the multiple funding sources that have been and continue to be available to the Company, the Company expects to have sufficient sources of liquidity to meet its funding needs.

The
Company has historically accessed diverse funding sources, including short-term and long-term unsecured bank lines of credit in the United States, Europe and
Asia, as well as private securitization markets in the United States. In addition, the Company has access to unsecured bank lines of credit with various banks from around the world (see Note 7
in the Notes to Consolidated Financial Statements).

The
Company operates under certain covenants as defined under its various credit agreements with its banks. In September 2003 the Company entered into a new multicurrency
revolving credit facility that permits unsecured borrowings up to $250.0 million through September 2006. The proceeds from the new facility were used to repay outstanding borrowings
under several of its other credit facilities. At December 31, 2003 there was $84.9 million outstanding under the new facility. Debt issuance costs of $1.8 million were capitalized
and are being amortized to interest expense over the three-year term of the facility. The Company is required to meet certain financial covenants under this facility as described in
Note 7 in the Notes to Consolidated Financial Statements. The Company was in compliance with the covenants at December 31, 2003 and is not aware of any circumstances currently that would
impact said compliance during the next twelve months.

25

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Cash Flows from Operations 

The Company's cash provided from operations in 2003 was a strong $95.6 million, slightly below the record level of $98.3 million generated in 2002.
Overall working capital management in 2003 slipped from the successful efforts achieved in 2002. This resulted in $16.0 million less cash provided from working capital than in 2002.

The
accounts receivable balance increased only 2 percent in 2003 compared to 2002, excluding the impact of currency and acquisition. This is notable considering sales in the
fourth quarter of 2003 increased almost 7 percent compared to sales in the fourth quarter of 2002, excluding the impact of currency and acquisition. The Company's overall days sales outstanding
(DSO), (the measure of how many days of product sales are yet to be collected from customers) was 60.3 days in 2003 compared to 58.9 days for 2002. The Company has put a significant
amount of effort into improving the collection activities in the U.S. that has resulted in a reduction in DSO from 33.1 to 32.1 at the end of 2003. The Company is now looking at creating shared
service centers in Europe to aid in reducing the number of days sales outstanding.

The
Company's inventory management activities took a step back in 2003 that resulted in approximately $7.6 million more being invested in inventories at the end of 2003 compared
to 2002. Part of this increase in inventory is a direct result of the Company's efforts to reorganize its sales and distribution operations in Europe. The Company began the process in 2003 to move
inventory in Europe from its individual sales companies back to the original manufacturing locations and centralized logistics centers. The Company anticipates that this will reduce inventory in the
long term and enable it to better respond to customers' needs and maintain lower overall inventory levels. This action should also reduce the amount of risk associated with potentially excess and
obsolete inventory.

Accounts
payable management has improved in 2003 as the Company has achieved better terms in paying its suppliers that are more in line with the timing of the collections from its own
customers. This resulted in increased cash flow by $3.6 million compared to 2002.

Overall,
the Company's cash balances remained level with 2002, on a comparable dollar basis. The Company's overall goal is to minimize the amount of cash on its balance sheet as long as
it has outstanding bank borrowings. At the end of 2003, over $5.5 million of the Company's cash resided in China, and an additional $2.6 million was located in Brazil. Due to the nature
of governmental and other regulatory controls, it is extremely difficult to move cash out of these countries for reasons other than payment for goods shipped into these countries. As the Company
continues to look at expanding its manufacturing capabilities in low cost regions, the Company will look to utilize the cash already located in these countries to fund these expansions.

Cash Used in Investing Activities 

The Company has continued to selectively invest in capital equipment for its manufacturing plants for more efficient manufacturing processes and for new product
development. In addition, in 2003 the Company invested over $10.0 million in a new common business system mentioned above in the Executive Summary. This amount represents all of the user
licenses for its worldwide operations as well as certain capitalizable costs for outside consulting and internal dedicated resource costs for the development of the new system. The Company anticipates
it will incur an additional $4.0 million of capitalized costs in 2004 before the implementation phase of this common business system begins.

During
2003 the Company completed one acquisition for a net cash outlay of $7.2 million. See the discussion of Business Combinations below and Note 3 in the Notes to
Consolidated Financial Statements for further discussion.

26

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Cash Used in Financing Activities 

Aside from the activities under the Company's various borrowing arrangements as discussed earlier, the Company also pays a dividend to its shareholders on a
quarterly basis. The dividend is set by the Company's Board of Directors and is currently at an annual rate of $0.28 per share. This has resulted in $13.3 million of annual dividend payments
for each of the last 3 years. The Company does not anticipate this changing in 2004. In addition, the Company periodically makes distributions to its minority interest partners from its various
joint venture activities. This amount can vary from year to
year depending on the amount of undistributed earnings of the businesses and the needs of the partners.

Contractual Cash Obligations 

The majority of the Company's contractual obligations to make cash payments to third parties are for financing obligations. These include future lease payments
under both operating and capital leases. The following table discloses the Company's future commitments under contractual obligations as of December 31, 2003:

|Contractual Cash Obligations       |  | Total |         | 2004 |   | 2005    |  | 2006 |        | 2007 |   | 2008   |  | Thereafter
|---------------------------------- |  | ----- | ------- | ---- | - | ------- |  | ---- | ------ | ---- | - | ------ |  | ----------
|Long-term debt and notes payable   |  | $     | 355,451 |      | $ | 225,043 |  | $    | 58,204 |      | $ | 12,396 |  | $         
|Capital leases                     |  |       | 22,665  |      |   | 1,367   |  |      | 1,332  |      |   | 1,151  |  |           
|Operating leases                   |  |       | 132,104 |      |   | 16,150  |  |      | 14,784 |      |   | 13,327 |  |           
|                                   |  |       |         |      |   |         |  |      |        |      |   |        |  |           
|Total Contractual Cash Obligations |  | $     | 510,220 |      | $ | 242,560 |  | $    | 74,320 |      | $ | 26,874 |  | $         
|                                   |  |       |         |      |   |         |  |      |        |      |   |        |  |           

In addition to the above contractual obligations, the Company has certain other funding needs that are non-contractual by nature,
including funding of certain pension plans. For 2004, the Company anticipates contributing $7.0 million to its U.S. pension plan and $0.9 million to its UK pension plan. There are no
plans to fund the German pension plan, which is customary in that country.

Other Matters

Critical Accounting Estimates 

The SEC's guidance surrounding the disclosure of critical accounting estimates requires disclosures about estimates a company makes in applying its accounting
policies. However, such discussion is limited to "critical accounting estimates," or those that management believes meet two criteria: 1) the accounting estimate must require a company to make
assumptions about matters that are highly uncertain at the time the accounting estimate is made, and 2) different estimates that the company reasonably could have used for the accounting
estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, must have a material impact on the presentation of the company's
financial condition, changes in financial condition or results of operations.

Besides
the estimates that meet the two criteria for a "critical estimate" above, the Company makes many other accounting estimates in preparing its financial statements and related
disclosures. All estimates, whether or not deemed critical, can affect the reported amounts of assets, liabilities, revenues and expenses as well as disclosures of contingent assets and liabilities.
Estimates are based on experience and information available prior to the issuance of the financial statements. Materially different results can occur as circumstances change and additional information
becomes known, including estimates not deemed "critical" under the SEC's guidance.

The
discussion below should be read in conjunction with disclosures elsewhere in this discussion and in the Notes to the Consolidated Financial Statements related to estimates,
uncertainties, contingencies, and new accounting standards. Significant accounting policies are discussed in Note 1 to the Consolidated Financial Statements beginning on page 46. The
development and selection of accounting estimates,

27

---

including
those deemed "critical," and the associated disclosures in this discussion, have been discussed by management with the audit committee of the Board of Directors.

Inventory Valuation As a manufacturer in the capital goods industry, inventory is a substantial portion of the assets of the
Company, amounting to almost 20 percent of total assets at December 31, 2003. The Company must periodically evaluate the carrying value of its inventory to assess the proper valuation.
This includes having adequate allowances and period adjustments to 1) cover losses in the normal course of operation, 2) provide for excess and obsolete inventory, and 3) ensure
that inventory is valued at the lower of cost or market. On a quarterly basis, management within each segment performs an analysis of the underlying inventory to identify the need for appropriate
allowances to cover all of these. In doing so, management applies consistent practices based upon historical data such as actual loss experience, past and projected usage, actual margins generated
from trade sales of its products, and finally its best judgment to estimate the appropriate allowances.

Warranty Provisions The Company warrants its various products over differing periods depending upon the type of product and
application. Consequently, the Company records liabilities for the estimated warranty costs that may be incurred under its basic warranty based on past trends of actual warranty claims compared to the
actual sales levels to which those claims apply. These liabilities are accrued at the time the sales of the products are recorded. Factors that affect the Company's warranty liability include the
number of units in the field currently under warranty, historical and anticipated rates of warranty claims on those units and the cost per claim to satisfy the Company's warranty obligation. The
anticipated rate of warranty claims is the primary factor impacting the Company's estimated warranty obligation. Each quarter, the Company reevaluates its estimates to assess the adequacy of its
recorded warranty liabilities and adjusts the amounts as necessary.

In
addition to its normal warranty liability, the Company, from time to time in the normal course of business, incurs costs to repair or replace defective products with a specific
customer or group of customers. The Company refers to these as "field recalls" and in these instances, the Company will record a specific provision for the expected costs it will incur to repair or
replace these products utilizing information from customers and internal information regarding the specific cost of materials and labor. Typically, field recalls are infrequent in occurrence, however,
when they occur, field recalls can be for a large number of units and quite costly to rectify. Because of the sporadic and infrequent nature of field recalls, and due to the extreme range of costs
associated with field recalls, the Company cannot accurately estimate these costs at the time the products are sold. Therefore, these costs are recorded at the time information becomes known to the
Company. As the field recalls are settled, the Company relieves the specific liability related to that field recall. These specific field recall liabilities are reviewed at least on a quarterly basis.

Long-Lived Asset Recovery A significant portion of the Company's total assets consist of property, plant and
equipment (PP&E) and definite life intangibles, as well as goodwill and indefinite life intangibles. Changes in technology or in the Company's intended use of these assets, as well as changes in the
broad global economy in which the Company operates, may cause the estimated period of use or the carrying value of these assets to change.

This
requires the Company to periodically assess the estimated useful lives of its assets in order to match, through depreciation, the cost of those assets with the benefits derived over
the period of usefulness. The useful lives of these assets can be shortened through greater use due to volume increases, rapidly changing technology such as the use of electronics and
computer-operated controls, and through inadequate maintenance. Despite management's best efforts to determine the appropriate useful lives of its equipment, certain situations arise that lead to an
asset or group of assets becoming impaired, meaning their economic value becomes less than the value at which the Company is carrying the asset on its books. Examples of these situations are product
rationalization efforts or restructuring of manufacturing facilities. When these situations arise, the Company tests the assets for impairment and will write down the asset in

28

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the
period when the impairment becomes known. If information would become known that would change the depreciable rate of the Company's assets by 10 percent, recorded depreciation expense would
have been impacted by approximately $7.8 million.

Valuation of Trade Receivables The Company records trade receivables due from its customers at the time a sale is recorded
in accordance with its revenue recognition policy. The future collectability of these amounts can be impacted by the Company's collection efforts, the financial stability of its customers, and the
general economic climate in which it operates. The Company applies a consistent practice of establishing an allowance for accounts that it believes may become uncollectible through reviewing the
historical aging of its receivables, looking at the historical losses incurred as a percentage of net sales, and by monitoring the financial strength of its customers. In addition, local customary
practices have to be taken into account due to varying payment terms being applied in various parts of the world where the Company conducts its business. If the Company becomes aware of a customer's
inability to meet its financial obligations (e.g., where it has filed for bankruptcy), the Company establishes a specific allowance for the potential bad debt to reduce the net recognized receivable
to the amount it reasonably believes will be collected. The valuation of trade receivables is performed quarterly.

Workers Compensation The Company has an insurance policy to cover workers compensation claims in the United States, in which
the Company pays the first $0.25 million per claim, per incident. The Company establishes its workers compensation reserve based on historic growth factors of claims and an estimate of
incurred, but not reported claims. This analysis is performed on a quarterly basis, or more frequently if factors dictate a more frequent review.

Pensions The Company has noncontributory defined benefit pension plans for a majority of its employees. In certain
countries, such as the United States and the United Kingdom, these plans are funded with plan assets whereas in other countries such as Germany, the plans are completely unfunded, which is customary.
The measurement of the Company's pension obligations and costs is dependent on a variety of assumptions used by the Company's actuaries. These assumptions include estimates of the present value of
projected future pension payments to all plan participants, taking into consideration the likelihood of potential future events such as salary increases and other experience. These assumptions may
have an effect on the amount and timing of future contributions. The plan trustee conducts an independent valuation of the fair value of pension plan assets.

The
assumptions used in developing the required estimates include the following key factors:

| |  | Discount rates
Salary growth
Retirement rates |  | Inflation
Expected return on plan assets
Mortality rates |  | 
| |  | --------------------------------------------- |  | -------------------------------------------------------- |  | 

The Company bases the discount rate assumption on investment yields available at or near year-end on corporate long-term bonds rated AA.
The inflation assumption is based on an evaluation of external market indicators. The salary growth assumptions reflect the Company's long-term actual experience, the near-term
outlook and assumed inflation. The expected return on plan assets reflects asset allocations, investment strategy and the views of investment managers and other large pension plan sponsors. Retirement
and mortality rates are based primarily on actual plan experience and actuarial tables, respectively. The effects of actual results differing from our assumptions are accumulated and amortized over
future periods and, therefore, generally affect our recognized expense in such future periods.

29

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The Company's funding policy for the U.S. plans is to contribute amounts sufficient to meet the minimum funding requirement of the Employee Retirement Income Security Act of 1974, plus
any additional amounts the Company may deem to be appropriate. For 2004, the Company anticipates contributing $7.0 million to its U.S. plans and $0.9 million to its U.K. plans.

Postretirement Benefits Other Than Pensions The Company provides a single postretirement health care benefit for certain
employee groups in the United States. This plan is contributory and contains certain other cost-sharing features such as deductibles and coinsurance. The Company does not
pre-fund this plan and has the right to modify or terminate this plan in the future.

The
Company accounts for its postretirement benefits in accordance with Statement of Financial Accounting Standards (SFAS) No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions," which requires the postretirement liability recognized in the Consolidated Balance Sheets and the postretirement expense recognized in the Consolidated Statements of
Income be determined on an actuarial basis.

To
account for its postretirement benefits in accordance with SFAS No. 106, the Company must make two determinations. First, it must determine the actuarial assumption for the
discount rate used to reflect the time value of money in the calculation of the accumulated postretirement benefit obligation for the end of the current year and to determine the postretirement cost
for the subsequent year. For guidance in determining this rate, the Company looks at investment yields available at or near year-end on corporate bonds rated AA.

Second,
the Company must determine the actuarial assumption for the health care trend rate used in the calculation of the accumulated postretirement benefit obligation for the end of the
current year and to determine the net periodic postretirement benefit cost for the subsequent year. See Note 9 in the Notes to Consolidated Financial Statements for information on the
assumptions used as of December 31, 2003. As of December 31, 2003, a one-percentage-point change in the assumed health care cost trend rate would impact the expense
recognized in 2004 by $0.3 million and would affect the post-retirement benefit obligation by $2.3 million.

Deferred Income Taxes Tax regulations require items to be included in the tax return at different times than the items are
reflected in the financial statements. Some of the differences are permanent, such as expenses which are not deductible on a tax return, and some of the differences are temporary, such as depreciation
expense. Timing differences create deferred tax assets and liabilities.
Deferred tax assets generally are attributable to items that can be used as a tax deduction or credit in a tax return in future years but the amount has already been included as an expense in the
financial statements. Deferred tax liabilities generally represent deductions which have been taken on the tax return but have not been recognized as expense in the financial statements. Valuation
allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.

New Accounting Policies

In 2003 the Company adopted SFAS No. 146, "Accounting for the Costs Associated with Exit or Disposal Activities" which requires companies to recognize
liabilities and costs associated with exit or disposal activities when they are incurred, rather than when management commits to a plan to exit an activity. In 2003 the Company relocated the
operations of certain production facilities and began to restructure its sales and distribution operations in Europe. Certain costs incurred related to these restructurings were accounted for in
accordance with SFAS No. 146. Other costs, such as post-employment benefits and fixed asset disposals, were accounted for in accordance with accounting standards which were not
modified by the issuance of SFAS No. 146.

The
Company also adopted SFAS No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure" in 2003. SFAS No. 148, which amended SFAS
No. 123, provides alternative methods of

30

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transition
for companies that voluntarily change to the fair value based method of accounting for stock-based compensation. In particular, SFAS No. 148 allows entities that adopt the
recognition provisions of SFAS No. 123 for stock-based compensation in a fiscal year beginning before December 16, 2003 to use one of three methods for application. The Company adopted
the recognition provisions of SFAS No. 123 as of January 1, 2003. In accordance with SFAS No. 148, the Company has selected the prospective method of reporting this change in
accounting principle, which allows the Company to apply the recognition provisions to all employee awards granted, modified or settled after January 1, 2003.

In
May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150 requires
companies to classify certain financial instruments as liabilities that may previously have been classified as equity. The Company adopted SFAS No. 150 in 2003 and reviewed all joint venture
agreements which may require different accounting treatment under SFAS No. 150 than previously adopted. The Company has a limited partnership agreement which indicates a termination date of
December 31, 2035. This entity is consolidated in the Company's financial statements. The agreement indicates that if the partnership were to terminate the assets would be distributed in
accordance with the balance of the capital accounts. If the limited partnership were to terminate the Company estimates approximately $60 million would be distributed to the minority interest
owner.

The
FASB issued Interpretation (FIN) No. 46R, "Consolidation of Variable Interest Entities" in December 2003, which requires variable interest entities to be consolidated
by the party determined to be the primary beneficiary. A primary beneficiary of a variable interest entity (VIE) is the party that absorbs a majority of the entity's expected losses, receives a
majority of its expected residual returns, or both, as a result of holding the variable interest. The effective date for the adoption of FIN No. 46R for interests in VIEs created prior to
February 1, 2003 is the end of the first quarter, 2004 and the adoption is not expected to effect the Company's financial statements. The effective date for new VIEs created after
January 31, 2003 was immediate and the adoption had no effect on the Company's financial statements.

In
January 2004 the FASB issued Staff Position (FSP) 106-1 "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug Improvement and
Modernization Act of 2003" (the Act). The FSP permits a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer
accounting for the effects of the Act, which the Company has elected to do. Any measure of the accumulated postretirement benefit liability or net periodic postretirement benefit cost in the financial
statements or Note 9 in the Notes to Consolidated Financial Statements does not reflect the impact of the Act on the plans. At this time, specific authoritative guidance on the accounting for
the federal subsidy provided by the Act is pending and that guidance could require the Company to modify previously reported information, however the Company does not expect the Act to have a
significant effect on its financial statements.

Business Combination 

During the second quarter 2003, the Company exercised its option to acquire an additional 40 percent of the outstanding shares of Comatrol S.p.A for
approximately $10.3 million. With this purchase, the Company now owns 85 percent of Comatrol and has consolidated the financial results of the business for the last three quarters of
2003. Prior to purchasing its controlling interest in Comatrol, the Company accounted for the results of its ownership interest under the equity method of accounting. The Company has the option to
acquire the remaining ownership interest (15 percent) in Comatrol for approximately 3.7 million euros, which equates to $4.7 million at December 31, 2003, using an exchange
rate of 0.795 euros to the U.S. dollar. The option period runs from April 1, 2004 through April 30, 2004. Should the Company not elect to exercise this option, the minority owners of
Comatrol could exercise their option requiring the Company to acquire the remaining 15 percent of Comatrol for the amount disclosed above. This put option period runs from May 1, 2004
through May 31, 2004. Should neither party exercise their respective option, all such options expire after May 31, 2004.

31

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Non-Audit Services of Independent Auditors

The Company's auditors, KPMG LLP, perform the following non-audit services that have been approved by the Audit Committee of the Board of Directors:
international and U.S. tax planning and compliance services; tax and financial due diligence for acquisitions; expatriate tax services; benefit plan audits, tax and accounting technical support, and
internal control documentation analysis in connection with the requirements under section 404 of the Sarbanes Oxley Act.

Outlook

The Company is beginning to experience strong economic growth in the Americas and continued high growth in the Asia-Pacific region, but only mild
economic growth in Europe. The increasing trend in orders and backlog support the optimism related to sales growth. The Company plans to increase market share through strategic efforts to win new
applications and increase product content per vehicle. The Company has the capacity and is in good position to capitalize on the emerging upturn in the markets it serves. Management of the Company
expects to realize annual savings of over $2.5 million after tax, or $0.05 per share, from the restructurings completed in 2003. The Company will continue to evaluate whether to invest further
resources for restructurings during 2004 that would lead to improved earnings performance in future years.

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk.

Certain market risks are discussed on page 23 and page 24 of this report, and the other disclosure requirements are considered either not applicable or not
material.

Item 8.    Financial Statements and Supplementary Data.

The Consolidated Financial Statements, Report of Management, and Independent Auditors' Report are presented on pages 42-74 of this report.

Item 9A.    Controls and Procedures.

At December 31, 2003 the Registrant carried out an evaluation under the supervision and with the participation of the Registrant's management, including
the Registrant's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Registrant's disclosure controls and procedures pursuant to Exchange Act
Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Registrant's disclosure controls and procedures are
effective to ensure that information required to be disclosed in the reports that the Registrant files or submits under the Exchange Act is recorded, processed, summarized, and reported as required
and within the time periods specified in the SEC's rules and forms. There have been no significant changes in the Registrant's internal controls or in other factors that could significantly affect
these controls subsequent to the date of this evaluation.

32

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PART III

Item 10.    Directors and Executive Officers of the Registrant

Information regarding directors of the Company is set forth under the section entitled "Election of Directors" of the Company's Proxy Statement for the annual
meeting of stockholders to be held May 5, 2004, and is incorporated herein by reference. Information regarding executive officers of the Company is set forth in Part I of this report
under the caption "Executive Officers of the Company." Information regarding the failure of certain officers of the Company to file on a timely basis reports required by Section 16(a) of the
Securities Exchange Act of 1934 is set forth under the section entitled "Section 16(a) Beneficial Ownership Reporting Compliance" of the Company's Proxy Statement for the annual meeting of
stockholders to be held May 5, 2004, and is incorporated herein by reference. Information regarding the Company's code of conduct and code of ethics is set forth under the section entitled
"GOVERNANCE OF THE COMPANYCode of Conduct and Code of Ethics" of the Company's Proxy Statement for the annual meeting of stockholders to be held May 5, 2004, and is incorporated
herein by reference. Copies of the Worldwide Code of Legal and Ethical Business Conduct and the Code of Ethics for Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer or
Controller and other Senior Financial Staff are posted on the Company's website at
www.sauer-danfoss.com, and printed copies of such codes may be obtained, without charge, by written request addressed to Kenneth D. McCuskey, Corporate Secretary, 2800 E. 13th Street,
Ames, Iowa 50010.

The
Company's Audit Committee Charter and Compensation Committee Charter are posted on the Company's website set forth in the preceding paragraph. Also, printed copies of such charters
may be obtained, without charge, by sending a written request to the Corporate Secretary at the address set forth in the preceding paragraph.

Item 11.    Executive Compensation

Information as to Executive Compensation is set forth under the section entitled "Executive Compensation" of the Company's Proxy Statement for the annual meeting
of stockholders to be held May 5, 2004, and is incorporated herein by reference.

Item 12.    Security Ownership of Certain Beneficial Owners and Management

Information regarding securities authorized for issuance under equity compensation plans is set forth under the section entitled "Executive
Compensation  Equity Compensation" of the Company's Proxy Statement for the annual meeting of stockholders to be held May 5, 2004, and is incorporated herein by reference.
Information regarding security ownership is set forth under the section entitled "Security Ownership of Certain Beneficial Owners and Management" of the Company's Proxy Statement for the annual
meeting of stockholders to be held May 5, 2004, and is incorporated herein by reference.

Item 13.    Certain Relationships and Related Transactions

In connection with the acquisition of Danfoss Fluid Power in May 2000 and the acquisition of additional assets and business operations of the fluid power
business of Danfoss A/S in January 2001, the Company has entered into several agreements with Danfoss A/S to purchase ongoing operational services from Danfoss A/S. Information regarding these
relationships and agreements is set forth in Note 13 in the Notes to Consolidated Financial Statements on page 68 of this report, and is incorporated herein by reference. Information
regarding another related party transaction is set forth under the
section entitled "GOVERNANCE OF THE COMPANYRelated Transaction" of the Company's Proxy Statement for the annual meeting of stockholders to be held May 5, 2004.

Item 14.    Principal Accountant Fees and Services

Information regarding accounting services and fees is set forth under the section entitled "Ratification of Appointment of Independent Accountants" of the
Company's Proxy Statement for the annual meeting of stockholders to be held May 5, 2004, and is incorporated herein by reference.

33

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PART IV

Item 15.    Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

(1)   The
following consolidated financial statements and related information, included in Item 8, are filed as a separate section of this report:



(2)   The
following schedule:



(3)   Exhibits

| | Exhibit
No. |  | Description of Document                                                                                                                                                                                                                                                                   
| | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 3.1         |  | The Amended and Restated Certificate of Incorporation of the Company dated May 3, 2000, is attached as Exhibit 3.1 to the Company's Form 10-Q filed on August 16, 2000, and is incorporated herein by
reference.                                                                          
| | 3.2         |  | The Amended and Restated Bylaws of the Company dated June 4, 2003, is attached as Exhibit 3.2 to the Company's Form 10-Q filed on August 16, 2000, and is incorporated herein by reference.                                                                                               
| | 4           |  | The form of Certificate of the Company's Common Stock, $.01 Par Value, is attached as Exhibit 4 to the Company's Form 10-Q filed on August 13, 2003 and is incorporated herein by reference.                                                                                              
| | 10.1(a)     |  | The Termination Agreement and Release dated May 3, 2000 relating to the termination of a Silent Partnership Agreement is attached as Exhibit 10.1(a) to the Company's Form 10-Q filed on August 16, 2000, and is
incorporated herein by reference.                                        
| | 10.1(b)     |  | The Registration Rights Agreement is attached as Exhibit 10.1(b) to Amendment No. 1 to the Company's Form S-1 Registration Statement filed on April 23, 1998, and is incorporated herein by
reference.                                                                                    
| | 10.1(c)     |  | The form of Indemnification Agreement entered into between the Company and each of its directors and certain officers is attached as Exhibit 10.1(c) to Amendment No. 1 to the Company's Form S-1 Registration
Statement filed on April 23, 1998, and is incorporated herein by reference.
| |             |  |                                                                                                                                                                                                                                                                                           

34

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| | 10.1(d) |  | The Lease Agreement for the Company's Dubnica nad Váhom, Slovakia facility is attached as Exhibit 10.1(f) to Amendment No. 1 to the Company's Form S-1 Registration Statement filed on April 23, 1998, and
is incorporated herein by reference.
| | ------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 10.1(e) |  | The Lease Agreement for the Company's Swindon, England facility is attached as Exhibit 10.1(g) to Amendment No. 1 to the Company's Form S-1 Registration Statement filed on April 23, 1998, and is incorporated
herein by reference.           
| | 10.1(f) |  | The Lease Agreement for the Company's Minneapolis, Minnesota, facility is attached as Exhibit 10.1(h) to Amendment No. 1 to the Company's Form S-1 Registration Statement filed on April 23, 1998, and is
incorporated herein by reference.    
| | 10.1(g) |  | The Lease Agreement for the Company's Berching, Germany, facility dated November 15, 1996, is attached as Exhibit 10.1(g) to the Comp[any's Form 10-K filed on March 12, 2003, and is incorporated herein by
reference.                        
| | 10.1(h) |  | The Lease Agreement for the Company's Shanghai/Pudong, China, facility is attached as Exhibit 10.1(j) to Amendment No. 1 to the Company's Form S-1 Registration Statement filed on April 23, 1998, and is
incorporated herein by reference.    
| | 10.1(i) |  | The Lease Agreement for the Company's Odense, Denmark, facility dated November 15, 1996, is attached as Exhibit 10.1(h) to the Company's Form 10-K filed on March 12, 2003, and is incorporated herein by
reference.                           
| | 10.1(j) |  | The Indenture of Lease agreement for the Company's Norborg, Denmark, facility effective May 3, 2000, is attached as Exhibit 10.1(ah) to the Company's Form 10-K filed on March 30, 2001, and is incorporated
herein by reference.              
| | 10.1(k) |  | The Lease Agreement for the Company's Hillsboro, Oregon, facility effective January 19, 2001, is attached as Exhibit 10.1(ai) to the Company's Form 10-K filed on March 30, 2001, and is incorporated herein by
reference.                     
| | 10.1(l) |  | The Lease Agreement for the Company's leased facility in Ames, Iowa, effective April 1, 2002, is attached as Exhibit 10.1(am) to the Company's Form 10-Q filed on May 15, 2002, and is incorporated herein by
reference.                       
| | 10.1(m) |  | The Office Lease for the Company's Chicago, Illinois, Executive Office effective June 1, 2002, is attached as Exhibit 10.1(an) to the Company's Form 10-Q filed on May 15, 2002, and is incorporated herein by
reference.                      
| | 10.1(n) |  | The Executive Employment Agreement with David J. Anderson dated January 1, 2003, is attached as Exhibit 10.1(m) to the Company's Form 10-K filed on March 12, 2003, and is incorporated herein by
reference.                                   
| | 10.1(o) |  | The Executive Employment Agreement with Karl J. Schmidt dated January 1, 2003, is attached as Exhibit 10.1(n) to the Company's Form 10-K filed on March 12, 2003, and is incorporated herein by
reference.                                     
| | 10.1(p) |  | The Executive Employment Agreement with James R. Wilcox dated January 1, 2003, is attached as Exhibit 10.1(o) to the Company's Form 10-K filed on March 12, 2003, and is incorporated herein by
reference.                                     
| | 10.1(q) |  | The Executive Employment Agreement with Hans J. Cornett dated January 1, 2003, is attached as Exhibit 10.1(p) to the Company's Form 10-K filed on March 12, 2003, and is incorporated herein by
reference.                                     
| | 10.1(r) |  | The Executive Employment Agreement with Thomas Kittel dated January 1, 2003, is attached as Exhibit 10.1(q) to the Company's Form 10-K filed on March 12, 2003, and is incorporated herein by
reference.                                       
| |         |  |                                                                                                                                                                                                                                                

35

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| | 10.1(s)  |  | The Addendum to Executive Employment Agreement, dated December 1, 2002, relating to the Executive Employment Agreement referred to in 10.1(r) above with Thomas Kittel is attached as Exhibit 10.1(r) to the Company's
Form 10-K filed on March 12, 2003, and is incorporated herein by reference.                 
| | -------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 10.1(t)  |  | The Executive Employment Agreement with Finn Lyhne dated January 1, 2003, is attached as Exhibit 10.1(s) to the Company's Form 10-K filed on March 12, 2003, and is incorporated herein by
reference.                                                                                                              
| | 10.1(u)  |  | The Addendum to Executive Employment Agreement, dated December 1, 2002, relating to the Executive Employment Agreement referred to in 10.1(t) above with Finn Lyhne is attached as Exhibit 10.1(t) to the Company's
Form 10-K filed on March 12, 2003, and is incorporated herein by reference.                    
| | 10.1(v)  |  | The Executive Employment Agreement with Richard Jarboe dated January 1, 2003, is attached as Exhibit 10.1(u) to the Company's Form 10-K filed on March 12, 2003, and is incorporated herein by
reference.                                                                                                          
| | 10.1(w)  |  | The Executive Employment Agreement with Henrik Krabsen dated January 1, 2003, is attached as Exhibit 10.1(v) to the Company's Form 10-K filed on March 12, 2003, and is incorporated herein by
reference.                                                                                                          
| | 10.1(x)  |  | The Executive Employment Agreement with Kenneth D. McCuskey dated January 1, 2003, is attached as Exhibit 10.1(w) to the Company's Form 10-K filed on March 12, 2003, and is incorporated herein by
reference.                                                                                                     
| | 10.1(y)  |  | The Executive Employment Agreement with Albert Zahalka dated January 1, 2003, is attached as Exhibit 10.1(x) to the Company's Form 10-K filed on March 12, 2003, and is incorporated herein by
reference.                                                                                                          
| | 10.1(z)  |  | The Executive Employment Agreement with Ronald C. Hanson dated July 1, 2003, is attached hereto.                                                                                                                                                                                                                   
| | 10.1(aa) |  | The Amended and Restated Post-Retirement Care Agreement for Klaus Murmann, effective May 3, 2000, is attached as Exhibit 10.1 (s) to the Company's Form 10-Q filed on August 16, 2000, and is incorporated herein
by reference.                                                                                    
| | 10.1(ab) |  | The Sauer-Danfoss Inc. Annual Management Performance Incentive Plan restated as of January 1, 2002, is attached as Exhibit 10.1(ao) to the Company's Form 10-Q filed on May 15, 2002, and is incorporated herein by
reference.                                                                                     
| | 10.1(ac) |  | The Sauer-Sundstrand Company Supplemental Retirement Benefit Plan for Certain Key Executives is attached as Exhibit 10.1(t) to Amendment No. 1 to the Company's Form S-1 Registration Statement filed on April 23,
1998, and is incorporated herein by reference.                                                  
| | 10.1(ad) |  | The Sauer-Sundstrand Company Supplemental Retirement Benefit Plan for Certain Key Executives Previously Employed by the Sundstrand Corporation is attached as Exhibit 10.1(u) to Amendment No. 1 to the Company's
Form S-1 Registration Statement filed on April 23, 1998, and is incorporated herein by reference.
| | 10.1(ae) |  | The Sauer-Sundstrand Employees' Savings & Retirement Plan is attached as Exhibit 10.1(v) to Amendment No. 1 to the Company's Form S-1 Registration Statement filed on April 23, 1998, and is incorporated
herein by reference.                                                                                     
| | 10.1(af) |  | The Amendment Number One, effective December 15, 2000, to the Sauer-Sundstrand Employees' Savings and Retirement Plan referred to in Exhibit 10.1(ad) above, is attached as Exhibit 10.1(aj) to the Company's
Form 10-Q filed on August 15, 2001, and is incorporated herein by reference.                         
| |          |  |                                                                                                                                                                                                                                                                                                                    

36

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| | 10.1(ag) |  | The Amendment Number Two, effective January 1, 2002, to the Sauer-Danfoss Employees' Savings Plan, (formerly the Sauer-Sundstrand Employees' Savings and Retirement Plan), referred to in Exhibit 10.1(ad) above, is
attached as Exhibit 10.1(t) to the Company's Form 10-K filed on March 29, 2002, and is incorporated herein by reference.
| | -------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 10.1(ah) |  | Amendment No. 1 to the Compact Controls, Inc. 401(k) Plan and Amendment No. 3 to the Sauer-Danfoss Employees' Savings Plan, effective December 23, 2001, is attached hereto.                                                                                                                                                                 
| | 10.1(ai) |  | Amendment Number Four to the Sauer-Danfoss Employees' Savings Plan, effective February 8, 2002, is attached hereto.                                                                                                                                                                                                                          
| | 10.1(aj) |  | The Fifth Amendment to the Sauer-Danfoss Employees' Savings Plan, effective February 25, 2002, is attached hereto.                                                                                                                                                                                                                           
| | 10.1(ak) |  | Amendment Number 6 to the Sauer-Danfoss Employees' Savings Plan, effective July 24, 2002, is attached hereto.                                                                                                                                                                                                                                
| | 10.1(al) |  | Amendment Number 7 to the Sauer-Danfoss Employees' Savings Plan, effective January 20, 2003, is attached hereto.                                                                                                                                                                                                                             
| | 10.1(am) |  | Amendment Number Eight to the Sauer-Danfoss Employees' Savings Plan, effective January 24, 2003, is attached hereto.                                                                                                                                                                                                                         
| | 10.1(an) |  | Amendment Number 9 to the Sauer-Danfoss Employees' Savings Plan, effective December 18, 2003, is attached hereto.                                                                                                                                                                                                                            
| | 10.1(ao) |  | The European Employees' Pension Plan is attached as Exhibit 10.1(y) to Amendment No. 1 to the Company's Form S-1 Registration Statement filed on April 23, 1998, and is incorporated herein by
reference.                                                                                                                                    
| | 10.1(ap) |  | The Sauer-Danfoss Inc. 1998 Long-Term Incentive Plan is attached as Exhibit 10.1(p) to Amendment No. 1 to the Company's Form S-1 Registration Statement filed on April 23, 1998, and is incorporated herein by
reference.                                                                                                                    
| | 10.1(aq) |  | The Amendment, effective May 3, 2000, to the Sauer-Danfoss Inc. 1998 Long-Term Incentive Plan referred to in 10.1(ap) above is attached as Exhibit 10.1 (v) to the Company's Form 10-Q filed on August 16, 2000,
and is incorporated herein by reference.                                                                                    
| | 10.1(ar) |  | The Amendment to the Sauer-Danfoss Inc. 1998 Long-Term Incentive Plan effective December 4, 2002, is attached as Exhibit 10.1(bd) to the Company's Form 10-K filed on March 12, 2003, and is incorporated herein by
reference.                                                                                                               
| | 10.1(as) |  | The Sauer-Danfoss Inc. Non-employee Director Stock Option and Restricted Stock Plan is attached as Exhibit 10.1(q) to Amendment No. 1 to the Company's Registration Statement filed on April 23, 1998, and is
incorporated herein by reference.                                                                                              
| | 10.1(at) |  | The Amendment, effective May 3, 2000, to the Sauer-Danfoss Inc. Non-Employee Director Stock Option and Restricted Stock Plan referred to in 10.1(as) above is attached as Exhibit 10.1 (x) to the Company's
Form 10-Q filed on August 16, 2000, and is incorporated herein by reference.                                                     
| | 10.1(au) |  | The Amendment to the Sauer-Danfoss Inc. Non-Employee Director Stock Option and Restricted Stock Plan effective December 4, 2002, is attached as Exhibit 10.1(ak) to the Company's Form 10-K filed on March 12, 2003,
 and is incorporated herein by reference.                                                                               
| | 10.1(av) |  | The Trademark and Trade Name Agreement dated May 3, 2000, between the Company and Danfoss A/S is attached as Exhibit 10.1 (ac) to the Company's Form 10-Q filed on August 16, 2000, and is incorporated herein by
reference.                                                                                                                 
| | 10.1(aw) |  | The Stock Exchange Agreement dated January 22, 2000, by and among the Registrant, Danfoss A/S, Danfoss Murmann Holding A/S. and K. Murmann Verwaltungsgesellschaft mbH is attached as Annex A to the Company's Proxy
Statement filed on March 28, 2000, and is incorporated herein by reference.                                             
| |          |  |                                                                                                                                                                                                                                                                                                                                              

37

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| | 10.1(ax) |  | The Sauer-Danfoss Employees' Retirement Plan as amended and restated, effective January 1, 2000, and renamed as of May 3, 2000, is attached as Exhibit 10.1(ah) to the Company's Form 10-Q filed on November 15,
2000, and is incorporated herein by reference.                                                                              
| | -------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 10.1(ay) |  | The Amendment Number One, effective December 15, 2000, to the Sauer-Danfoss Employees' Retirement Plan referred to in Exhibit 10.1(ax) above, is attached as Exhibit 10.1(ax) to the Company's Form 10-Q filed
on August 15, 2001, and is incorporated herein by reference.                                                                  
| | 10.1(az) |  | The Second Amendment, effective March 26, 2001, to the Sauer-Danfoss Employees' Retirement Plan, (formerly the Sauer-Sundstrand Employees' Savings and Retirement Plan), referred to in Exhibit 10.1(ax) above, is
attached as Exhibit 10.1(ag) to the Company's Form 10-Q filed on August 15, 2001, and is incorporated herein by reference.
| | 10.1(ba) |  | The Third Amendment to the Sauer-Danfoss LaSalle Factory Employee Savings Plan, effective January 1, 2001, is attached as Exhibit 10.1(al) to the Company's Form 10-Q filed on November 14, 2001, and is
incorporated herein by reference.                                                                                                   
| | 10.1(bb) |  | Amendment Number Four to the Sauer-Danfoss LaSalle Factory Employee Savings Plan, effective February 8, 2002, is attached as Exhibit 10.1(ap) to the Company's Form 10-K filed on March 29, 2002, and is
incorporated herein by reference.                                                                                                   
| | 10.1(bc) |  | The Fifth Amendment to the Sauer-Danfoss LaSalle Factory Employee Savings Plan, effective February 25, 2002, is attached as Exhibit 10.1(aq) to the Company's Form 10-K filed on March 29, 2002, and is
incorporated herein by reference.                                                                                                    
| | 10.1(bd) |  | Amendment Number 6 to the Sauer-Danfoss LaSalle Factory Employee Savings Plan, effective January 20, 2003, is attached hereto.                                                                                                                                                                                                               
| | 10.1(be) |  | The Seventh Amendment to the Sauer-Danfoss LaSalle Factory Employee Savings Plan, effective January 1, 2004, is attached hereto.                                                                                                                                                                                                             
| | 10.1(bf) |  | The Sauer-Danfoss Racine Employees' Savings Plan, effective December 1, 2000, is attached as Exhibit 10.1(am) to the Company's Form 10-Q filed on November 14, 2001, and is incorporated herein by
reference.                                                                                                                                
| | 10.1(bg) |  | The Sauer-Danfoss Inc. Annual Officer Performance Incentive Plan (formerly known as the 1999 Sauer-Danfoss Inc. Bonus Plan) restated as of January 1, 2002, is attached as Exhibit 10.1(ap) to the Company's
Form 10-Q filed on May 15, 2002, and is incorporated herein by reference.                                                       
| | 10.1(bh) |  | The Sauer-Danfoss Inc. Annual Officer Performance Incentive Plan amended and restated as of March 4, 2003, is attached as Exhibit 10.1(bc) to the Company's Form 10-K filed on March 12, 2003 and is incorporated
herein by reference.                                                                                                       
| | 10.1(bi) |  | The Sauer-Danfoss Inc. Annual Officer Performance Incentive Plan amended and restated as of March 4, 2003, is attached as Exhibit 10.1(bc) to the Company's Form 10-K filed on March 12, 2003, and is incorporated
herein by reference.                                                                                                      
| | 10.1(bj) |  | The Separation Agreement and Release of All Claims entered into as of January 27, 2003 with Don O'Grady, is attached as Exhibit 10.1(ay) to the Company' Form 10-K filed on March 12, 2003, and is
incorporated herein by reference.                                                                                                         
| | 10.1(bk) |  | The Sauer-Danfoss Inc. Deferred Compensation Plan for Selected Employees dated December 9, 2003, is attached hereto.                                                                                                                                                                                                                         
| | 31.1     |  | Certification by the Chief Executive Officer Pursuant to Rule 13a-14(a).                                                                                                                                                                                                                                                                     
| | 31.2     |  | Certification by the Chief Financial Officer Pursuant to Rule 13a-14(a).                                                                                                                                                                                                                                                                     
| | 32.1     |  | Certification by the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350.                                                                                                                                                                                                                                                             
| | 32.2     |  | Certification by the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350.                                                                                                                                                                                                                                                             

38

---



39

---



SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

|                     | SAUER-DANFOSS INC.
|-------------------- | ------------------
|                     | By:               
|Date: March 15, 2004 |                   

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated. Each person signing below also hereby appoints David J. Anderson and Kenneth D. McCuskey, and each of them singly, his or her lawful
attorney-in-fact with full power to execute and file any and all amendments to this report together with exhibits thereto and generally to do all such things as such
attorney-in-fact may deem appropriate to enable Sauer-Danfoss Inc. to comply with the provisions of the Securities Exchange Act of 1934 and all requirements of the
Securities and Exchange Commission.

|Signature                                     |  | Title                                                           |  | Date          
|--------------------------------------------- |  | --------------------------------------------------------------- |  | --------------
|                                              |  |                                                                 |  |               
|/s/DAVID J. ANDERSONDavid J. Anderson         |  | Director and President and Chief Executive Officer              |  | March 15, 2004
|/s/KARL J. SCHMIDTKarl J. Schmidt             |  | Executive Vice President, Chief Financial Officer and Treasurer |  | March 15, 2004
|/s/KENNETH D. MCCUSKEYKenneth D. McCuskey     |  | Vice President and Chief Accounting Officer and Secretary       |  | March 15, 2004
|/s/OLE STEEN ANDERSENOle Steen Andersen       |  | Director                                                        |  | March 15, 2004
|/s/JOERGEN M. CLAUSENJoergen M. Clausen       |  | Director                                                        |  | March 15, 2004
|/s/NICOLA KEIMNicola Keim                     |  | Director                                                        |  | March 15, 2004
|/s/JOHANNES F. KIRCHHOFFJohannes F. Kirchhoff |  | Director                                                        |  | March 15, 2004
|                                              |  |                                                                 |  |               

40

---

|/s/HANS KIRKHans Kirk                   |  | Director |  | March 15, 2004
|--------------------------------------- |  | -------- |  | --------------
|/s/F. JOSEPH LOUGHREYF. Joseph Loughrey |  | Director |  | March 15, 2004
|/s/KLAUS H. MURMANNKlaus H. Murmann     |  | Director |  | March 15, 2004
|/s/SVEN MURMANNSven Murmann             |  | Director |  | March 15, 2004
|/s/STEVEN H. WOODSteven H. Wood         |  | Director |  | March 15, 2004

41

---



Sauer-Danfoss Inc. and Subsidiaries        Consolidated Statements of Income        (in thousands, except per share data)

|                                                                      |                                     | For the Years Ended December 31, |                           
|--------------------------------------------------------------------- | ----------------------------------- | -------------------------------- | --------------------------
|
|
|Net Sales                                                             |                                     | $                                | 1,126,774                 
|Costs and Expenses:                                                   |                                     |                                  |                           
|                                                                      | Cost of sales                       |                                  |                           
|                                                                      | Selling, general and administrative |                                  |                           
|                                                                      | Research and development            |                                  |                           
|                                                                      | Loss on disposal of fixed assets    |                                  |                           
|                                                                      |                                     |                                  |                           
|                                                                      |                                     |                                  | Total costs and expenses  
|                                                                      |                                     |                                  |                           
|                                                                      |                                     |                                  | Operating income          
|                                                                      |                                     |                                  |                           
|Nonoperating Income (Expenses):                                       |                                     |                                  |                           
|                                                                      | Interest expense                    |                                  |                           
|                                                                      | Interest income                     |                                  |                           
|                                                                      | Royalty income                      |                                  |                           
|                                                                      | Other, net                          |                                  |                           
|                                                                      |                                     |                                  |                           
|                                                                      |                                     |                                  | Nonoperating expenses, net
|                                                                      |                                     |                                  |                           
|Income Before Income Taxes and Minority Interest                      |                                     |                                  | 26,164                    
|Minority Interest and Equity Income, net                              |                                     |                                  | (15,405                   
|                                                                      |                                     |                                  |                           
|Income Before Income Taxes                                            |                                     |                                  | 10,759                    
|Income Tax Benefit (Expense)                                          |                                     |                                  | 474                       
|                                                                      |                                     |                                  |                           
|Net Income Before Cumulative Effect of Change in Accounting Principle |                                     |                                  | 11,233                    
|Cumulative Effect of Change in Accounting Principle                   |                                     |                                  |                          
|                                                                      |                                     |                                  |                           
|                                                                      |                                     |                                  | Net Income                
|                                                                      |                                     |                                  |                           
|Basic and diluted income per common share                             |                                     | $                                | 0.24                      
|                                                                      |                                     |                                  |                           
|Weighted average diluted shares outstanding                           |                                     |                                  | 47,516                    
|
|
|Net income:                                                           |                                     |                                  |                           
|Reported net income                                                   |                                     | $                                | 11,233                    
|Add back goodwill amortization                                        |                                     |                                  |                          
|                                                                      |                                     |                                  |                           
|Adjusted net income                                                   |                                     | $                                | 11,233                    
|                                                                      |                                     |                                  |                           
|Income per share:                                                     |                                     |                                  |                           
|Reported basic and diluted income per common share                    |                                     | $                                | 0.24                      
|Add back goodwill amortization                                        |                                     |                                  |                          
|                                                                      |                                     |                                  |                           
|Adjusted basic and diluted income per common share                    |                                     | $                                | 0.24                      
|                                                                      |                                     |                                  |                           

See accompanying notes to consolidated financial statements.

42

---

Sauer-Danfoss Inc. and Subsidiaries        Consolidated Balance Sheets        (in thousands, except per share data)

|                                                          |                                                                                                                                             | As of December 31, |                           
|--------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------- | ------------------ | --------------------------
|
|
|Assets                                                    |                                                                                                                                             |                    |                           
|Current Assets:                                           |                                                                                                                                             |                    |                           
|                                                          | Cash and cash equivalents                                                                                                                   |                    | $                         
|                                                          | Accounts receivable (net of allowance for doubtful accounts of $4,144 and $3,372 in 2003 and 2002, respectively)                            |                    |                           
|                                                          | Inventories                                                                                                                                 |                    |                           
|                                                          | Other current assets                                                                                                                        |                    |                           
|                                                          |                                                                                                                                             |                    |                           
|                                                          |                                                                                                                                             |                    | Total current assets      
|                                                          |                                                                                                                                             |                    |                           
|Property, Plant and Equipment, net                        |                                                                                                                                             |                    | 452,913                   
|                                                          |                                                                                                                                             |                    |                           
|Other Assets:                                             |                                                                                                                                             |                    |                           
|                                                          | Goodwill, net                                                                                                                               |                    |                           
|                                                          | Other intangible assets, net                                                                                                                |                    |                           
|                                                          | Investments in unconsolidated affiliates                                                                                                    |                    |                           
|                                                          | Deferred income taxes                                                                                                                       |                    |                           
|                                                          | Other                                                                                                                                       |                    |                           
|                                                          |                                                                                                                                             |                    |                           
|                                                          |                                                                                                                                             |                    | Total other assets        
|                                                          |                                                                                                                                             |                    |                           
|                                                          |                                                                                                                                             | $                  | 1,101,754                 
|                                                          |                                                                                                                                             |                    |                           
|Liabilities and Stockholders' Equity                      |                                                                                                                                             |                    |                           
|Current Liabilities:                                      |                                                                                                                                             |                    |                           
|                                                          | Notes payable and bank overdrafts                                                                                                           |                    | $                         
|                                                          | Long-term debt due within one year                                                                                                          |                    |                           
|                                                          | Accounts payable                                                                                                                            |                    |                           
|                                                          | Accrued salaries and wages                                                                                                                  |                    |                           
|                                                          | Accrued warranty                                                                                                                            |                    |                           
|                                                          | Other accrued liabilities                                                                                                                   |                    |                           
|                                                          |                                                                                                                                             |                    |                           
|                                                          |                                                                                                                                             |                    | Total current liabilities 
|                                                          |                                                                                                                                             |                    |                           
|Long-Term Debt                                            |                                                                                                                                             |                    | 130,408                   
|                                                          |                                                                                                                                             |                    |                           
|Other Liabilities:                                        |                                                                                                                                             |                    |                           
|                                                          | Long-term pension liability                                                                                                                 |                    |                           
|                                                          | Postretirement benefits other than pensions                                                                                                 |                    |                           
|                                                          | Deferred income taxes                                                                                                                       |                    |                           
|                                                          | Other                                                                                                                                       |                    |                           
|                                                          |                                                                                                                                             |                    |                           
|                                                          |                                                                                                                                             |                    | Total other liabilities   
|                                                          |                                                                                                                                             |                    |                           
|Minority Interest in Net Assets of Consolidated Companies |                                                                                                                                             |                    | 32,353                    
|                                                          |                                                                                                                                             |                    |                           
|Stockholders' Equity:                                     |                                                                                                                                             |                    |                           
|                                                          | Preferred stock, par value $.01 per share, authorized 4,500 shares, no shares issued or outstanding                                         |                    |                           
|                                                          | Common stock, par value $.01 per share, authorized 75,000 shares in 2003 and 2002; issued and outstanding 47,432 in 2003 and 47,419 in 2002 |                    |                           
|                                                          | Additional paid-in capital                                                                                                                  |                    |                           
|                                                          | Retained earnings                                                                                                                           |                    |                           
|                                                          | Accumulated other comprehensive income                                                                                                      |                    |                           
|                                                          | Unamortized restricted stock compensation                                                                                                   |                    |                           
|                                                          |                                                                                                                                             |                    |                           
|                                                          |                                                                                                                                             |                    | Total stockholders' equity
|                                                          | Commitments and contingencies                                                                                                               |                    |                           
|                                                          |                                                                                                                                             | $                  | 1,101,754                 
|                                                          |                                                                                                                                             |                    |                           

See accompanying notes to consolidated financial statements.

43

---



Sauer-Danfoss Inc. and Subsidiaries        Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)

|(in thousands, except per share data)          |                                                          | Number of
Shares
Outstanding |       | Common
Stock |     | Additional
Paid-in
Capital |   | Retained
Earnings |       | Accumulated
Other
Comprehensive
Income (Loss) |        | Unamortized
Restricted
Stock
Compensation |   | Common
Stock
in
Treasury |        | Total |     
|---------------------------------------------- | -------------------------------------------------------- | ---------------------------- | ----- | ------------ | --- | -------------------------- | - | ----------------- | ----- | --------------------------------------------- | ------ | ----------------------------------------- | - | ------------------------ | ------ | ----- | ----
|Year Ended December 31, 2001:                  |                                                          |                              |       |              |     |                            |   |                   |       |                                               |        |                                           |   |                          |        |       |     
|Beginning balance, as previously reported      |                                                          | 45,312                       |       | $            | 465 |                            | $ | 303,304           |       | $                                             | 57,348 |                                           | $ | (10,654                  | )      | $     | (57 
|Restatement adjustment                         |                                                          |                             |       |              |    |                            |   |                  |       |                                               | (967   | )                                         |   |                         |        |       |    
|                                               |                                                          |                              |       |              |     |                            |   |                   |       |                                               |        |                                           |   |                          |        |       |     
|Beginning balance, (as restated  see Note 17) |                                                          | 45,312                       |       |              | 465 |                            |   | 303,304           |       |                                               | 56,381 |                                           |   | (10,654                  | )      |       | (57 
|Comprehensive income (loss):                   |                                                          |                              |       |              |     |                            |   |                   |       |                                               |        |                                           |   |                          |        |       |     
|                                               | Net income (as restated  see Note 17)                   |                              |      |              |     |                           |   |                   |      |                                               |        | 4,336                                     |   |                          |       |       |     
|                                               | Pension adjustment                                       |                              |      |              |     |                           |   |                   |      |                                               |        |                                          |   |                          | (200   | )     |     
|                                               | Translation adjustment                                   |                              |      |              |     |                           |   |                   |      |                                               |        |                                          |   |                          | (4,809 | )     |     
|Total comprehensive loss                       |                                                          |                             |       |              |    |                            |   |                  |       |                                               |       |                                           |   |                         |        |       |    
|                                               | Treasury shares issued for acquisition                   |                              | 1,172 |              |     |                           |   |                   | 2,244 |                                               |        |                                          |   |                          |       |       |     
|                                               | Shares issued for acquisition                            |                              | 919   |              |     | 9                          |   |                   | 8,036 |                                               |        |                                          |   |                          |       |       |     
|                                               | Restricted stock grant                                   |                              | 8     |              |     |                           |   |                   | 78    |                                               |        |                                          |   |                          |       |       |     
|                                               | Restricted stock compensation                            |                              |      |              |     |                           |   |                   |      |                                               |        |                                          |   |                          |       |       |     
|                                               | Cash dividends ($.28 per share)                          |                              |      |              |     |                           |   |                   |      |                                               |        | (13,275                                   | ) |                          |       |       |     
|                                               |                                                          |                              |       |              |     |                            |   |                   |       |                                               |        |                                           |   |                          |        |       |     
|Ending balance (as restated  see Note 17)     |                                                          | 47,411                       |       |              | 474 |                            |   | 313,662           |       |                                               | 47,442 |                                           |   | (15,663                  | )      |       | (92 
|                                               |                                                          |                              |       |              |     |                            |   |                   |       |                                               |        |                                           |   |                          |        |       |     
|Year Ended December 31, 2002:                  |                                                          |                              |       |              |     |                            |   |                   |       |                                               |        |                                           |   |                          |        |       |     
|Comprehensive income (loss):                   |                                                          |                              |       |              |     |                            |   |                   |       |                                               |        |                                           |   |                          |        |       |     
|                                               | Net income (as restated  see Note 17)                   |                              |      |              |     |                           |   |                   |      |                                               |        | 13,705                                    |   |                          |       |       |     
|                                               | Pension adjustment                                       |                              |      |              |     |                           |   |                   |      |                                               |        |                                          |   |                          | (1,353 | )     |     
|                                               | Unrealized gains on forward currency exchange contracts  |                              |      |              |     |                           |   |                   |      |                                               |        |                                          |   |                          | 1,427  |       |     
|                                               | Translation adjustment                                   |                              |      |              |     |                           |   |                   |      |                                               |        |                                          |   |                          | 20,935 |       |     
|Total comprehensive income                     |                                                          |                             |       |              |    |                            |   |                  |       |                                               |       |                                           |   |                         |        |       |    
|                                               | Restricted stock grant                                   |                              | 8     |              |     |                           |   |                   | 98    |                                               |        |                                          |   |                          |       |       |     
|                                               | Restricted stock compensation                            |                              |      |              |     |                           |   |                   |      |                                               |        |                                          |   |                          |       |       |     
|                                               | Cash dividends ($.28 per share)                          |                              |      |              |     |                           |   |                   |      |                                               |        | (13,277                                   | ) |                          |       |       |     
|                                               |                                                          |                              |       |              |     |                            |   |                   |       |                                               |        |                                           |   |                          |        |       |     
|Ending balance (as restated  see Note 17)     |                                                          | 47,419                       |       |              | 474 |                            |   | 313,760           |       |                                               | 47,870 |                                           |   | 5,346                    |        |       | (119
|                                               |                                                          |                              |       |              |     |                            |   |                   |       |                                               |        |                                           |   |                          |        |       |     
|Year Ended December 31, 2003:                  |                                                          |                              |       |              |     |                            |   |                   |       |                                               |        |                                           |   |                          |        |       |     
|Comprehensive income (loss):                   |                                                          |                              |       |              |     |                            |   |                   |       |                                               |        |                                           |   |                          |        |       |     
|                                               | Net income                                               |                              |      |              |     |                           |   |                   |      |                                               |        | 11,233                                    |   |                          |       |       |     
|                                               | Pension adjustment                                       |                              |      |              |     |                           |   |                   |      |                                               |        |                                          |   |                          | (1,935 | )     |     
|                                               | Unrealized losses on forward currency exchange contracts |                              |      |              |     |                           |   |                   |      |                                               |        |                                          |   |                          | (1,360 | )     |     
|                                               | Translation adjustment                                   |                              |      |              |     |                           |   |                   |      |                                               |        |                                          |   |                          | 35,325 |       |     
|Total comprehensive income                     |                                                          |                             |       |              |    |                            |   |                  |       |                                               |       |                                           |   |                         |        |       |    
|                                               | Stock incentive expense                                  |                              |      |              |     |                           |   |                   | 423   |                                               |        |                                          |   |                          |       |       |     
|                                               | Restricted stock grant                                   |                              | 13    |              |     |                           |   |                   | 136   |                                               |        |                                          |   |                          |       |       |     
|                                               | Restricted stock compensation                            |                              |      |              |     |                           |   |                   |      |                                               |        |                                          |   |                          |       |       |     
|                                               | Deemed dividend                                          |                              |      |              |     |                           |   |                   |      |                                               |        | (621                                      | ) |                          |       |       |     
|                                               | Cash dividends ($.28 per share)                          |                              |      |              |     |                           |   |                   |      |                                               |        | (13,280                                   | ) |                          |       |       |     
|                                               |                                                          |                              |       |              |     |                            |   |                   |       |                                               |        |                                           |   |                          |        |       |     
|Ending balance                                 |                                                          | 47,432                       |       | $            | 474 |                            | $ | 314,319           |       | $                                             | 45,202 |                                           | $ | 37,376                   |        | $     | (157
|                                               |                                                          |                              |       |              |     |                            |   |                   |       |                                               |        |                                           |   |                          |        |       |     

See accompanying notes to consolidated financial statements.

44

---

Sauer-Danfoss Inc. and Subsidiaries        Consolidated Statements of Cash Flows

|                                                                                                                                                                                                                          |                                                                  | For the Years Ended December 31,                                                  |                                                                            
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------- | --------------------------------------------------------------------------------- | ---------------------------------------------------------------------------
|
|
|Cash Flows from Operating Activities:                                                                                                                                                                                     |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Net income                                                       |                                                                                   | $                                                                          
|                                                                                                                                                                                                                          |                                                                  | Adjustments to reconcile net income to net cash provided by operating activities: |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   | Cumulative effect of change in accounting principle                        
|                                                                                                                                                                                                                          |                                                                  |                                                                                   | Depreciation and amortization                                              
|                                                                                                                                                                                                                          |                                                                  |                                                                                   | Minority interest and equity income, net                                   
|                                                                                                                                                                                                                          |                                                                  |                                                                                   | (Increase) decrease in working capital, excluding effects of acquisitions 
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   | Other                                                                      
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|Cash Flows from Investing Activities:                                                                                                                                                                                     |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Purchases of property, plant and equipment                       |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Payments for acquisitions, net of cash acquired                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Proceeds from sales of property, plant and equipment             |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|Cash Flows from Financing Activities:                                                                                                                                                                                     |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Net borrowings (repayments) on notes payable and bank overdrafts |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Net borrowings (repayments) on revolving credit facility         |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Net borrowings (repayments) of long-term debt                    |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Payments for debt financing costs                                |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Cash dividends                                                   |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Distribution to minority interest partners                       |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|Effect of Exchange Rate Changes on Cash                                                                                                                                                                                   |                                                                  |                                                                                   | 953                                                                        
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|Cash and Cash Equivalents:                                                                                                                                                                                                |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Net increase (decrease) during the year                          |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Beginning balance                                                |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|Supplemental Cash Flow Disclosures:                                                                                                                                                                                       |                                                                  |                                                                                   |                                                                            
|Interest paid                                                                                                                                                                                                             |                                                                  | $                                                                                 | 18,581                                                                     
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|Income taxes paid                                                                                                                                                                                                         |                                                                  | $                                                                                 | 12,825                                                                     
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|Supplemental schedule of noncash investing and financing activities:                                                                                                                                                      |                                                                  |                                                                                   |                                                                            
|During 2001, the Company acquired assets of certain distribution operations of the fluid power business of Danfoss A/S in exchange for 2,091 shares of common stock. The consideration paid and allocation is as follows: |                                                                  |                                                                                   |                                                                            
|Consideration paid:                                                                                                                                                                                                       |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Common stock issued at fair value                                |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Other liabilities assumed                                        |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                           
|Allocated to:                                                                                                                                                                                                             |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Inventory                                                        |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Accounts receivable                                              |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Other current assets                                             |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Property, plant and equipment                                    |                                                                                   |                                                                            
|                                                                                                                                                                                                                          | Goodwill and other intangibles                                   |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                            
|                                                                                                                                                                                                                          |                                                                  |                                                                                   |                                                                           

See accompanying notes to consolidated financial statements.

45

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Sauer-Danfoss Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2003, 2002, and 2001

(in thousands, except per share data)

(1) Summary of Significant Accounting Policies:

Basis of Presentation and Principles of Consolidation 

Sauer-Danfoss Inc., a U.S. Delaware corporation, and subsidiaries (the Company) is a leading international manufacturer of components and integrated
hydraulic, electric, and electronic systems that generate, transmit and control power in mobile equipment. The Company's products are used by original equipment manufacturers of mobile equipment,
including construction, road building, agricultural, turf care, and specialty vehicle equipment. The Company's products are sold throughout the world either directly or through distributors.

The
consolidated financial statements represent the consolidation of all companies in which the Company has a controlling interest and are stated in accordance with accounting principles
generally accepted in the United States of America. The Company records its investment in each unconsolidated
affiliated company (generally 20 to 50 percent owned) at its related equity in the net assets of such affiliate. All significant intercompany balances, transactions and profits have been
eliminated in the consolidated financial statements.

Use of Estimates 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make
estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results may differ from those estimates.

Revenue Recognition 

Net sales are recorded at the time of shipment to customers along with related expenses including estimates for future warranty expense. This is consistent with
when the risks and rewards of ownership and title to the product have transferred to the customer.

Cash and Cash Equivalents 

Cash equivalents are considered by the Company to be all highly liquid instruments purchased with original maturities of three months or less.

Trade Receivables 

The Company records trade receivables due from its customers at the time sales are recorded in accordance with its revenue recognition policy. The future
collectibility of these amounts can be impacted by the Company's collection efforts, the financial stability of its customers, and the general economic climate in which it operates. The Company
applies a consistent practice of establishing an allowance for accounts that it believes may become uncollectible through reviewing the historical aging of its receivables and by monitoring the
financial strength of its customers. If the Company becomes aware of a customer's inability to meet its financial obligations (e.g., where it has filed for bankruptcy), the Company establishes a
specific allowance for the potential bad debt to reduce the net recognized receivable to the amount it reasonably believes will be collected. The valuation of trade receivables is performed quarterly.

46

---

Inventories 

Inventories are valued at the lower of cost or market, using various cost methods, and include the cost of material, labor and factory overhead. The percentage of
year-end inventory valued under the average cost, first-in, first-out (FIFO), and last-in, first-out (LIFO) methods was 54%, 28%, and 18%,
respectively, for 2003 and 55%, 28%, and 17%, respectively, for 2002.

Property, Plant and Equipment and Depreciation 

Property, plant and equipment are stated at historical cost, net of accumulated depreciation. Depreciation is generally computed using the
straight-line method for building equipment and buildings over 10 to 37 years and for machinery and equipment over 3 to 8 years (3 to 12 years for additions in 1999
and prior). Additions and improvements that substantially extend the useful life of a particular asset are capitalized. Repair and maintenance costs ($22,390, $20,264 and $22,012 in 2003, 2002, and
2001, respectively) are charged to expense. When property, plant and equipment are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any
gain or loss is included in the consolidated statements of income.

Goodwill and Other Intangible Assets 

Goodwill and other intangibles represent the excess of the purchase price over the estimated fair values of net tangible assets acquired in the purchase of
businesses. Prior to 2002, goodwill and other intangibles were being amortized on a straight-line basis over periods ranging from 2 to 40 years or the specific remaining
identifiable life on a straight-line basis. Beginning in 2002 with the adoption of Statement of Financial Accounting Standards (SFAS) No. 142, the Company no longer amortizes
goodwill and will write down goodwill only for impairments. Other intangibles with remaining identifiable lives will continue to be amortized as they have been in the past. Refer to Note 3 for
a summary of activity in goodwill for 2003 and 2002. The following table details the components of the other intangible assets balances at December 31, 2003 and 2002:

|                             |  | Trade
Name |        | Technology |   | Customer
Relationships |  | Other |       | Total
|---------------------------- |  | ---------- | ------ | ---------- | - | ---------------------- |  | ----- | ----- | -----
|December 31, 2003            |  |            |        |            |   |                        |  |       |       |      
|Cost                         |  | $          | 19,000 |            | $ | 11,358                 |  | $     | 7,271 |      
|Accumulated amortization     |  |            | 1,629  |            |   | 2,254                  |  |       | 433   |      
|                             |  |            |        |            |   |                        |  |       |       |      
|Other intangible assets, net |  | $          | 17,371 |            | $ | 9,104                  |  | $     | 6,838 |      
|                             |  |            |        |            |   |                        |  |       |       |      
|December 31, 2002            |  |            |        |            |   |                        |  |       |       |      
|Cost                         |  | $          | 19,000 |            | $ | 10,700                 |  | $     | 500   |      
|Accumulated amortization     |  |            | 1,086  |            |   | 1,426                  |  |       | 34    |      
|                             |  |            |        |            |   |                        |  |       |       |      
|Other intangible assets, net |  | $          | 17,914 |            | $ | 9,274                  |  | $     | 466   |      
|                             |  |            |        |            |   |                        |  |       |       |      

47

---

Amortization of other intangibles was $2,793 and $3,642 in 2003 and 2002, respectively. Amortization of goodwill and other intangibles was $6,946 for 2001.
Amortization expense is expected to be approximately $2,500 for each of the next three years, $2,300 in 2007 and $1,700 in 2008.

Product Warranty 

The Company warrants its various products over differing periods depending upon the type of product and application. Consequently, the Company records warranty
liabilities for the estimated costs that may be incurred under its basic warranty based on past trends of actual warranty claims compared to the actual sales levels to which those claims apply. These
liabilities are accrued at the time the sales of the products are recorded. Factors that affect the Company's warranty liability include the number of units in the field currently under warranty,
historical and anticipated rates of warranty claims on those units and the cost per claim to satisfy the Company's warranty obligation. The anticipated rate of warranty claims is the primary factor
impacting the Company's estimated warranty obligation. Each quarter, the Company reevaluates its estimates to assess the adequacy of its recorded warranty liabilities and adjusts the amounts as
necessary.

In
addition to its normal warranty liability, the Company, from time to time in the normal course of business, incurs costs to repair or replace defective products with a specific
customer or group of customers. The Company refers to these as field recalls and in these instances, the Company records a specific provision for the expected costs it will incur to repair or replace
these products utilizing information from customers and internal information regarding the specific cost of materials and labor. Due to the sporadic and infrequent nature of field recalls, and the
potential for a range of costs associated with field recalls, the Company cannot accurately estimate these costs at the time the products are sold. Therefore, these costs are recorded at the time
information becomes known to the
Company. As the field recalls are carried out, the Company relieves the specific liability related to that field recall. These specific field recall liabilities are reviewed on a quarterly basis, if
not more frequently. The following table presents the activity in the accrued warranty and field recall accounts for the years ended December 31, 2003 and 2002:

Year Ended December 31,2003

2002Balance at January 1

$
14,242

$
8,472Amounts assumed in acquisition





434Charged to costs and expenses


8,757


7,482Settlement of warranty and field recall claims


(6,979
)

(2,763
)Effect of exchange rate changes


1,176


617Balance at December 31

$
17,196

$
14,242


Impairment of Long-Lived Assets and Assets to be Disposed Of 

Consistent with the requirements of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," the Company periodically
assesses whether events or circumstances have occurred

48

---

that
may indicate the carrying value of its long-lived tangible and intangible assets may not be recoverable. The carrying value of long-lived tangible and intangible assets to
be held and used is evaluated based on the expected future undiscounted operating cash flows. When events or circumstances indicate the carrying value of an asset is impaired, the Company recognizes
an impairment loss to the extent that the carrying value of the assets exceeds the fair value of the assets. Refer to Note 6 for discussion of the $1,500 impairment charge recorded in 2003.

Income Taxes 

The provision for income taxes has been determined using the asset and liability approach of accounting for income taxes. Under this approach, deferred taxes
represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. The provision for income taxes represents income taxes paid or
payable for the current year plus the change in deferred taxes during the year. Deferred taxes result from differences between the financial and tax bases of the Company's assets and liabilities, net
operating loss carryforwards, and tax credits and are adjusted for changes in tax rates and tax laws when changes are enacted. Valuation allowances are recorded to reduce deferred tax assets when it
is more likely than not that a tax benefit will not be realized.

Income Per Share 

Basic net income per common share is based on the weighted average number of common shares outstanding in each year. Diluted net income per common share assumes
that outstanding common shares were increased by shares issuable upon exercise of restricted stock shares, which have no exercise price.

Fair Value of Financial Instruments 

Fair value estimates, methods, and assumptions are set forth below.

The
carrying values of cash and cash equivalents, accounts and other receivables, notes payable and bank overdrafts, and accounts payable approximates fair value because of the
short-term nature of these instruments.

The
fair value of long-term debt is calculated by discounting scheduled cash flows through maturity using estimated market discount rates. The discount rate is estimated
using the rates currently offered for long-term debt of similar remaining maturities. At December 31, 2003, the Company estimated the fair value of its long-term debt,
including amounts due within one year, at $295,686 compared to its carrying value of $289,998. The estimated fair value of long term debt at December 31, 2002 was $266,998 compared to its
carrying value of $262,283. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in
assumptions could significantly affect these estimates.

Translation of Foreign Currencies 

Assets and liabilities of consolidated foreign subsidiaries are translated into U.S. dollars at exchange rates in effect at the end of each period, while revenues
and expenses are translated at average exchange

49

---

rates
prevailing during the period. The resulting translation adjustments are included in stockholders' equity. Gains or losses on transactions denominated in foreign currencies and the related tax
effects are reflected in the consolidated statements of income. Due to changes in translation rates between periods, comparisons of balances and revenue and expense activity between periods may not be
meaningful.

Derivatives and Hedging 

During 2002, the Company entered into a foreign currency hedge contract to protect against the effects of foreign currency fluctuations for a loan to the U.S.
holding company from a Danish bank denominated in euros. At December 31, 2003, the notional amount of this hedge was 25,350 euros and it expires in January, 2005. The
mark-to-market gain or loss due to currency fluctuations on both the loan and the currency contract are reported in Other Income (Expense) in the Consolidated Statements of
Income.

New Accounting Principles 

In 2003 the Company adopted, SFAS No. 146, "Accounting for the Costs Associated with Exit or Disposal Activities" which requires companies to recognize
liabilities and costs associated with exit or disposal activities when they are incurred, rather than when management commits to a plan to exit an activity. In 2003 the Company relocated the
operations of certain production facilities and began to restructure its sales and distribution operations in Europe. Certain costs incurred related to these restructurings were accounted for in
accordance with SFAS No. 146. Other costs, such as postemployment benefits and fixed asset disposals, were accounted for in accordance with accounting standards which were not modified by the
issuance of SFAS No. 146.

The
Company also adopted SFAS No. 148, "Accounting for Stock-Based Compensation  Transition and Disclosure" in 2003. SFAS No. 148, which amended
SFAS No. 123, provides alternative methods of transition for companies that voluntarily change to the fair value based method of accounting for stock-based compensation. In particular, SFAS
No. 148 allows entities that adopt the recognition provisions of SFAS No. 123 for stock-based compensation in a fiscal year beginning before December 16, 2003 to use one of three
methods for application. The Company adopted the recognition provisions of SFAS No. 123 as of January 1, 2003 using the fair-value method. In accordance with SFAS
No. 148, the Company has selected the prospective method of reporting this change in accounting principle, which allows the Company to apply the recognition provisions to all employee awards
granted, modified or settled after January 1, 2003.

In
May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150 requires
companies to classify certain financial instruments as liabilities that may previously have been classified as equity. The Company adopted SFAS No. 150 in 2003 and reviewed all joint venture
agreements which may require different accounting treatment under SFAS No. 150 than previously adopted. The Company has a limited partnership agreement which indicates a termination date of
December 31, 2035. This entity is consolidated in the Company's financial statements. The agreement indicates that if the partnership were to terminate the assets would be distributed in
accordance with the balance of the capital accounts. If the

50

---

limited
partnership were to terminate the Company estimates approximately $60,000 would be distributed to the minority interest owner.

Effective
January 1, 2002 the Company adopted SFAS No. 141, "Business Combinations," which requires the purchase method of accounting be used for all business combinations,
and SFAS No. 142, "Goodwill and Other Intangible Assets", which requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for
impairment anually. In connection with the adoption of SFAS No. 142, the Company reclassified $6,091 of "Established Workforce" from other intangibles into goodwill and performed an evaluation
of goodwill as of January 1, 2002. The results of this evaluation indicated that goodwill related to the open circuit reporting unit within the Work Function segment was impaired. The
performance of this reporting unit has not met management's original expectations, primarily due to economic factors and the competitive nature of this commodity-type product. The Company
measured the amount of impairment based on a comparison of the fair value to its carrying value. Fair value was determined using a discounted cash flow methodology by applying an appropriate weighted
average cost of capital, and cost methodology. The Company recognized a $695 noncash after-tax charge as a cumulative effect of change in accounting principle for the write-off
of goodwill related to the open circuit reporting unit. The Company expects the performance of the open circuit business to improve over the next few years as a result of product rationalization and
the moving of manufacturing into lower-cost countries. The Company remains committed to this business. Refer to Note 3 for a summary of changes in goodwill during 2002 and 2003.
During the first quarter of both 2004 and 2003, the Company completed its annual test for potential goodwill impairment consistent with the methodology applied upon adoption in 2002. No additional
impairment was indicated as a result of either test.

The
FASB issued Interpretation (FIN) No. 46R, "Consolidation of Variable Interest Entities" in December 2003, which requires variable interest entities to be consolidated
by the party determined to be the primary beneficiary. A primary beneficiary of a variable interest entity (VIE) is the party that absorbs a majority of the entity's expected losses, receives a
majority of its expected residual returns, or both, as a result of holding the variable interest. The effective date for the adoption of FIN No. 46R for interests in VIEs created prior to
February 1, 2003 is the end of the first quarter, 2004. The adoption of FIN No. 46R is not expected to have a significant effect the Company's financial position or net income. The
effective date for new VIEs created after January 31, 2003 was immediate and the adoption had no effect on the Company's financial statements.

In
January 2004 the FASB issued Staff Position (FSP) 106-1 "Accounting and Disclosure Requirments Related to the Medicare Prescription Drug Improvement and
Modernizaton Act of 2003" (the Act). The FSP permits a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer
accounting for the effects of the Act, which the Company has elected to do. Any measure of the accumulated postretirement benefit liability or net periodic postretirement benefit cost in the financial
statements or Note 9 does not reflect the impact of the Act on the plans. At this time, specific authoritative guidance on the accounting for the federal subsidy provided by the Act is pending
and that guidance could require the Company to modify previously reported information, however the Company does not expect the Act to have a significant effect on its financial statements.

51

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Reclassifications 

Certain previously reported amounts have been reclassified to conform to the current period presentation.

(2) Business Ventures:

On December 30, 1996, the German Holding Company and ZTS, a.s. formed a business venture organized as a Slovakian corporation under the name Sauer ZTS,
a.s. The German Holding Company contributed approximately $5,800 of cash and technology for a 65% interest in Sauer ZTS, a.s. During 1998, the Company contributed an additional $693 to increase its
interest in Sauer ZTS, a.s. to 87.8%. During 2000, the Company contributed $138 to increase its interest in Sauer ZTS, a.s. to 88.4%. During 2001, the Company contributed $1,491 to increase its
interest in Sauer ZTS, a.s. to 89.6% and changed the name of the company to Sauer-Danfoss (Dubnica) a.s. During 2002, the Company contributed $879 to purchase the remaining interest in Sauer-Danfoss
(Dubnica) a.s. The principal business of Sauer-Danfoss (Dubnica) a.s. is the manufacture of high power hydrostatic transmissions. As of December 31, 2003 the Company has merged Sauer-Danfoss
(Dubnica) a.s. with two of its other wholly-owned Slovakian subsidiaries to form Sauer-Danfoss a.s. The Company has consolidated Sauer-Danfoss a.s. into its consolidated financial statements.

On
September 27, 2001, the Company completed the transaction with Daikin Industries, Ltd. to establish two joint venture companies. The two companies, a sales company and a
manufacturing company, operate as part of the Company's global organization covering the Asia-Pacific region. The Company owns 65% of the sales company and 45% of the manufacturing
company. Accordingly,
the Company consolidates the sales company, and accounts for the manufacturing company under the equity method.

Effective
April 1, 2001, the Company entered into an agreement with Topcon Laser Systems, Inc. to create a new joint venture company called TSD Integrated Controls LLC
(TSD), which focuses on the development and marketing of electronic systems used to control the work functions of vehicles. TSD operates out of the Company's Minneapolis, Minnesota, facility and out
of a facility in Pleasanton, California. The Company owns 50.1% of TSD and consolidates TSD into its consolidated financial statements.

(3) Business Combinations:

During the second quarter 2003, the Company exercised its option to acquire an additional 40% of the outstanding shares of Comatrol S.p.A for approximately
$10,300. The Company acquired Comatrol, located in Reggio Emilia, Italy, with 100 employees and approximately $22,000 in annual sales, for its development technology. The Company has consolidated the
financial results of Comatrol since April 2003. Prior to purchasing the controlling interest in Comatrol, the Company accounted for the results of its 45% ownership interest, acquired for
approximately $8,400 in the first quarter 2002, under the equity method of accounting. The combined transactions resulted in $9,431 of goodwill. In addition, values of $3,427 and $592 were assigned to
customer relationships and process technology, respectively, which are being amortized over five and four years, respectively. The Company has the option to acquire the remaining ownership interest
(15%) in Comatrol for approximately 3,700 euros; using an exchange rate of

52

---

0.7950
euros to the U.S. dollar at December 31, 2003 this equates to $4,654. The option period runs from April 1, 2004 through April 30, 2004. Should the Company not elect to
exercise this option, the minority owners of Comatrol could exercise their option requiring the Company to acquire the remaining 15% of Comatrol for the amount disclosed above. This put option period
runs from May 1, 2004 through May 31, 2004. Should the sellers not exercise their put option by May 31, 2004 all options will lapse and the Company will not be required to
purchase any additional ownership interest in Comatrol.

During
the second quarter 2002, the Company acquired the assets of the low-voltage motor business of Thrige Electric to acquire development technology. The acquisition was an
all cash transaction of approximately $17,400 and included factories in Odense, Denmark, Berching, Germany, and Kaiserslautern, Germany. Thrige Electric is engaged in the production of
low-voltage motors and integrated pump, steering or drive units used primarily in mobile machines in the material handling market. Thrige Electric has approximately 450 employees and
annual sales of approximately $50,000. The Company owns 100% of the Thrige Electric operations and has consolidated the financial results of this business since the date of acquisition. The
transaction resulted in $8,291 of goodwill being recognized in 2002. The Company completed the allocation of the purchase
price in 2003, resulting in $2,554 being reclassified from goodwill to customer relationships, which is being amortized over fifteen years and is classified with other intangible assets.

The
changes in the carrying amount of goodwill for the years ended December 31, 2002 and 2003 are as follows:

Propel
Segment

Work Function
Segment

Controls
Segment

TotalBalance as of January 1, 2002

$
28,485

$
17,718

$
42,704

$
88,907Reclassification of established workforce


2,725


1,609


1,757


6,091Goodwill acquired during period








8,291


8,291Impairment losses





(695
)




(695
)Translation adjustment


820


489


1,385


2,694Balance as of December 31, 2002


32,030


19,121


54,137


105,288Goodwill acquired during period








9,431


9,431Reclassify goodwill to other intangible assets








(2,554
)

(2,554
)Translation adjustment


2,139


1,277


4,073


7,489Balance as of December 31, 2003

$
34,169

$
20,398

$
65,087

$
119,654


(4) Restructuring Charges:

During 2003, the Company relocated the operations of its Sturtevant, Wisconsin, and West Branch, Iowa, locations to other existing facilities and outsourced
certain processes to reduce costs and increase

53

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efficiencies.
The Company has also begun to restructure its European sales, marketing, and distribution operations. The following table summarizes the restructuring charges incurred in 2003:

Sturtevant,
Wisconsin

West Branch,
Iowa

European Sales
OperationsEmployee termination costs

$
274

$
589

$
1,195Employee retraining & relocation costs





237


62Property and equipment impairment and loss on disposal


373


3,506


Equipment relocation costs


936


591


Repayment of Job Training Grant





214


Other costs


46


869


64Total

$
1,629

$
6,006

$
1,321


The cost for restructuring in 2003 totaled $8,956 consisting of $3,281, $1,796, and $3,879 included in costs of sales, selling, general and administrative
expenses, and loss on disposal of fixed assets, respectively. The costs related to the Sturtevant and West Branch restructurings are included in the Work Function segment. The charges related to the
European sales and distribution restructuring are allocated to all segments.

The
Sturtevant relocation was completed in June 2003. The West Branch relocation is expected to be completed in early 2004. Future costs expected to be incurred related to the
West Branch relocation are primarily related to remaining employee and equipment moving charges and are estimated to be approximately $700. The Company continues to analyze the details of its European
sales operations restructuring and has not yet committed to a specific action plan.

(5) Inventories:

The composition of inventories is as follows:

December 31,2003

2002Raw materials

$
73,311

$
60,143Work in process


38,862


30,662Finished goods and parts


95,781


82,841LIFO allowance


(9,084
)

(8,960
)Total

$
198,870

$
164,686


54

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(6) Property, Plant and Equipment and Property Held for Disposal:

The cost and related accumulated depreciation of property, plant and equipment are summarized as follows:

December 31,2003

2002 (1)Cost Land and improvements

$
13,547

$
13,663Buildings and improvements


107,646


101,914Machinery and equipment


938,069


842,143Construction in progress


33,342


34,207Plant and equipment under capital leases


16,519


13,935Total cost


1,109,123


1,005,862Less  accumulated depreciation


(656,210
)

(570,760
)Net property, plant and equipment

$
452,913

$
435,102


---

Depreciation
expense for 2003, 2002, and 2001 was $77,584, $68,951, and $62,965, respectively.

In
connection with the West Branch relocation discussed in Note 4 the Company intends to sell the land and building at that location. The Company obtained an independent
third-party appraisal that resulted in recording an impairment charge of approximately $1,500 in 2003. This charge is included in the total loss on disposal of fixed assets on the Consolidated
Statements of Income. At December 31, 2003 the building is included in property, plant and equipment of the Work Function segment but will be reclassified to property held for sale in 2004 when
all operations have been relocated from the property.

During
2001, the Company closed a manufacturing facility in Racine, Wisconsin, as part of a restructuring related to an acquisition. An independent third-party appraisal was obtained in
2000 and the Company adjusted the carrying value of the facility to $6,900 based on the results of the valuation. An appraisal perfomed in 2003 indicated a value in excess of the current carrying
value. The Company also has an undeveloped piece of land in Brooklyn Park, Minnesota, which is classified as held for sale and has a carrying value of approximately $3,000. These two properties are
classified as current assets on the Consolidated Balance Sheets at December 31, 2003 and are included in Global Services for segment reporting. The Racine facility was classified as a current
asset at December 31, 2002 also. The Company is actively pursuing offers to sell these properties, but as of December 31, 2003, no formal offers had been received. Based upon its most
recent analysis, the Company believes that no further impairments existed at December 31, 2003.

55

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(7) Long-Term Debt:

Long-term debt consisted of the following:

December 31,2003

2002Multicurrency Revolving Credit Facility

$
55,068

$
U.S. Revolving Credit Facility





22,050U.S. 1997 Senior Notes, due through 2007


16,000


19,000U.S. 2000 Senior Notes, due through 2010


35,000


35,000U.S. Industrial Development Revenue Bonds, due in 2004


8,530


8,530German Long-Term Bank Facilities maturing through 2018


32,975


52,992Danish Long-Term Bank Facilities, due through 2006


135,602


114,102Other borrowings


6,823


10,609Total debt


289,998


262,283Less  long-term debt due within one year


(159,590
)

(27,085
)Long-term debt

$
130,408

$
235,198


The Company entered into a new multicurrency revolving credit facility in September, 2003 which permits unsecured borrowings up to $250,000 through September,
2006. The proceeds from the new facility were used to repay the outstanding borrowings on the U.S. revolving credit facility and certain other borrowings. Debt issuance costs of approximately $1,800
were capitalized and are being amortized to interest expense over the three-year term of the facility. Borrowings under the agreement bear interest equal to the relevant interbank offering
rate plus a margin ranging from 0.65% to 1.65% (1.15% at December 31, 2003), depending on the Company's ratio of net debt to EBITDA, as defined. The weighted average interest rate on
outstanding borrowings under the multicurrency revolving credit facility was approximately 2.8% at December 31, 2003. The Company is required to pay a commitment fee on the unused portion of
this credit facility. As of December 31, 2003, this fee was 0.52% and the Company had incurred $288 of expense in 2003 as a result of this commitment fee.

Under
the revolving credit agreement, the Company has the option to set up ancillary facilities with syndicate bank members. As of December 31, 2003, $29,787 was borrowed under
these ancillary facilities and is included in the notes payable and bank overdrafts balance of $65,453 at December 31, 2003. The facility includes a material adverse change clause. This clause,
combined with the rollover of borrowings for intervals less than 360 days, requires all borrowings under the facility, including the ancillary facilities, to be classified as current. The
agreement also contains financial covenants relating to the Company's EBITDA to net interest expense and net debt to EBITDA, as defined. The Company was in compliance with the covenants at
December 31, 2003.

On
December 15, 1997, the Company issued $25,000 of 6.68% Senior Notes (1997 Senior Notes), of which $16,000 remains outstanding at December 31, 2003. The 1997 Senior Notes
have remaining annual repayments from December 15, 2004, through December 15, 2007. The 1997 Senior Notes contain certain restrictions and require the maintenance of minimum tangible net
worth and maximum leverage, as defined. At December 31, 2003, the Company was in compliance with these requirements.

56

---

On
October 1, 2000, the Company issued $35,000 of 8.07% Senior Notes (2000 Senior Notes). The 2000 Senior Notes have scheduled annual payments starting on September 30,
2008, through September 30, 2010. The 2000 Senior Notes contain certain restrictions and require the maintenance of certain financial ratios that are similar to the 1997 Senior Notes. At
December 31, 2003, the Company was in compliance with these requirements.

On
May 1, 1996, the Company issued $9,000 of Industrial Development Revenue Bonds (Bonds) in connection with the construction of the West Branch, Iowa facility, of which $8,530
remains outstanding. The Bonds are at variable interest rates. At December 31, 2003 and 2002, the interest rate on the bonds was 1.20% and 1.60%, respectively. The Bonds are secured by a bank
letter of credit, which expires on May 22, 2004. Consequently, the Bonds are classified as current and the Company anticipates repaying the remaining amount outstanding in 2004. The Bonds
contain certain covenants similar to those included in the Senior Notes. At December 31, 2003, the Company was in compliance with these requirements.

The
German Long-Term Bank Facilities represent a series of long-term bank facilities, with an aggregate principal of $32,975 outstanding at December 31,
2003. Interest on these facilities may be either fixed or variable depending on the individual loan. Interest rates range from 2.6% to 6.6% at December 31, 2003. These facilities contain a
variety of repayment schedules and have final maturities ranging from December 2004 through June 2018.

The
Danish Long-Term Bank Facilities represent a series of long-term bank facilities, with an aggregate principal of $135,602 outstanding at December 31,
2003. The Danish Long-Term Facilities require the Company to maintain certain minimum levels of profitability and equity, as defined. The Company was in compliance with the requirements at
December 31, 2003. At December 31, 2003 the interest rate charged on this facility ranges from 4.85% to 5.15%.

Payments
required to be made on long-term debt outstanding as of December 31, 2003, during the years ending 2004 through 2008 and for years thereafter, are $159,590,
$58,204, $12,396, $11,254 $17,209, and $31,345, respectively.

The
Company also maintains revolving credit facilities, notes payable and bankers' acceptances for its European and other operations. At December 31, 2003, accounts receivable,
inventories, property, plant, machinery and equipment in the amount of $12,674 were pledged as collateral under these European and other operations credit facilities.

(8) Pension Benefits:

The Company has noncontributory defined benefit plans covering a significant number of its employees. The benefits under these plans are based primarily on years
of service and compensation levels. The Company's funding policy outside of Germany is to contribute annually an amount that falls within the range determined to be deductible for income tax purposes.
The net pension liabilities reflected in the accompanying consolidated balance sheets result principally from unfunded pension plans of the Company's operations in Germany, where it is common practice
to fund pension obligations at the time payments are made to retirees, and the unfunded portion of the U.S. plan. The measurements for the U.S. pension plan were performed using December 31,
2003 and 2002 data.

57

---

Pension
expense for 2003, 2002, and 2001 for these defined benefit plans consists of the following components:

December 31,2003

2002

2001Service cost

$
4,001

$
3,538

$
3,240Interest cost


9,054


7,919


7,151Expected return on plan assets


(6,811
)

(6,824
)

(6,945
)Amortization of prior service cost


657


562


592Amortization of net loss


630


267


132Amortization of transition obligation








(251
)Net periodic pension expense

$
7,531

$
5,462

$
3,919


The following table sets forth the plans' funded status as of the respective balance sheet dates:

December 31,2003

2002Benefit obligation at January 1

$
(141,676
)
$
(113,703
)Service cost


(4,001
)

(3,538
)Interest cost


(9,054
)

(7,919
)Benefit obligation assumed by acquisition





(1,140
)Plan participant contributions


(479
)

(329
)Plan amendments





(1,276
)Actuarial loss


(10,485
)

(12,592
)Benefit payments


9,334


5,668Effect of exchange rate changes


(9,175
)

(6,847
)Benefit obligation at December 31


(165,536
)

(141,676
)Reconciliation of fair value of plan assetsFair value of plan assets at January 1


83,668


89,502Actual return on plan assets


13,627


(4,756
)Employer contributions


8,295


1,109Effect of exchange rate changes


2,956


2,547Plan participants' contributions


479


329Benefit payments


(8,137
)

(5,063
)Fair value of plan assets at December 31


100,888


83,668Funded status at December 31


(64,648
)

(58,008
)Unrecognized prior service cost


24,464


20,239Unrecognized actuarial (gain) loss


3,792


5,026Net amount recognized

$
(36,392
)
$
(32,743
)


58

---



Amounts
recognized in the balance sheet as of:

December 31,2003

2002Long-term pension liability, net (1)

$
(35,579
)
$
(36,364
)Current pension liability


(7,258
)

(2,147
)Intangible asset


2,394


2,999Accumulated other comprehensive income


4,051


2,769Net amount recognized

$
(36,392
)
$
(32,743
)


---

Significant
assumptions used in determining pension expense and related pension obligations are as follows:

December 31,2003

2002

2001Discount rates United States

6.25
%
7.0
%
7.5
%Germany

5.3-6.0

5.8-6.5

6.5United Kingdom

5.5

5.5

5.8Rates of increase in compensation levels United States

3.5

4.5

4.5Germany

2.5

2.5

2.5United Kingdom

4.0

3.5

3.8Expected long-term rate of return on assets United States

8.5

8.5

8.5United Kingdom

6.0

6.5

6.8


The target asset allocation for the U.S. pension assets, on average, is 60% in equity securities and 40% in fixed income securities. This allocation is expected
to earn an average annual rate of return of approximately 8.5% measured over a planning horizon of twenty years with reasonable and acceptable levels of risk. This expected level will be obtained,
with an allowance for expenses, and cash investments, if equity securities realize an average annual return of 11% and fixed income securities produce an average annual yield of 6%. The target asset
allocation for the U.K. pension assets, on average, is 56% in equity securities, 43% in fixed income securities and 1% in cash. This allocation is expected to earn an average annual rate of return of
approximately 6.0%.

59

---

The
weighted average asset allocations by asset category for the U.S. and U.K. pension plans at December 31 are as follows:

U.S. Plan

U.K. Plan2003

2002

2003

2002Equity securities

50
%
60
%
60
%
58Debt securities

46

39

39

41Other

4

1

1

1Total

100
%
100
%
100
%
100
%


At December 31, 2003 the weighted average asset allocation for the U.K. pension plan was 60%, 39%, and 1% in equity securities, debt securities, and other,
respectively. The Company plans to contribute approximately $7,000 and $930 to the U.S and U.K. pension plans, respectively, in 2004.

(9) Postretirement Benefits Other than Pensions:

The Company provides health benefits for certain retired employees and certain dependents when the employee becomes eligible for these benefits by satisfying plan
provisions that include certain age and service requirements. Health benefits for retirees of non-U.S. operations, where applicable, are provided through government-sponsored plans to
which contributions by the Company are required. The health benefit plans covering certain groups of U.S. employees are contributory, with contributions reviewed annually and adjusted as appropriate.
These plans contain other cost-sharing features such as deductibles and coinsurance. The Company does not pre-fund these plans and has the right to modify or terminate any of
these plans in the future.

The
components of the postretirement benefit expense of the Company-sponsored plans for 2003, 2002, and 2001 were as follows:

2003

2002

2001Service cost

$
539

$
528

$
438Interest cost


1,636


1,476


1,258Net deferral and amortization


322


158


24Postretirement benefit expense

$
2,497

$
2,162

$
1,720


60

---

The funded status of the Company-sponsored plans was as follows:

December 31,2003

2002Reconciliation of benefit obligation:Accumulated postretirement benefit liability at January 1

$
(22,306
)
$
(19,368
)Service cost


(539
)

(528
)Interest cost


(1,636
)

(1,476
)Actuarial gain (loss)


(4,167
)

(2,626
)Benefit payments


1,495


1,692Accumulated postretirement benefit liability at December 31


(27,153
)

(22,306
)Reconciliation of fair value of plan assets:Fair value of plan assets at January 1





Employer contributions


1,495


1,692Benefit payments


(1,495
)

(1,692
)Fair value of plan assets at December 31





Funded status


(27,153
)

(22,306
)Unrecognized actuarial loss


9,374


5,524Postretirement benefit liability

$
(17,779
)
$
(16,782
)


The assumed weighted average annual rate of increase in the per capita cost of medical benefits is 10.0% for 2004 and is assumed to decrease ratably in 2005
through 2009 and remain level at 4.5% thereafter.

U.S.
employees retiring after March 1, 1993, and hired prior to January 1, 1993, will receive the standard health benefits up to age 65 and then will be eligible for a
Medicare reimbursement allowance based on years of service. U.S. employees hired after January 1, 1993, will only be eligible after age 65 for a Medicare reimbursement allowance based on years
of service.

A
one percent increase or decrease in the annual health care trend rates would have increased or decreased the accumulated postretirement benefit obligation at December 31, 2003,
by $2,294, and increased or decreased postretirement benefit expense for 2003 by $259. The weighted average discount rate used to estimate the accumulated postretirement benefit obligation was 6.25%,
7.0%, and 7.5% for 2003, 2002, and 2001, respectively.

The
Company also maintains the Sauer-Danfoss Employees' Savings Plan and the Sauer-Danfoss LaSalle Factory Employee Savings Plan for eligible employees. Company contributions include
both base and matching amounts. The Company contributed approximately $1,900, $1,800, and $1,600 to these plans in 2003, 2002, and 2001, respectively.

61

---

(10) Income Taxes:

The Company's income (loss) before income taxes is as follows:

Years Ended December 31,2003

2002 (1)

2001 (1)United States

$
(26,545
)
$
(2,556
)
$
(8,751
)European and other


37,304


23,478


15,703Total

$
10,759

$
20,922

$
6,952


---

The
Company's primary German operation is treated as a flow-through entity for United States tax purposes. The above analysis of pretax income and the following analysis of
the income tax provision by taxing jurisdiction are therefore not directly related.

The
benefit (expense) for income taxes by taxing jurisdiction location is as follows:

Years Ended December 31,2003

2002 (1)

2001 (1)Current:United StatesFederal

$


$
424

$
6,009State





(966
)

1,026European and other


(8,403
)

(9,498
)

(8,405
)Total current


(8,403
)

(10,040
)

(1,370
)Deferred:United StatesFederal


6,519


1,744


(1,905
)State


1,179


278


(576
)European and other


1,179


801


1,235Total deferred


8,877


2,823


(1,246
)Total income tax benefit (expense)

$
474

$
(7,217
)
$
(2,616
)


---

62

---

A
reconciliation of the U.S. statutory tax rate and effective income tax rate based on the Company's income before income taxes is as follows:

Years Ended December 31,2003 (1)

2002 (1)

2001U.S. statutory tax rate

35.0
%
35.0
%
35.0
%Deferred tax benefit not previously recognized

(17.5
)


(18.2
)Goodwill and nondeductible expenses



2.1

16.5European and Asian locations' losses not tax benefited

3.9

1.8

14.3Taxes on foreign locations' income at rates which differ from the U.S. rate

(13.7
)
(8.4
)
(7.5
)State income taxes

(11.0
)
1.9

(2.9
)Other

(1.2
)
2.1

0.4Effective income tax rate

(4.5
)%
34.5
%
37.6
%


---

The
components of the Company's net deferred tax assets and liabilities, determined on a jurisdictional and entity basis, are attributable to the following:

December 31,2003

2002Assets

Liabilities

Assets

Liabilities (1)Tax loss and tax credit carryforwards

$
41,066

$


$
25,417

$
Internal Revenue Code Section 743 and other tax basis step-ups


1,495





2,205


Deferred compensation, post-retirement medical and accrued pension benefits


11,827


(1,909
)

3,715


7,729Fixed asset basis differences


128


(42,694
)

2,438


(41,009
)Inventory and warranty accruals


8,187


(1,304
)

10,649


(1,031
)Intangible asset fair market value step-up





(7,781
)




(9,679
)Other items


8,796


(2,438
)

4,148


(334
)Gross deferred tax assets/liabilities


71,499


(56,126
)

48,572


(44,324
)Valuation allowance


(25,076
)




(23,648
)

Net deferred tax assets/liabilities


46,423


(56,126
)

24,924


(44,324
)Less-current portion


(7,165
)




(6,853
)

Net deferred tax assets/liabilities, long-term

$
39,258

$
(56,126
)
$
18,071

$
(44,324
)


---

63

---

For
the years ended December 31, 2003 and 2002, the valuation allowance increased by $1,428 and $916, respectively. The increases stem primarily from valuation allowances
established against foreign tax credits generated. Of the U.S. net operating losses, $56,106 was acquired in acquisition; therefore IRC Section 382 will limit the amount of loss that may be
used to offset future taxable income in any one year. To the extent the unrecognized tax benefit of certain acquired net operating loss carryforwards are recognized in the future, the tax benefits of
such recognition will reduce goodwill. At December 31, 2003 and 2002, approximately $16,956 and $17,312 of the valuation allowance related to the acquired net operating loss carryforwards. See
further discussion of the tax return carryforwards below.

As
of December 31, 2003 and 2002, the Company had not provided U.S. federal income taxes on $149,247 and $94,571 of undistributed earnings recorded by certain subsidiaries outside
the United States since these earnings were deemed permanently invested. Although it is not practicable to determine the deferred tax liability on the unremitted earnings, foreign tax credits would be
available to reduce U.S. tax liability if these foreign earnings were remitted.

The
Company had the following tax return carryforwards available to offset future years' taxable income at December 31, 2003:

Amount

Expiration DatesGerman net operating losses

$
74,707

NoneU.S. net operating losses

$
84,023

20042023Other foreign net operating losses

$
10,266

20042013Foreign tax credits (available to offset U.S. taxes)

$
8,539

20052008


The German net operating losses reflected above have reduced U.S. income taxes in prior years due to the treatment of the Company's primary German operations as a
flow-through entity for U.S. tax purposes. Accordingly, no net deferred tax asset has been established for the German loss carryforwards.

The
ultimate realization of net deferred tax assets is dependent upon the generation of future taxable income during (i) the years in which temporary differences reverse and
(ii) the years prior to the expiration of net operating loss and credit carryforwards. Management considers projected future taxable income and tax planning strategies in making this
assessment. Based on these factors, management believes it is more likely than not that the Company will realize benefits of the net deferred tax assets as of December 31, 2003.

The
Internal Revenue Service (IRS) has audited the Company's federal income tax returns for years 1997 through 2001. The Company received notices of proposed tax adjustments for those
years and filed appeals in response to those IRS notices. Final proposed adjustments have been received for these years. Although the outcome of such appeals cannot be predicted with certainty and no
assurances can be given with respect to such appeals, the Company believes that the ultimate outcome of the audit will not have a materially adverse effect on its results of operations, liquidity or
financial position.

64

---

(11) Minority Interests:

Minority interest in net assets and income reflected in the accompanying consolidated financial statements consists of:



The
following tables set forth the components of minority interest in the consolidated balance sheets:

December 31,2003

2002Hydro-Gear Limited Partnership

$
22,250

$
21,739Sauer Shanghai Hydraulic Transmission Company


2,310


3,621Sauer-Danfoss-Daikin, Ltd.


5,270


1,362TSD Integrated Controls LLC


542


396Comatrol S.p.A.


1,981


Total

$
32,353

$
27,118


Until May 3, 2000, the Company was the general partner and 80% owner of the German Operating Company. The Murmann Limited Partners had certain rights,
which included an annual cash payment equal to 7.6% of the income of Sauer Inc. and subsidiaries before taxes and the Murmann Limited Partnership Interests and the right to consent to certain
actions of the German Operating Company. However, the Company had the right to elect by the action of its independent directors or the holders of its common stock other than the Murmann family to
terminate the Murmann Limited Partnership Interests in exchange for 2,250 shares of common stock of Sauer Inc. As such, the Company controlled and consolidated the German Operating Company.

As
a result of the Danfoss Fluid Power acquisition, the Company elected, by the action of its independent directors, to terminate the limited partnership interests. Pursuant to the terms
of the agreement creating the limited partnership, in exchange for the termination of the limited partnership interests, the Company issued 2,250 shares of its common stock and paid the balance of the
current accounts of the Limited Partners of $3,873. The difference between the fair market value of the shares

65

---

issued
and the historical basis of the limited partnership interest was considered to be a deemed dividend of $17,337 under common control accounting. In addition, the agreement required the Company
to pay an amount in cash equal to the income tax payable as a result of the exchange of the shares of common stock of the Company for the limited partnership interests, but not to exceed 11,942 euros,
$15,047 at December 31, 2003, using an exchange rate of 1.26 euros to the U.S. dollar. As of December 31, 2002, the Company had paid $3,254 toward this tax liability. However, as of that
date, the Murmann Limited Partners were in dispute in the German tax courts over the total amount of tax liability related to this transaction. In 2003, the Murmann Limited Partners incurred an
additional tax liability of $621 which the Company, pursuant to the terms of the agreement, paid to the Murmann Limited Partners. The Company recorded this amount as a deemed dividend in 2003.

(12) Long-Term Incentive Plan:

The Company's Long-Term Incentive Plan provides for the grant of stock options, stock appreciation rights, restricted stock, performance units,
performance shares and other incentive awards to officers and key employees and for the reimbursement to certain participants for the personal income tax liability resulting from such awards. The
total number of shares of common stock that may be subject to awards or be issued under the Long-Term Incentive Plan shall not exceed 2,400 shares, of which no more than 1,200 shares may
be issued as restricted stock.

The
Company also has a Nonemployee Director Stock Option and Restricted Stock Plan which permits the granting of non-qualified stock options and restricted common stock to
directors of the Company who are not employees of the Company. The total number of shares of common stock to be issued under this plan shall not exceed 250 shares.

Prior
to 2003, the Company accounted for employee stock awards under the recognition and measurement provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees."
Effective January 1, 2003, the Company adopted the fair value recognition provisions of FASB Statement No. 123 (FAS 123), "Accounting for Stock-Based Compensation" prospectively
to all employee awards granted, modified, or settled after January 1, 2003. Awards previously made under the Non-employee Director Stock Option and Restricted Stock plan vest over a
three-year period and the effect of applying the fair value recognition provisions of FAS 123 are not considered significant. As noted in Note 1 above, the Company has
selected the prospective method under SFAS No. 148 for reporting this change in accounting principle.

On
March 5, 2003, the Board granted approximately 339 stock options to certain members of management. The options become exercisable over a three-year vesting period
with the ultimate number of options granted determined based on the financial performance of the Company over the period as defined in the stock option agreements. These options expire ten years from
the date of grant. At December 31, 2003, these are the only stock options outstanding and none of the options were exercisable. The Company recognizes compensation expense for stock options
over the vesting period based on its best estimate of the number of options that will ultimately vest. Expense recognized in 2003 related to the stock options was $177.

66

---

The
Company utilized the Black-Scholes option-pricing model to determine the fair value of stock options on the date of grant. The following table sets forth key assumptions used in
determining fair value:

Weighted average fair value per share of options granted


$3.55Dividend yield


3.0
%Expected volatility


49
%Risk-free interest rate


3.9
%Expected lives


10 years


During 2003, 2002 and 2001, the Company awarded performance units to employees totaling 306, 242 and 220, respectively. The performance units entitle the
participants to an amount equal to the Company's dividends and vest after three years with the Company recognizing compensation expense over the vesting period.The settlement of performance units is
in shares of company stock or cash as determined by the Board of Directors. Compensation expense for the portion assumed to be settled in cash is adjusted based on fluctuations in the market price of
shares over the vesting period. Compensation expense recognized in conjunction with the performance units outstanding was $368 and $985 in 2003 and 2002, respectively. No compensation expense was
recognized in 2001 based on the Company's estimates of payments on the performance units outstanding.

Under
the Nonemployee Director Stock Option and Restricted Stock Plan the Company awarded 14, 8, and 8 shares of restricted stock to nonemployee directors in 2003, 2002, and 2001,
respectively. The restricted stock awards entitle the participants to full dividend and voting rights. Unvested shares are restricted as to disposition and subject to forfeiture under certain
circumstances. The value of each award was established based on the market value of the stock as of the grant date. The shares vest over three years. Unearned compensation related to the restricted
stock is shown as a reduction of stockholders' equity in the accompanying consolidated balance sheets and is being amortized ratably over the vesting period of the grants. Unearned compensation was
computed based on the market value of the restricted shares. Compensation expense recognized in conjunction with the restricted stock outstanding in 2003, 2002, and 2001 amounted to $98, $71, and $43,
respectively.

(13) Related Party Transactions:

In connection with the acquisition of Danfoss Fluid Power on May 3, 2000, the Company entered into several agreements with Danfoss A/S to purchase
ongoing operational services from Danfoss A/S. These services include rental of shared facilities, administrative support and information technology support. These fees are paid on a monthly
basis. Payments required under these agreements as of December 31, 2003, during the years ending 2004 though 2008 and for years thereafter, are $8,862, $8,742, $8,742, $6,195, $6,145, and
$42,661, respectively. Total expense recognized for goods and services purchased from Danfoss A/S for 2003, 2002, and 2001 was $47,284, $36,899 and $44,157, respectively.

67

---

(14) Commitments, Contingencies, and Guarantees:

The Company leases certain facilities and equipment under operating leases, many of which contain renewal options. Total rental expense on all operating leases
during 2003, 2002, and 2001 was $15,132, $11,513, and $10,457, respectively.

Minimum
future rental commitments under all noncancelable operating leases as of December 31, 2003, during the years ending 2004 through 2008 and for the years thereafter, are
$16,150, $14,784, $13,327, $10,270, $8,923, and $68,650, respectively.

The
Company also leases certain facilities and equipment under capital leases. Minimum future lease payments under all noncancelable capital leases as of December 31, 2003, during
the years ending 2004
through 2008 and for the years thereafter, are $1,367, $1,332, $1,151, $1,146, $1,146, and $16,523, respectively.

The
Company, from time to time, is involved in various legal matters considered normal in the course of its business. The Company intends to vigorously defend against all such claims. It
is the Company's policy to accrue for amounts related to these matters if it is probable that a liability has been incurred and an amount can be reasonably estimated. Although the outcome of such
matters cannot be predicted with certainty and no assurances can be given with respect to such matters, the Company believes that the outcome of these matters in which it is currently involved will
not have a materially adverse effect on its results of operations, liquidity or financial position.

68

---



(15) Quarterly Financial Data (Unaudited):

Summarized quarterly data is set forth in the following table on a restated basis. Gross profit and net income have been restated to give effect to the impact of
expenses discussed in Note 17.

QuarterFirst

Second

Third

Fourth

Total2003Net sales

$
300,425

$
308,462

$
255,370

$
262,517

$
1,126,774Gross profit

$
71,674

$
77,295

$
51,964

$
51,431

$
252,364Net income (loss)

$
10,165

$
11,262

$
(2,229
)
$
(7,965
)
$
11,233Basic and diluted net income (loss) per common share (1)

$
0.21

$
0.24

$
(0.05
)
$
(0.17
)
$
0.242002(as restated  see Note 17)Net sales

$
243,048

$
264,117

$
223,920

$
221,223

$
952,308Gross profit

$
58,932

$
67,984

$
47,474

$
44,602

$
218,992Net income (loss)

$
6,688

$
9,327

$
(586
)
$
(1,724
)
$
13,705Basic and diluted net income (loss) per common share

$
0.14

$
0.20

$
(0.01
)
$
(0.04
)
$
0.29Impact of restatement on:Gross profit


(109
)

(109
)

(109
)

(110
)

(437
)Net income (loss)


(67
)

(67
)

(67
)

(66
)

(267
)Basic and diluted net income (loss) per common share


(0.02
)







(0.01
)

2001(as restated  see Note 17)Net sales

$
261,102

$
221,641

$
183,474

$
189,062

$
855,279Gross profit

$
65,078

$
52,329

$
34,309

$
40,870

$
192,586Net income (loss)

$
12,054

$
4,105

$
(7,729
)
$
(4,094
)
$
4,336Basic and diluted net income (loss) per common share

$
0.26

$
0.09

$
(0.16
)
$
(0.09
)
$
0.09Impact of restatement on:Gross profit


(321
)

(109
)

(109
)

(108
)

(647
)Net income (loss)


(195
)

(67
)

(66
)

(66
)

(394
)Basic and diluted net income (loss) per common share


(0.01
)







(0.01
)

(0.01
)


---

(16) Segment and Geographic Information:

The Company reports its operating segments around its various product lines of Propel, Work Function and Controls. Propel products include hydrostatic
transmissions and related products that transmit the power from the engine to the wheel to propel a vehicle. Work Function products include steering motors as well as gear pumps and motors that
transmit power for the work functions of the

69

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vehicle.
Controls products include electrohydraulic controls, microprocessors, electric motors, and valves that control and direct the power of a vehicle.

The
accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates individual segment performance based on
segment income or loss defined as the respective segment's portion of the total Company's net income, excluding net interest, income taxes, minority interest, and equity in net earnings of affiliates.
The following table presents the significant items by operating segment for the results of operations for the years ended December 31, 2003, 2002 and 2001, respectively:

Propel

Work Function

Controls

Corporate
Function

Total2003Trade sales

$
505,012

$
345,536

$
276,226

$


$
1,126,774Segment income (loss)


50,101


9,287


13,659


(29,483
)

43,564Depreciation expense


33,181


23,500


14,134


6,769


77,584Total assets


375,977


301,066


234,896


189,815


1,101,754Capital expenditures


16,056


18,102


14,634


11,199


59,9912002(as restated  see Note 17)Trade sales

$
440,221

$
294,952

$
217,135

$


$
952,308Segment income (loss)


47,269


19,046


5,804


(22,879
)

49,240Depreciation expense


31,713


19,424


10,899


6,915


68,951Total assets


351,458


264,107


188,291


166,659


970,515Capital expenditures


10,936


17,000


10,581


3,761


42,2782001(as restated  see Note 17)Trade sales

$
399,509

$
268,411

$
187,359

$


$
855,279Segment income (loss)


36,941


8,941


6,575


(20,246
)

32,211Depreciation expense


30,599


17,999


8,353


6,014


62,965Total assets


351,426


251,881


138,640


142,307


884,254Capital expenditures


24,930


25,034


14,047


5,686


69,697


70

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A summary of the Company's net sales and long-lived assets by geographic area is presented below:

Net Sales (1)

Long-Lived Assets (2)2003

2002

2001

2003

2002United States

$
455,520

$
418,692

$
411,881

$
183,609

$
207,344Germany


108,654


87,234


80,080


70,001


61,069Italy


82,663


65,254


55,350


29,397


9,376France


60,963


46,311


44,292


1,080


831United Kingdom


50,420


51,468


47,139


24,196


25,020Japan


43,820


36,184


12,573


608


411Denmark (3)


19,020


15,090


14,678


193,530


177,712Slovakia (3)


1,021


1,063


992


52,669


44,878Other countries


304,693


231,012


188,294


72,404


55,206Totals

$
1,126,774

$
952,308

$
855,279

$
627,494

$
581,847


---

No
single customer accounted for 10% or more of total consolidated sales in any year presented.

(17) Restatement:

The 2002 and 2001 financial statement amounts have been restated due to accounting errors identified during the closing of the Company's West Branch, Iowa,
operations. The errors relate to an unreconciled account and unrecognized depreciation associated with a purchase accounting fair value adjustment related to fixed assets. Both items originated in
2000 in connection with the closing of the Racine, Wisconsin, facility and relocation of its opertions to the West Branch location. The following table presents the impact on net income of the
restatement adjustments for the periods affected:

|                                  |                                           | For the Years Ended December 31, |       
|--------------------------------- | ----------------------------------------- | -------------------------------- | ------
|
|Net income as previously reported |                                           | $                                | 13,972
|Adjustments                       |                                           |                                  |       
|                                  | Depreciation expense                      |                                  |       
|                                  | Expense related to account reconciliation |                                  |       
|                                  | Income tax effect                         |                                  |       
|                                  |                                           |                                  |       
|Restated net income               |                                           | $                                | 13,705
|                                  |                                           |                                  |       

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---

The following table summarizes the impact of the restatement on the financial statements:

|                                                                      |  | As previously reported |       | As restated
|--------------------------------------------------------------------- |  | ---------------------- | ----- | -----------
|
|
|Consolidated Statements of Income:                                    |  |                        |       |            
|Cost of sales                                                         |  | $                      | 732.9 |            
|Total costs and expenses                                              |  |                        | 899.7 |            
|Operating income                                                      |  |                        | 52.6  |            
|Income Before Income Taxes and Minority Interest                      |  |                        | 33.1  |            
|Income Before Income Taxes                                            |  |                        | 22.1  |            
|Income Tax Expense                                                    |  |                        | 7.4   |            
|Net Income Before Cumulative Effect of Change in Accounting Principle |  |                        | 14.7  |            
|Net Income                                                            |  |                        | 14.0  |            
|Basic and diluted income per common share                             |  | $                      | 0.29  |            
|Consolidated Balance Sheet:                                           |  |                        |       |            
|Assets:                                                               |  |                        |       |            
|Other current assets                                                  |  | $                      | 30.0  |            
|Total current assets                                                  |  |                        | 360.7 |            
|Property, Plant and Equipment, net                                    |  |                        | 436.2 |            
|Total Assets                                                          |  |                        | 971.1 |            
|Liabilities and Stockholders' Equity                                  |  |                        |       |            
|Accounts payable                                                      |  |                        | 69.4  |            
|Total current liabilities                                             |  |                        | 214.8 |            
|Deferred income taxes                                                 |  |                        | 44.8  |            
|Total other liabilities                                               |  |                        | 125.0 |            
|Retained earnings                                                     |  |                        | 49.5  |            
|Total stockholders' equity                                            |  |                        | 368.9 |            

72

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Report of Management

The management of Sauer-Danfoss Inc. is responsible for the integrity and objectivity of the financial information presented in this annual report.
Sauer-Danfoss believes that the consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, applying certain
estimates and judgments as required.

Management
of the Company is also responsible for maintaining a system of internal accounting controls and procedures designed to provide reasonable assurance at reasonable cost that
assets are safeguarded against loss or unauthorized use and that financial records are adequate and can be relied upon to produce financial statements in accordance with accounting principles
generally accepted in the United States of America. This system is augmented by written policies and procedures, careful selection and training of financial management personnel, a continuing
management commitment to the integrity of the system, and through examinations by an internal audit department that coordinates its activities with the Company's independent accountants. The Company
is currently in the process of completing the documentation and testing requirements of Section 404 of the Sarbanes-Oxley Act of 2002. The Company anticipates being able to meet these
requirements by the end of 2004.

KPMG
LLP is retained to conduct an audit of the Company's consolidated financial statements in accordance with auditing standards generally accepted in the United States of America and
to provide an independent assessment that helps ensure fair presentation of the Company's consolidated results of operations, financial position, and cash flows.

The
Audit Committee of the Board of Directors is composed entirely of independent outside directors. The Committee meets periodically with management, internal auditors, and the
independent accountants, both separately and jointly, to discuss internal accounting controls and the quality of financial reporting. To ensure complete independence, the internal auditors and
representatives of KPMG LLP have full access to meet with the Audit Committee, with or without management representatives present, to discuss the results of their audits and their opinions on the
adequacy of internal controls and the quality of financial reporting. The Audit Committee has the direct responsiblity for the appointment of the independent accounting firm to be retained for the
coming year, subject to stockholder approval.

|David J. Anderson
President and Chief Executive Officer |  | Karl J. Schmidt
Executive Vice President and
Chief Financial Officer, Treasurer
|------------------------------------------------------- |  | -------------------------------------------------------------------------------

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Independent Auditors' Report

To
the Shareholders of Sauer-Danfoss Inc.:

We
have audited the accompanying consolidated balance sheets of Sauer-Danfoss Inc. (a Delaware corporation) and subsidiaries as of December 31, 2003 and 2002, and the
related consolidated statements of income, stockholders' equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2003. These
consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We
conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sauer-Danfoss Inc. and
subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003
in conformity with accounting principles generally accepted in the United States of America.

As
described in note 12 to the consolidated financial statements, in 2003 the Company changed its method of accounting for stock compensation expense. As described in
note 1 to the consolidated financial statements, in 2002 the Company changed its method of accounting for goodwill and other intangibles.

As
described in note 17 to the consolidated financial statements, the accompanying consolidated balance sheet as of December 31, 2002 and the related consolidated
statements of income, stockholders' equity and comprehensive income and cash flows for each of the years in the two year period ended December 31, 2002 have been restated.

/s/
KPMG LLP

Des
Moines, Iowa
March 11, 2004

74

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Schedule II  Sauer-Danfoss Inc. and Subsidiaries  Valuation and Qualifying Accounts  Years Ended December 31, 2001, 2002, and 2003  (in thousands)

|                                      |  | Balance at
Beginning of
Year |       | Charged to
Costs and
Expenses |       | Receivables
Written Off/Settlement of Claim |        | Balance
Assumed on
Acquisition |     | Foreign
Currency
Translation
Adjustment |     | Balance at
End of
Year
|------------------------------------- |  | ---------------------------- | ----- | ----------------------------- | ----- | ------------------------------------------- | ------ | ------------------------------ | --- | --------------------------------------- | --- | ----------------------
|For the year ended
December 31, 2001: |  |                              |       |                               |       |                                             |        |                                |     |                                         |     |                       
|Allowance for doubtful accounts       |  | $                            | 3,588 |                               | 4,350 |                                             | (2,357 | )                              |    |                                         | (11 | )                     
|For the year ended
December 31, 2002: |  |                              |       |                               |       |                                             |        |                                |     |                                         |     |                       
|Allowance for doubtful accounts       |  | $                            | 5,570 |                               | 103   |                                             | (2,626 | )                              | 132 |                                         | 193 |                       
|For the year ended
December 31, 2003: |  |                              |       |                               |       |                                             |        |                                |     |                                         |     |                       
|Allowance for doubtful accounts       |  | $                            | 3,372 |                               | 497   |                                             | (487   | )                              | 330 |                                         | 432 |                       

75

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Report of KPMG LLP on Financial Statement Schedule

To
the Shareholders of Sauer-Danfoss Inc.:

Under
date of March 11, 2004, we reported on the consolidated balance sheets of Sauer-Danfoss Inc. and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of income, stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2003, which are
included in this Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement
schedule as listed in Item 15.(a)(2) of this Form 10-K. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statement schedule based on our audits.

In
our opinion, the financial statement schedule, when considered in relation to the 2003, 2002, and 2001 basic consolidated financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.

As
described in note 12 to the consolidated financial statements, in 2003 the Company changed its method of accounting for stock compensation expense. As described in
note 1 to the consolidated financial statements, in 2002 the Company changed its method of accounting for goodwill and other intangibles.

As
described in note 17 to the consolidated financial statements, the accompanying consolidated balance sheet as of December 31, 2002 and the related consolidated
statements of income, stockholders' equity and comprehensive income and cash flows for each of the years in the two year period ended December 31, 2002 have been restated.

/s/
KPMG LLP

Des
Moines, Iowa
March 11, 2004

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